Back to GetFilings.com
===============================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003.
-------------------
COMMISSION FILE NUMBER: 0-23336
---------
AROTECH CORPORATION
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 95-4302784
- ------------------------------------------ ---------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
632 BROADWAY, SUITE 1200, NEW YORK, NEW YORK 10012
- -------------------------------------------------- -------------------------
(Address of principal executive offices) (Zip Code)
(646) 654-2107
------------------------------------------------------------------------
(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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
APPLICABLE ONLY TO CORPORATE ISSUERS:
The number of shares outstanding of the issuer's common stock as of October 31,
2002 was 42,724,203.
===============================================================================
AROTECH CORPORATION
INDEX
PART I - FINANCIAL INFORMATION
Item 1 - Interim Consolidated Financial Statements (Unaudited):
- --------------------------------------------------------------
Consolidated Balance Sheets at September 30, 2003 and December 31, 2002........................ 3
Consolidated Statements of Operations for the Nine Months Ended September 30, 2003 and 2002,
and the Three Months Ended September 30, 2003 and 2002..................................... 5
Consolidated Statements of Changes in Stockholders' Equity during the Nine-Month Period Ended
September 30, 2003......................................................................... 6
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2003 and 2002.... 7
Note to the Interim Consolidated Financial Statements.......................................... 9
Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations. 19
- ----------------------------------------------------------------------------------------------
Item 3 - Quantitative and Qualitative Disclosures about Market Risk............................ 43
- -------------------------------------------------------------------
Item 4 - Controls and Procedures............................................................... 43
- --------------------------------
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings..................................................................... 44
- --------------------------
Item 2 - Changes in Securities and Use of Proceeds............................................. 44
- --------------------------------------------------
Item 4 - Submission of Matters to a Vote of Security Holders................................... 45
- ------------------------------------------------------------
Item 5 - Other Information..................................................................... 46
- --------------------------
Item 6 - Exhibits and Reports on Form 8-K...................................................... 46
- -----------------------------------------
SIGNATURES..................................................................................... 47
2
AROTECH CORPORATION
ITEM 1. INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED BALANCE SHEETS
(U.S. DOLLARS)
- --------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 2003 DECEMBER 31, 2002
ASSETS (Unaudited) (Note 1.b.)
CURRENT ASSETS:
Cash and cash equivalents................................................ $ 2,652,943 $ 1,457,526
Certificates of deposit due within one year.............................. 47,531 633,339
Trade receivables, net of allowance for doubtful accounts in the
amount of $41,000 and $40,636 as of September 30, 2003 and December
31, 2002, respectively.............................................. 5,361,487 3,776,195
Other receivables........................................................ 1,250,566 1,032,311
Inventories.............................................................. 1,650,310 1,711,479
Assets of discontinued operations........................................ 52,262 349,774
---------------------- -------------------
TOTAL CURRENT ASSETS........................................... 11,015,099 8,960,624
---------------------- -------------------
SEVERANCE PAY FUND........................................................... 917,898 1,025,071
PROPERTY AND EQUIPMENT, NET.................................................. 2,377,999 2,555,249
GOODWILL..................................................................... 5,087,239 4,954,981
OTHER INTANGIBLE ASSETS, NET................................................. 2,478,696 2,567,457
---------------------- -------------------
$ 21,876,931 $ 20,063,382
====================== ===================
==========================================================================================================================
The accompanying notes are an integral part of the Financial Statements.
3
AROTECH CORPORATION
CONSOLIDATED BALANCE SHEETS
(U.S. DOLLARS, EXCEPT SHARE AND PER SHARE DATA)
- ---------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 2003 DECEMBER 31, 2002
(Unaudited) (Note 1.b.)
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade payables.......................................................... $ 2,647,805 $ 2,900,117
Other accounts payable and accrued expenses............................. 2,515,630 2,009,109
Current portion of promissory note due to purchase of a subsidiary...... 630,940 1,200,000
Short term loans........................................................ 20,046 108,659
Liabilities of discontinued operations.................................. 399,958 1,053,798
---------------------- --------------------
TOTAL CURRENT LIABILITIES.................................................... 6,214,379 7,271,683
LONG TERM LIABILITIES
Accrued severance pay................................................... 2,913,146 2,994,233
Convertible debenture................................................... 1,115,001 -
Promissory note due to purchase of a subsidiary......................... 150,000 516,793
---------------------- --------------------
TOTAL LONG-TERM LIABILITIES.................................................. 4,178,147 3,511,026
MINORITY RIGHTS.............................................................. 73,230 243,172
SHAREHOLDERS' EQUITY:
Share capital -
Common stock - $0.01 par value each;
Authorized: 100,000,000 shares as of September 30, 2003 and December
31, 2002; Issued: 41,420,498 shares as of September 30, 2003 and
35,701,594 shares as of December 31, 2002; Outstanding - 40,865,165
shares as of September 30, 2003 and 35,146,261 shares as of
December 31, 2002................................................... 414,207 357,017
Preferred shares - $0.01 par value each; ...............................
Authorized: 1,000,000 shares as of September 30, 2003 and December
31, 2002; No shares issued and outstanding as of September 30, 2003
and December 31, 2002............................................... - -
Additional paid-in capital 120,105,276 114,082,584
Deferred stock compensation............................................. (12,000) (12,000)
Accumulated deficit..................................................... (104,447,685) (100,673,619)
Treasury stock, at cost (common stock - 555,333 shares as of September
30, 2003 and December 31, 2002) ...................................... (3,537,106) (3,537,106)
Notes receivable from shareholders...................................... (1,198,798) (1,177,589)
Accumulated other comprehensive income (loss)........................... 87,281 (1,786)
---------------------- --------------------
TOTAL SHAREHOLDERS' EQUITY................................................... 11,411,175 9,037,501
---------------------- --------------------
$ 21,876,931 $ 20,063,382
====================== ====================
===========================================================================================================================
The accompanying notes are an integral part of the Financial Statements.
4
AROTECH CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(U.S. DOLLARS, EXCEPT SHARE AND PER SHARE DATA)
- -----------------------------------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, THREE MONTHS ENDED SEPTEMBER 30,
2003 2002 2003 2002
--------------- --------------- ---------------- ----------------
Revenues......................................................... $ 13,232,486 $ 4,258,310 $ 5,705,898 $ 3,262,711
Cost of revenues................................................. 8,365,212 2,428,844 3,252,323 1,668,941
--------------- --------------- ---------------- ----------------
Gross profit..................................................... 4,867,274 1,829,466 2,453,575 1,593,770
Research and development......................................... 762,629 379,785 252,085 161,138
Selling and marketing expenses................................... 2,395,190 712,502 757,614 552,863
General and administrative expenses.............................. 3,579,371 3,347,955 1,105,864 1,378,485
Amortization of intangible assets ............................... 727,127 251,721 103,584 251,721
--------------- --------------- ---------------- ----------------
7,464,317 4,691,963 2,219,147 2,344,207
--------------- --------------- ---------------- ----------------
Operating profit (loss).......................................... (2,597,043) (2,862,497) 234,428 (750,437)
Financial income (expenses), net................................. (1,084,582) 140,017 (100,761) 23,297
--------------- --------------- ---------------- ----------------
Net income (loss) before taxes................................... (3,681,625) (2,722,480) 133,667 (727,140)
Tax expenses..................................................... (308,137) (105,466) (31,089) (104,832)
--------------- --------------- ---------------- ----------------
Net income (loss) before minority interest in income of a
subsidiary.................................................... (3,989,762) (2,827,946) 102,578 (831,972)
Loss (Income) to minority........................................ 134,813 (91,150) (25,485) (91,150)
--------------- --------------- ---------------- ----------------
Net income (loss) from continuing operations..................... $ (3,854,949) $ (2,919,096) $ 77,093 $ (923,122)
Net income (loss) from discontinued operations .................. 80,883 (12,694,639) (2,285) (8,716,422)
--------------- --------------- ---------------- ----------------
Net income (loss) for the period................................. $ (3,774,066) $ (15,613,735) $ 74,808 $ (9,639,544)
=============== =============== ================ ================
Basic net earnings (loss) per share from continuing operations... $ (0.10) $ (0.09) $ 0.00 $ (0.03)
=============== =============== ================ ================
Diluted net earnings (loss) per share from continuing operations. $ (0.10) $ (0.09) $ 0.00 $ (0.03)
=============== =============== ================ ================
Basic and diluted net earnings (loss) per share from
discontinued operations........................................ $ 0.00 $ (0.40) $ (0.00) $ (0.26)
=============== =============== ================ ================
Combined basic net earnings (loss) per share .................... $ (0.10) $ (0.49) $ 0.00 $ (0.29)
=============== =============== ================ ================
Combined diluted net earnings (loss) per share .................. $ (0.10) $ (0.49) $ 0.00 $ (0.29)
=============== =============== ================ ================
Weighted average number of shares used in computing basic net
earnings (loss) per share...................................... 37,276,260 31,545,914 40,371,940 33,441,137
=============== =============== ================ ================
Weighted average number of shares used in computing diluted net
earnings (loss) per share...................................... 37,276,260 31,545,914 47,076,792 33,441,137
=============== =============== ================ ================
===================================================================================================================================
The accompanying notes are an integral part of the Financial Statements.
5
AROTECH CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(U.S. DOLLARS, EXCEPT SHARE AND PER SHARE DATA)
- -----------------------------------------------------------------------------------------------------------------------------
COMMON STOCK ADDITIONAL DEFERRED
--------------------------- PAID-IN STOCK ACCUMULATED TREASURY
SHARES AMOUNT CAPITAL COMPENSATION DEFICIT STOCK
------------ ------------- --------------- ------------ ----------------- ----------------
BALANCE AT JANUARY 1, 2003 - 35,701,594 $ 357,017 $114,082,584 $ (12,000) $(100,673,619) $ (3,537,106)
NOTE 1.b.....................
CHANGES DURING THE NINE-MONTH
PERIOD ENDED SEPTEMBER 30,
2003
Compensation related to
issuance of warrants to
holders of convertible
debentures................ 1,290,000
Compensation related to
beneficial conversion
feature of convertible
debentures................. 600,000
Conversion of convertible
debentures................ 2,358,871 23,589 1,486,088
Exercise of warrants........ 2,357,606 23,576 1,707,157
Shares issued to
consultants and investors. 215,294 2,153 152,178
Compensation related to
options and warrants
issued to consultants and
investors................. 152,844
Employee option exercises... 97,162 972 56,313
Conversion of promissory
note ..................... 563,971 5,640 444,360
Shares issued in connection
with increase in
investment in subsidiary . 126,000 1,260 122,220
Interest accrued on notes
receivable from
shareholders.............. 11,532
Other comprehensive loss -
foreign currency
translation adjustment....
Net loss..................... (3,774,066)
------------ ------------- --------------- ------------ ----------------- ----------------
Total comprehensive loss.....
BALANCE AT SEPTEMBER 30, 2003 -
UNAUDITED..................... 41,420,498 $ 414,207 $120,105,276 $ (12,000) $(104,447,685) $ (3,537,106)
============ ============= =============== ============ ================= ================
AROTECH CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(U.S. DOLLARS, EXCEPT SHARE AND PER SHARE DATA)
- ------------------------------------------------------------------------------------------
ACCUMULATED
NOTES OTHER
RECEIVABLE COMPREHENSIVE TOTAL
FROM INCOME COMPREHENSIVE
SHAREHOLDERS (LOSS) LOSS TOTAL
------------- ------------ -------------- --------------
BALANCE AT JANUARY 1, 2003 -
NOTE 1.b..................... $ (1,177,589) $ (1,786) $ 9,037,501
CHANGES DURING THE NINE-MONTH
PERIOD ENDED SEPTEMBER 30,
2003
Compensation related to
issuance of warrants to
holders of convertible
debentures................ $ 1,290,000
Compensation related to
beneficial conversion
feature of convertible
debentures................. $ 600,000
Conversion of convertible
debentures................ (9,677) $ 1,500,000
Exercise of warrants........ $ 1,730,733
Shares issued to
consultants and investors. $ 154,331
Compensation related to
options and warrants
issued to consultants and
investors................. $ 152,844
Employee option exercises... $ 57,285
Conversion of promissory
note ..................... $ 450,000
Shares issued in connection
with increase in
investment in subsidiary . $ 123,480
Interest accrued on notes
receivable from
shareholders.............. (11,532) -
Other comprehensive loss -
foreign currency
translation adjustment.... 89,067 89,067 89,067
Net loss..................... (3,774,066) $ (3,774,066)
------------- ------------ -------------- --------------
Total comprehensive loss..... (3,684,999)
==============
BALANCE AT SEPTEMBER 30, 2003 -
UNAUDITED.....................$ (1,198,798) $ 87,281 $ 11,411,175
============= ============ ==============
========================================================================================================================
The accompanying notes are an integral part of the Financial Statements.
6
AROTECH CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED) (U.S. DOLLARS)
- --------------------------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30,
2003 2002
-------------------- -------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss for the period................................................... $ (3,774,066) $ (15,613,734)
Net loss (profit) for the period from discontinued operations............. (80,883) 12,694,639
Adjustments required to reconcile net loss to net cash used in operating
activities:
Depreciation............................................................ 529,155 445,270
Amortization of intangible assets....................................... 732,364 251,720
Amortization of deferred financial expenses............................. 1,005,001 -
Amortization of prepaid financial expenses.............................. 236,250 -
Stock-based compensation due to options granted to suppliers and
investors............................................................. 152,844 185,450
Stock-based compensation due to shares granted to suppliers............. 154,331 -
Stock-based compensation due to shares granted to employees............. - 13,000
Profit (Loss) to minority............................................... (134,813) 91,150
Write-off of inventory.................................................. 23,830 -
Impairment of fixed assets.............................................. 62,332 -
Interest (income) expenses accrued on promissory notes due to purchase
of subsidiary......................................................... (35,853) 20,703
Capital gain from sale of property and equipment........................ (3,163) (4,257)
Markdown (Markup) of notes receivable from stockholders................. (12,519) 341,894
Accrued severance pay, net.............................................. 24,984 213,745
Changes in operating asset and liability items:
Increase in trade receivables........................................... (1,495,380) (389,021)
Increase in accounts receivable......................................... (336,839) (101,487)
Increase in software capitalized research and development costs......... (169,548) -
Decrease (Increase) in inventories...................................... 130,404 (409,887)
Increase (Decrease) in trade payables................................... (320,782) 250,611
Increase (Decrease) in accounts payable and accrued expenses............ 444,651 (1,100,395)
-------------------- -------------------
Net cash used in operating activities from continuing operations (2,867,700) (3,110,599)
(reconciled from continuing operations).................................
Net cash used in operating activities from discontinued operations
(reconciled from discontinued operations).............................. (360,502) (5,042,187)
-------------------- -------------------
NET CASH USED IN OPERATING ACTIVITIES..................................... (3,228,202) (8,152,786)
-------------------- -------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Repayment of promissory note related to purchase of subsidiary.......... (750,000) -
Investment in 100-% owned subsidiaries(1)............................... - (2,958,083)
Investment in 51%-owned subsidiary(2)................................... - (1,182,723)
Purchase of intangible assets and inventory............................. (196,331) -
Purchase of property and equipment...................................... (417,530) (226,016)
Loans granted to stockholders, net...................................... (4,457) (4,528)
Proceeds from sale of property and equipment............................ 7,585 4,257
Decrease in demo inventories, net....................................... 8,733 22,332
Decrease (Increase) in certificates of deposit due within one year...... 585,807 (595,386)
Net cash used in discontinued operations................................ - (317,026)
-------------------- -------------------
NET CASH USED IN INVESTING ACTIVITIES..................................... (766,193) (5,257,173)
-------------------- -------------------
FORWARD $ (3,994,395) $ (13,409,959)
-------------------- -------------------
==========================================================================================================================
The accompanying notes are an integral part of the Financial Statements.
7
AROTECH CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED) (U.S. DOLLARS)
- --------------------------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30,
2003 2002
-------------------- -------------------
FORWARD $ (3,994,395) $ (13,409,959)
-------------------- -------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease in short-term credit from banks................................ (93,799) -
Proceeds from issuance of share capital, net............................ - 3,624,698
Proceeds from exercise of options and warrants.......................... 1,788,018 149,997
Payment on capital lease obligation..................................... (343) (1,541)
Convertible debenture received.......................................... 3,500,000 -
-------------------- -------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES.................................... 5,193,876 3,773,154
-------------------- -------------------
DECREASE IN CASH AND CASH EQUIVALENTS........................................ 1,199,481 (9,636,805)
CASH EROSION DUE TO EXCHANGE RATE DIFFERENCES................................ (4,064) -
BALANCE OF CASH AND CASH EQUIVALENTS AT THE BEGINNING OF THE PERIOD.......... 1,457,526 12,671,754
-------------------- -------------------
BALANCE OF CASH AND CASH EQUIVALENTS AT THE END OF THE PERIOD................ $ 2,652,943 $ 3,034,949
==================== ===================
SUPPLEMENTARY INFORMATION ON ACTIVITIES NOT INVOLVING CASH FLOW:
Issuance of share capital (including additional paid-in capital) in respect
of notes receivable........................................................ $ - $ 85,055
==================== ===================
Exercise of options and warrants against notes receivable.................... $ - $ 73,000
==================== ===================
Declared dividend not yet paid to minority................................... $ - $ 410,328
==================== ===================
Purchase of intangible assets against notes receivable....................... $ 300,000 $ -
==================== ===================
Increase of investment in subsidiary against shares of common stock.......... $ 123,480 $ -
==================== ===================
Conversion of promissory note to shares of common stock...................... $ 450,000 $ -
==================== ===================
Conversion of convertible debenture to shares of common stock................ $ 1,500,000 $ -
==================== ===================
Benefit due to convertible debentures and warrants........................... $ 1,890,000 $ -
==================== ===================
- -------------------
(1) In July 2002, the Company acquired substantially all of the assets of
I.E.S. Electronics Industries U.S.A., Inc. ("IES"). The net fair value of
the assets acquired and the liabilities assumed, at the date of
acquisition, was as follows:
The accompanying notes are an integral part of the Financial Statements.
8
AROTECH CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED) (U.S. DOLLARS)
- ------------------------------------------------------------------------------------------
Working capital, excluding cash and cash equivalents $ 1,197,000
(unaudited)...........................................
Fixed assets (unaudited).............................. 396,776
Capital lease obligation (unaudited).................. (15,526)
Intangible assets (unaudited)......................... 6,694,726
In-process research and development (unaudited)....... 26,000
--------------------
8,298,976
Issuance of shares, net (unaudited)................... (3,653,929)
Issuance of promissory note (unaudited)............... (1,686,964)
--------------------
$ 2,958,083
====================
(2) In July 2002, the Company acquired 51% of the outstanding ordinary shares
of MDT Protective Industries Ltd. ("MDT"). The net fair value of the assets
acquired was as follows :
Working capital, excluding cash and cash equivalents $ 443,631
(unaudited)...........................................
Fixed assets (unaudited).............................. 139,623
Minority rights (unaudited)........................... (319,175)
Intangible assets (unaudited)......................... 1,357,721
--------------------
1,621,800
Issuance of shares, net (unaudited)................... (439,077)
--------------------
$ 1,182,723
====================
==========================================================================================
The accompanying notes are an integral part of the Financial Statements.
9
AROTECH CORPORATION
NOTE TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1: BASIS OF PRESENTATION
a. Company:
Arotech Corporation, formerly known as Electric Fuel Corporation ("Arotech" or
the "Company"), and its subsidiaries are engaged in the design, development and
commercialization of its proprietary zinc-air battery technology for defense and
security products, military applications and electric vehicles. The Company is
primarily operating through Electric Fuel Ltd. ("EFL") a wholly-owned subsidiary
based in Beit Shemesh, Israel, through IES Interactive Training Systems, Inc., a
wholly-owned subsidiary based in Littleton, Colorado, through Electric Fuel
Battery Corporation, a wholly-owned subsidiary based in Auburn, Alabama, through
M.D.T. Protective Industries, Ltd., a majority-owned subsidiary based in Lod,
Israel, and through MDT Armor Corp., a majority-owned subsidiary based in
Auburn, Alabama. The Company's production facilities are primarily located in
Auburn, Alabama, and its research and development operations are primarily
located in Israel.
b. Basis of presentation:
The accompanying interim consolidated financial statements have been prepared by
Arotech Corporation in accordance with generally accepted accounting principles
in the United States and the rules and regulations of the Securities and
Exchange Commission, and include the accounts of Arotech Corporation and its
subsidiaries. Certain information and footnote disclosures, normally included in
financial statements prepared in accordance with generally accepted accounting
principles in the United States, have been condensed or omitted pursuant to such
rules and regulations. In the opinion of the Company, the unaudited financial
statements reflect all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation of the financial position at
September 30, 2003 and the operating results and cash flows for the nine months
ended September 30, 2003 and 2002.
The results of operations for the nine months ended September 30, 2003 are not
necessarily indicative of results that may be expected for any other interim
period or for the full fiscal year ending December 31, 2003.
The balance sheet at December 31, 2002 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.
c. Accounting for stock-based compensation:
The Company has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB No. 25") and FASB No.
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation" ("FIN No. 44") in accounting for its employee stock option plans.
Under APB No. 25, when the exercise price of the Company's stock options is less
than the market price of the underlying shares on the date of grant,
compensation expense is recognized.
Under Statement of Financial Accounting Standard No. 123 "Accounting for
Stock-Based Compensation ("SFAS No. 123"), pro forma information regarding net
income and net earnings per share is required, and has been determined as if the
Company had accounted for its employee stock options under the fair value method
10
AROTECH CORPORATION
of SFAS No. 123. The fair value for these options is amortized over their
vesting period and estimated at the date of grant using a Black-Scholes Option
Valuation Model with the following weighted-average assumptions for the nine and
three months ended September 30, 2003 and 2002:
NINE MONTHS ENDED SEPTEMBER 30, THREE MONTHS ENDED SEPTEMBER 30,
------------------------------- --------------------------------
2003 2002 2003 2002
--------------- ------------ -------------- --------------
(Unaudited)
Risk free interest 1% 2% 1% 2%
Dividend yields 0% 0% 0% 0%
Volatility 0.69 0.643 0.69 0.643
Expected life 4 4 4 4
Pro forma information under SFAS No. 123:
NINE MONTHS ENDED SEPTEMBER 30, THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------- --------------------------------
2003 2002 2003 2002
Unaudited
(U.S. Dollars, except per share data)
-------------------------------------------------------------------
Net income (loss) as reported $ (3,774,066) $ (15,613,735) $ 74,808 $ 9,639,544
=============== =============== =============== ===============
Add: Stock-based compensation expense $ (2,073,362) $ (1,745,999) $ (660,205) $ (504,882)
determined under fair value method for
all awards, net of related tax effects
=============== =============== =============== ===============
Pro forma net loss $ (5,847,428) $ (17,359,734) $ (585,397) $ (10,144,426)
=============== =============== =============== ===============
Basic loss per share, as reported $ (0.10) $ (0.49) $ 0.00 $ (0.29)
=============== =============== =============== ===============
Diluted loss per share, as reported $ (0.10) $ (0.49) $ 0.00 $ (0.29)
=============== =============== =============== ===============
Pro forma basic and diluted loss per share $ (0.16) $ (0.55) $ (0.01) $ (0.30)
=============== =============== =============== ===============
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. Inventories are
composed of the following:
SEPTEMBER 30, 2003 DECEMBER 31, 2002
------------------ -----------------
(Unaudited) (Note 1.b.)
Raw materials................... $ 953,148 $ 893,666
Work-in-progress................ 184,667 296,692
Finished goods.................. 512,495 521,121
------------------ -----------------
$ 1,650,310 $ 1,711,479
================== =================
NOTE 3: IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN No. 46") which clarifies the application of
Accounting Research Bulletin (ARB) No. 51, "Consolidated Financial Statements,"
relating to consolidation of certain entities. First, FIN No. 46 will require
identification of the Company's participation in variable interest entities
(VIEs), which are defined as entities with a level of invested equity that is
not sufficient to fund future activities to permit them to operate on a
11
AROTECH CORPORATION
stand-alone basis, or whose equity holders lack certain characteristics of a
controlling financial interest. Then, for entities identified as VIEs, FIN No.
46 sets forth a model to evaluate potential consolidation based on an assessment
of which party to the VIE, if any, bears a majority of the exposure to its
expected losses, or stands to gain from a majority of its expected returns. FIN
No. 46 is effective for all new VIEs created or acquired after January 31, 2003.
For VIEs created or acquired prior to February 1, 2003, the provisions of FIN
No. 46 must be applied for the first interim or annual period beginning after
December 15, 2003. FIN No. 46 also sets forth certain disclosures regarding
interests in VIEs that are deemed significant, even if consolidation is not
required. The Company does not expect the adoption of FIN No. 46 will have a
material impact on its results of operations or financial position.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" ("SFAS No. 149"). SFAS No. 149
amends and clarifies the accounting for derivative instruments, including
certain derivative instruments embedded in other contracts, and for hedging
activities under SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities." SFAS No. 149 is generally effective for contracts entered
into or modified after June 30, 2003 and for hedging relationships designated
after June 30, 2003. The Company does not expect the adoption of SFAS No. 149
will have a material impact on its results of operations or financial position.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS No.
150"). SFAS No. 150 requires that certain financial instruments, which under
previous guidance were accounted for as equity, must now be accounted for as
liabilities. The financial instruments affected include mandatory redeemable
stock, certain financial instruments that require or may require the issuer to
buy back some of its shares in exchange for cash or other assets and certain
obligations that can be settled with shares of stock. SFAS No. 150 is effective
for all financial instruments entered into or modified after May 31, 2003 and
must be applied to the Company's existing financial instruments effective July
1, 2003, the beginning of the first fiscal period after June 15, 2003. The
adoption of SFAS No. 150 is not expected to have a material effect on the
Company's financial position, results of operations or cash flows.
NOTE 4: SEGMENT INFORMATION
a. General:
The Company and its subsidiaries operate primarily in two business segments and
follow the requirements of SFAS No. 131.
The Company previously managed its business in three reportable segments
organized on the basis of differences in its related products and services. With
the discontinuance of Consumer Batteries segment and acquiring two subsidiaries
during 2002, two reportable segments remain: Electric Fuel Batteries, and
Defense and Security Products. As a result the Company reclassified information
previously reported in order to comply with new segment reporting.
The Company's reportable operating segments have been determined in accordance
with the Company's internal management structure, which is organized based on
operating activities. The accounting policies of the operating segments are the
same as those of the Company. The Company evaluates performance based upon two
12
AROTECH CORPORATION
primary factors, one is the segment's operating income and the other is based on
the segment's contribution to the Company's future strategic growth.
b. The following is information about reported segment revenues, income (losses)
and assets for the nine and three months ended September 30, 2003 and 2002 (in
U.S. Dollars):
ELECTRIC FUEL DEFENSE AND
BATTERIES SECURITY PRODUCTS ALL OTHER TOTAL
----------------- ---------------- ----------------- -----------------
NINE MONTHS ENDED SEPTEMBER 30, 2003
Revenues from outside customers $ 4,697,143 $ 8,535,343 $ - $ 13,232,486
Depreciation expenses and amortization (339,572) (773,710) (143,000) (1,256,282)
Direct expenses (1) (4,339,425) (7,974,297) (2,440,156) (14,753,878)
----------------- ---------------- ----------------- -----------------
Segment gross profit (loss) $ 18,146 $ (212,664) $ (2,583,156) (2,777,674)
================= ================ =================
Financial expense (after deduction of
minority interest) (1,077,275)
-----------------
Net loss from continuing operations $ (3,854,949)
=================
Segment assets (2) $ 1,404,092 $ 8,145,087 $ 394,755 $ 9,943,934
================= ================ ================= =================
NINE MONTHS ENDED SEPTEMBER 30, 2002
Revenues from outside customers $ 1,617,310 $ 2,641,000 $ - $ 4,258,310
Depreciation expenses and amortization (233,000) (261,341) (172,000) (666,341)
Direct expenses (1) (1,941,196) (2,182,724) (2,522,908) (6,646,828)
----------------- ---------------- ----------------- -----------------
Segment gross profit (loss) $ (556,886) $ 196,935 $ (2,694,908) (3,054,859)
================= ================ =================
Financial income (after deduction of
minority interest) 135,763
-----------------
Net loss from continuing operations $ (2,919,096)
=================
THREE MONTHS ENDED SEPTEMBER 30, 2003
Revenues from outside customers $ 1,844,061 $ 3,861,837 $ - $ 5,705,898
Depreciation expenses and amortization (113,524) (122,814) (48,000) (284,338)
Direct expenses (1) (1,580,982) (2,863,475) (799,279) (5,243,736)
----------------- ---------------- ----------------- -----------------
Segment gross profit (loss) $ 149,555 $ 875,548 $ (847,279) 177,824
================= ================ =================
Financial expense (after deduction of
minority interest) (100,731)
-----------------
Net profit from continuing operations $ 77,093
=================
THREE MONTHS ENDED SEPTEMBER 30, 2002
Revenues from outside customers $ 621,711 $ 2,641,000 $ - $ 3,262,711
Depreciation expenses and amortization (75,000) (261,341) (55,000) (391,341)
Direct expenses (1) (928,830) (2,182,724) (701,982) (3,813,536)
----------------- ---------------- ----------------- -----------------
Segment gross profit (loss) $ (382,119) $ 196,935 $ (756,982) (942,166)
================= ================ =================
Financial income (after deduction of
minority interest) 19,044
-----------------
Net loss from continuing operations $ (923,122)
=================
- -------------------------------------
(1) Including sales and marketing, general and administrative and tax
expenses.
(2) Consisting of property and equipment and intangible assets.
NOTE 5: NET EARNINGS (LOSS) PER SHARE
Basic net earnings (loss) per share are computed based on the weighted average
number of shares of Common Stock outstanding during the period. For the same
periods, diluted net earnings (loss) per share further include the effect of
dilutive stock options outstanding during the period, all in accordance with
SFAS No. 128, "Earnings per Share." The following table sets forth the
computation of basic and diluted net earnings (loss) per share (in U.S.
dollars):
13
AROTECH CORPORATION
NINE MONTHS ENDED SEPTEMBER 30, THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------- --------------------------------
2003 2002 2003 2002
Unaudited
1) NUMERATOR: (U.S. Dollars, except share and per share data)
-------------------------------------------------------------------
Net income (loss) $ (3,774,066) $ (15,613,735) $ 74,808 $ (9,639,544)
Effect of dilutive securities:
Interest expenses attributable to
convertible debentures * - - 78,750 -
--------------- --------------- --------------- --------------
Numerator for combined diluted net
earnings (loss) per share (3,774,066) (15,613,735) 153,558 (9,639,544)
=============== =============== =============== ==============
Net income (loss) from continuing operations (3,854,949) (2,919,096) 77,093 (923,122)
Effect of dilutive securities:
Interest expenses attributable to
convertible debentures * - - 78,750 -
--------------- --------------- --------------- --------------
Numerator for diluted net earnings (loss)
per share from continuing operations (3,854,949) (2,919,096) 155,843 (923,122)
=============== =============== =============== ==============
Net income (loss) from discontinued
operations 80,833 (12,694,639) (2,285) (8,716,422)
=============== =============== =============== ==============
2) DENOMINATOR:
Weighted average number of shares of Common
Stock outstanding during the period
used to compute basic net earnings (loss) per
share 37,276,260 31,545,914 40,371,940 33,441,137
Incremental shares attributable to exercise
of outstanding options and warrants
(assuming proceeds would be used to
purchase Treasury Stock) ** - - 3,300,856 -
--------------- --------------- --------------- --------------
Incremental shares attributable to
convertible debentures (assuming
if-converted method) *** - - 3,403,996 -
--------------- --------------- --------------- --------------
Weighted average number of shares of Common
Stock used to compute diluted net earnings
(loss) per share 37,276,260 31,545,914 47,076,792 33,441,137
=============== =============== =============== ==============
- -------------------------------------
* The effect of inclusion of the interest of the convertible debentures in
the nine months ended at September 30, 2003 would have been antidilutive.
** The effect of inclusion of options and warrants in the nine months ended at
September 30, 2003 and 2002 and the three months ended at September 30,
2002 would have been antidilutive.
*** The effect of inclusion of convertible debentures in the nine months ended
at September 30, 2003 would have been antidilutive.
NOTE 6: CONVERTIBLE DEBENTURES AND WARRANTS
a. Debentures:
Pursuant to the terms of a Securities Purchase Agreement (the "SPA") dated
December 31, 2002, the Company issued and sold to a group of institutional
investors 9% secured convertible debentures due September 30, 2005
("Debentures") in an aggregate principal amount of $3.5 million. The Debentures
were convertible at any time prior to September 30, 2005 at a conversion price
14
AROTECH CORPORATION
of $0.75 per share. In April 2003, this conversion price was amended to $0.64
per share, and the Debentures became convertible into a maximum of 5,468,750
shares of common stock.
In June 2003, a total of $1,500,000 principal amount of debentures was converted
at a conversion price of $0.64 per share. No debenture conversion occurred
during the third quarter of 2003.
In determining whether the Debentures include a beneficial conversion option in
accordance with EITF 98-5, "Accounting for Convertible Securities with
Beneficial Conversion Features or Continently Adjustable Conversion Ratios," and
EITF 00-27, "Application of Issue No. 98-5 to Certain Convertible Instruments,"
the total proceeds were allocated to the Debentures and the detachable warrants
based on their related fair values. The fair value of these warrants was
determined using Black-Scholes pricing model, assuming a risk-free interest rate
of 3.5%, a volatility factor 64%, dividend yields of 0% and a contractual life
of five years.
In connection with these Debentures, the Company recorded beneficial conversion
feature of approximately $600,000 and in connection with the warrants, the
Company recorded financial expenses of approximately $1,290,000. The total of
$1,890,000 is amortized ratably over the life of the Debentures until September
30, 2005.
The Debentures are presented in the balance sheet as follows (U.S. Dollars):
SEPTEMBER 30, 2003
--------------------
(Unaudited)
Original principle amount....................................... $ 3,500,000
Amount converted into shares.................................... (1,500,000)
Compensation related to issuance of warrants and debenture...... (1,890,000)
Financial expenses related to amortization of compensation...... 1,005,001
--------------------
Total debentures, net........................................... $ 1,115,001
====================
b. Warrants:
As part of the SPA referred to above, the Company issued to the purchasers of
its Debentures an aggregate of 3,500,100 warrants ("Warrants"), exercisable at
prices ranging from $0.84 to $0.93. In April 2003, the Company amended the
Warrants to adjust their exercise prices to $0.64.
In May and June 2003, warrants to purchase a total of 1,957,606 shares of common
stock, having an aggregate exercise price of $1,425,232, were exercised. An
aggregate of 1,000,029 of these warrant were Warrants issued in connection with
the issuance of the Debentures, and were exercised at their exercise price of
$0.64 per share. The remaining 957,577 of these warrants had originally been
issued in May 2001 at an exercise price of $3.22 per share, but were repriced
immediately prior to exercise to $0.82 per share. In connection with this
repricing, the holders of these 957,577 warrants received an aggregate of
638,385 new five-year warrants to purchase shares at an exercise price of $1.45
per share and exercisable after December 31, 2004. As a result of this repricing
and the issuance of those new warrants, the Company recorded a compensation
expense in the amount of approximately $46,000 in the third quarter of 2003.
In July 2003, warrants to purchase a total of 400,000 shares of common stock,
having an aggregate exercise price of $328,000, were exercised. These warrants
had originally been issued in May 2001 at an exercise price of $3.22 per share,
but were repriced immediately prior to exercise to $0.82 per share. In
connection with this repricing, the holders of these 400,000 warrants received
an aggregate of 266,667 new five-year warrants to purchase shares at an exercise
15
AROTECH CORPORATION
price of $1.45 per share and exercisable after January 1, 2004. As a result of
this repricing and the issuance of these new warrants, the Company recorded a
compensation expense in the amount of approximately $77,000 in the third quarter
of 2003.
NOTE 7: CONTINGENCIES
The Company has received a letter from the Israel Investment Center alleging,
without any specifics, that the Company has not abided by the terms of certain
of the Company's grants from them. The Investment Center accordingly cancelled
the Company's "approved enterprise" status in connection with a portion of the
Company's existing facilities, but agreed that it would not seek return of any
grants issued in the past.
While continuation of the Company's "approved enterprise" status would have
given the Company certain tax benefits, inasmuch as the Company has a
substantial loss carryforward, the Company does not believe that the
cancellation of its "approved enterprise" status will have any material adverse
effect on it.
NOTE 8: RECENT DEVELOPMENTS
a. Acquisition of an additional interest in MDT:
In September 2003, the Company increased its holdings in both of its vehicle
armoring subsidiaries. The Company now holds 88% of MDT Armor Corporation
(compared to 76% before this transaction) and 75.5% of MDT Protective Industries
Ltd. (compared to 51% before this transaction). The Company acquired the
additional stake in MDT from AGA Means of Protection and Commerce Ltd. in
exchange for the issuance to AGA of 126,000 shares of its common stock, valued
at $0.98 per share based on the closing price of the Company's common stock on
the closing date of September 4, 2003, or a total of $123,480. Of this amount, a
total of $75,941 was allocated to intangible assets. The Company did not obtain
a valuation due to the immaterial nature of this acquisition.
b. Acquisition of certain assets of Bristlecone:
In September 2003, the Company's IES subsidiary purchased selected assets of
Bristlecone Corporation. The assets purchased consisted of inventories, customer
lists, and certain other assets (including intangible assets such as
intellectual property and customer lists), including the name "Bristlecone
Training Products" and the patents for the Heads Up Display (HUD) and a remote
trigger device, used by Bristlecone in connection with its designing and
manufacturing firearms training devices, for a total consideration of $183,688
in cash and $300,000 in promissory notes, payable in four equal semi-annual
payments of $75,000 each, to become due and payable on March 1, 2004, August 31,
2004, February 28, 2005 and August 31, 2005. The acquired patents are used in
the IES's Range FDU (firearm diagnostics unit).
The purchase consideration was estimated as follows:
U.S. Dollars
-------------------
Cash consideration $ 33,668
183,688
Present value of promissory notes 289,333
Transaction expenses 12,643
-------------------
Total consideration $ 485,664
===================
16
AROTECH CORPORATION
Based upon a preliminary valuation of tangible and intangible assets acquired,
the Company has allocated the total cost of the acquisition of Bristlecone's
assets as follows (in U.S. Dollars):
SEPTEMBER 30, 2003
-------------------
Tangible assets acquired $ 33,668
33,668
Intangible assets
Technology and patents 436,746
Customer list 15,250
-------------------
Total consideration $ 485,664
===================
The Company believes that the acquisition of Bristlecone is not material to its
business.
NOTE 9: SUBSEQUENT EVENTS
a. Exercise of warrants:
In October 2003, warrants to purchase a total of 500,013 shares of common stock,
having an aggregate exercise price of $320,008, were exercised. These warrant
were Warrants issued in connection with the issuance of the Debentures, and were
exercised at their exercise price of $0.64 per share.
b. Debenture conversion:
In October 2003, a total of $850,000 principal amount of debentures was
converted into an aggregate of 1,328,125 shares of our common stock at a
conversion price of $0.64 per share.
c. Sale of debentures:
Pursuant to the terms of a Securities Purchase Agreement dated September 30,
2003 (the "Purchase Agreement") by and between the Company and six institutional
investors (the "Investors"), the Company issued and sold to the Investors (i) an
aggregate principal amount of $5,000,000 in 8% secured convertible debentures
due September 30, 2006 (the "Initial Debentures"), convertible into shares of
the Company's common stock at any time after January 1, 2004 at a conversion
price of $1.15 per share, and (ii) three-year warrants to purchase up to an
aggregate of 1,250,000 shares of the Company's common stock at any time after
January 1, 2004 (the "Initial Warrants") at an exercise price of $1.4375 per
share.
The Investors also have the right, at their option, at any time prior to
September 30, 2006, to purchase up to an additional $6,000,000 in debentures
(the "Additional Debentures" and, together with the Initial Debentures, the
"Debentures") convertible into shares of the Company's common stock at any time
after January 1, 2004 at a conversion price of $1.45 per share, and to receive
warrants to purchase up to an aggregate of 1,500,000 shares of the Company's
common stock at any time after January 1, 2004 (the "Additional Warrants" and,
together with the Initial Warrants, the "Warrants") at an exercise price of
$1.8125 per share.
Under the terms of the Debentures and Notes, the Company is not obligated to
issue shares of its common stock upon conversion of a Debenture or exercise of a
Warrant if the issuance of such shares of common stock would exceed that number
of shares of common stock that the Company may issue without breaching the
Company's obligations under applicable Nasdaq Marketplace Rules unless and until
the Company obtains the approval of its shareholders to the extent required by
applicable Nasdaq Marketplace Rules.
17
AROTECH CORPORATION
d. Litigation:
In October 2003, I.E.S. Group, the parent company of IES Electronics Industries
Ltd., the seller from which the Company purchased the assets of its IES
subsidiary, filed a lawsuit in Tel-Aviv District Court against the Company and
certain of its past and present officers. The complaint alleges breaches by the
Company of certain of its agreements with IES Electronics Industries Ltd. and
claims monetary damages in the amount of approximately $3 million. The Company
believes that the lawsuit brought by the I.E.S. Group is without merit and
intends to fully and completely defend the claims vigorously. Although there can
be no assurance, management of the Company does not believe it has any material
exposure in this matter.
18
AROTECH CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following Management's Discussion and Analysis of Financial
Condition and Results of Operations contains forward-looking statements that
involve inherent risks and uncertainties. When used in this discussion, the
words "believes," "anticipated," "expects," "estimates" and similar expressions
are intended to identify such forward-looking statements. Such statements are
subject to certain risks and uncertainties that could cause actual results to
differ materially from those projected. Readers are cautioned not to place undue
reliance on these forward-looking statements, which speak only as of the date
hereof. We undertake no obligation to publicly release the result of any
revisions to these forward-looking statements that may be made to reflect events
or circumstances after the date hereof or to reflect the occurrence of
unanticipated events. Our actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors
including, but not limited to, those set forth elsewhere in this report. Please
see "Risk Factors," below, and in our other filings with the Securities and
Exchange Commission.
Arotech(TM) is a trademark and Electric Fuel(R) is a registered
trademark of Arotech Corporation. All company and product names mentioned may be
trademarks or registered trademarks of their respective holders. Unless the
context requires otherwise, all references to us refer collectively to Arotech
Corporation and Arotech's wholly-owned Israeli subsidiary, Electric Fuel
(E.F.L.) Limited (EFL), its majority-owned Israeli subsidiary, MDT Protective
Industries Ltd., and its wholly-owned Delaware subsidiaries, Electric Fuel
Transportation Corp. and IES Interactive Training, Inc.
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.
GENERAL
We are a world leader in primary and refuelable Zinc-Air fuel cell
technology, engaging directly and through our subsidiaries in the use of
Zinc-Air battery technology for defense and security products and other military
applications and for electric vehicles, in car armoring, and in interactive
multimedia use-of-force simulators. We operate in two business units:
>> we develop, manufacture and market defense and security
products, including advanced hi-tech multimedia and
interactive digital solutions for training of military, law
enforcement and security personnel, sophisticated lightweight
materials and advanced engineering processes to armor
vehicles, and homeland security consulting and other services;
and
>> we pioneer advancements in Zinc-Air battery technology for
defense and security products and other military applications
and for electric vehicles.
19
AROTECH CORPORATION
We incurred significant operating losses for the years ended December
31, 2000, 2001 and 2002 and the first nine months of 2003. While we expect to
continue to derive revenues from the sale of defense and security products that
we manufacture (directly and through our subsidiaries) and from components of
the Electric Fuel Electric Vehicle System, there can be no assurance that we
will be able to maintain profitability.
BACKGROUND
We began work in 1990 on the research, development and
commercialization of an advanced Zinc-Air battery system for powering electric
vehicles, work that continues to this day. Beginning in 1998, we also began to
apply our Zinc-Air fuel cell technology to the defense industry, by receiving
and performing a series of contracts from the U.S. Army's
Communications-Electronics Command (CECOM) to develop and evaluate advanced
primary Zinc-Air fuel cell packs. This effort culminated in 2002 in our receipt
of a National Stock Number, a Department of Defense catalog number assigned to
products authorized for use by the U.S. military, and our subsequent receipt of
$2.5 million and $1.6 million delivery orders for our newly designated BA-8180/U
military batteries.
We further enhanced our capabilities in the defense industry through
our purchase in the third quarter of 2002 of two new subsidiaries: IES
Interactive Training, Inc., which provides specialized "use of force" training
for police, homeland security personnel and the military, and MDT Protective
Industries Ltd., which is engaged in the use of sophisticated lightweight
materials and advanced engineering processes to armor vehicles.
Between 1998 and 2002, we were also engaged in the design, development
and commercialization of our proprietary Zinc-Air fuel cell technology for
portable consumer electronic devices such as cellular telephones, PDAs, digital
cameras and camcorders. In October 2002, we discontinued retail sales of our
consumer battery products because of the high costs associated with consumer
marketing and low volume manufacturing.
We were incorporated in Delaware in 1990 under the name "Electric Fuel
Corporation." We changed our name to "Arotech Corporation" in September 2003.
DEFENSE AND SECURITY PRODUCTS
Interactive Use-of-Force Training
Through our wholly-owned subsidiary, IES Interactive Training, Inc.
(IES), we provide specialized "use of force" training for police, homeland
security personnel and the military. We offer products and services that allow
organizations to train their personnel in safe, productive, and realistic
environments. We believe that our training systems offer more functionality,
greater flexibility, unprecedented realism and a wider variety of user interface
options than competing products. Our systems are sold to corporations,
government agencies, military and law enforcement professionals around the
world. The simulators are currently used by some of the worlds leading training
academies, including (in the United States) the Secret Service, the Bureau of
Alcohol, Tobacco and Firearms, the Houston Police Department, the Customs
Service, the Border Patrol, the Bureau of Engraving and Printing, the Coast
Guard, the Federal Law Enforcement Training Centers, the California Department
20
AROTECH CORPORATION
of Corrections, the Detroit Police Department, the Washington DC Metro Police
and international users such as the Israeli Defense Forces, the German National
Police, the Royal Thailand Army, the Hong Kong Police, the Russian Security
Police, and over 400 other training departments worldwide.
Our interactive training systems range from the powerful Range 3000
use-of-force simulator system to the multi-faceted A2Z Classroom Training
system. The Range 3000 line of simulators addresses the entire use of force
training continuum in law enforcement, allowing the trainee to use posture,
verbalization, soft hand skills, impact weapons, chemical spray, low-light
electronic weapons and lethal force in a scenario based classroom environment.
The A2Z Classroom Trainer provides the trainer with real time electronic
feedback from every student through wireless handheld keypads. The combination
of interactivity and instant response assures that learning takes place in less
time with higher retention.
Vehicle Armoring
Through our majority-owned MDT Protective Industries Ltd. (MDT), we
specialize in using state-of-the-art lightweight ceramic materials, special
ballistic glass and advanced engineering processes to fully armor vans and cars.
MDT is a leading supplier to the Israeli military, Israeli special forces and
special services. MDT's products are proven in intensive battlefield situations
and under actual terrorist attack conditions, and are designed to meet the
demanding requirements of governmental and private sector customers worldwide.
Security Consulting
Through our wholly-owned Arcon Security Corporation subsidiary, we
focus on protecting life, assets and operations with minimum hindrance to
personal freedom and daily activities. Arcon Security, which provides homeland
security consulting and other services, has signed an agreement with Rafael
Armament Development Authority Ltd., Israel's leading defense research and
Development Company, to market and implement certain of Rafael's Homeland
Security products and technology in the United States.
ELECTRIC FUEL BATTERIES
We have been engaged in research and development in the field of
Zinc-Air electrochemistry and battery design for over ten years, as a result of
which we have developed our current technology and its applications. We have
successfully applied our technology to our high-energy battery packs for
military and security applications. We have also applied our technology to the
development of a refuelable Zinc-Air fuel cell for powering zero-emission
electric vehicles. Through these efforts, we have sought to position ourselves
as a world leader in the application of Zinc-Air technology to innovative
primary and refuelable power sources.
We believe that our Zinc-Air batteries provide the highest energy and
power density combination available today in the defense market, making them
particularly appropriate where long missions are required and low weight is
important.
Military Batteries
Our line of existing battery products for the military and defense
sectors includes Advanced Zinc-Air Power Packs (AZAPPs) utilizing our most
advanced cells (which have specific energy of 400 watt-hours per kilogram), a
21
AROTECH CORPORATION
line of super-lightweight AZAPPs that feature the same 400 Wh/kg cell technology
in smaller cells, and our new, high-power Zinc-Air Power Packs (ZAPPs), which
offer extended-use portable power using our commercial Zinc-Air cell technology.
Our AZAPPs have received a National Stock Number (a Department of Defense
catalog number assigned to products authorized for use by the U.S. military),
making our AZAPPs available for purchase by all units of the U.S. Armed Forces.
Electric Vehicle
Our Electric Vehicle effort, conducted through our subsidiary Electric
Fuel Battery Corporation, continues to focus 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 the Zinc-Air energy
system. This approach supports our long-term strategy of achieving widespread
implementation of the Electric Fuel Zinc-Air energy system for electric vehicles
in large commercial and mass transit vehicle fleets. Our all-electric bus,
powered by our Zinc-Air fuel cell technology, has demonstrated a world-record
127-mile range under rigorous urban conditions, and we have successfully
demonstrated our vehicle in "on-the-road" programs in Germany, Sweden, Italy,
Israel and the United States, most recently in public tests in Las Vegas, Nevada
in November 2001, and in Washington, D.C., on Capitol Hill, with the
participation of certain members of the United States Senate, in March 2002. We
intend to strengthen existing relationships and to develop new networks of
strategic alliances with fleet operators, companies engaged in energy production
and transportation, automobile manufacturers and others in order to establish
the infrastructure necessary for further development and commercialization of
the Electric Fuel Zinc-Air system.
Lifejacket Lights
We produce water-activated lifejacket lights for commercial aviation
and marine applications based on our patented water-activated magnesium-cuprous
chloride battery technology. We intend to continue to work with OEMs,
distributors and end-user companies to expand our market share in the aviation
and marine segments. We presently sell four products in the safety products
group, two for use with marine life jackets and two for use with aviation life
vests. All four products are certified under applicable international marine and
aviation safety regulations.
FACILITIES
Our principal executive offices are located at 632 Broadway, New York,
New York 10012, and our telephone number at our executive offices is (646)
654-2107. Our corporate website is www.arotech.com. Our periodic reports to the
Securities Exchange Commission, as well as recent filings relating to
transactions in our securities by our executive officers and directors, that
have been filed with the Securities and Exchange Commission in EDGAR format are
available through hyperlinks located on the investor relations page of our
website, at http://www.arotech.com/compro/investor.html. Reference to our
websites does not constitute incorporation of any of the information thereon or
linked thereto into this quarterly report.
The offices and facilities of our two of our principal subsidiaries,
EFL and MDT, are located in Israel (in Beit Shemesh and Lod, respectively, both
of which are within Israel's pre-1967 borders). We conduct research and
development activities through EFL, and most of our senior management is located
22
AROTECH CORPORATION
at EFL's facilities. We also conduct development and production activities at
IES's offices in Littleton, Colorado, and at our new production facility in
Auburn, Alabama, which builds and tests advanced batteries for the defense
market.
RECENT DEVELOPMENTS
Sale of Debentures
Pursuant to the terms of a Securities Purchase Agreement dated
September 30, 2003 (the "Purchase Agreement") by and between Arotech Corporation
and six institutional investors (the "Investors"), we issued and sold to the
Investors (i) an aggregate principal amount of $5,000,000 in 8% secured
convertible debentures due September 30, 2006 (the "Initial Debentures"),
convertible into shares of our common stock at any time after January 1, 2004 at
a conversion price of $1.15 per share, and (ii) three-year warrants to purchase
up to an aggregate of 1,250,000 shares of our common stock at any time after
January 1, 2004 (the "Initial Warrants") at an exercise price of $1.4375 per
share.
The Investors also have the right, at their option, at any time prior
to September 30, 2006, to purchase up to an additional $6,000,000 in debentures
(the "Additional Debentures" and, together with the Initial Debentures, the
"Debentures") convertible into shares of our common stock at any time after
January 1, 2004 at a conversion price of $1.45 per share, and to receive
warrants to purchase up to an aggregate of 1,500,000 shares of our common stock
at any time after January 1, 2004 (the "Additional Warrants" and, together with
the Initial Warrants, the "Warrants") at an exercise price of $1.8125 per share.
Under the terms of the Purchase Agreement, we have granted the
Investors (i) a first position security interest in the stock of MDT Armor
Corporation and in any assets that we acquire in future Acquisitions (as defined
in the Purchase Agreement), (ii) a second position security interest in the
assets of our IES Interactive Training, Inc. subsidiary and in the stock of our
subsidiaries other than IES Interactive Training, Inc. and M.D.T. Protective
Industries, Ltd. (junior to the security interest of the holders of our 9%
secured convertible debentures due June 30, 2005), and (iii) a third position
security interest in the stock of our subsidiaries I.E.S. Defense Services,
Inc., IES Interactive Training, Inc. and M.D.T. Protective Industries, Ltd.
(junior to the security interest of the holders of our 9% secured convertible
debentures due June 30, 2005 and to the security interest of I.E.S. Electronics
Industries, Ltd.), all pursuant to the terms of separate security agreements.
Under the terms of the Debentures and Notes, we are not obligated to
issue shares of our common stock upon conversion of a Debenture or exercise of a
Warrant if the issuance of such shares of common stock would exceed that number
of shares of common stock that we may issue without breaching our obligations
under applicable Nasdaq Marketplace Rules unless and until we obtain the
approval of our shareholders to the extent required by applicable Nasdaq
Marketplace Rules.
Pursuant to our obligations under the Purchase Agreement, we will
solicit the approval of our shareholders regarding the issuance of the
Debentures and the Warrants, as may be required under Nasdaq Marketplace Rules,
at our next annual meeting of stockholders (the "Meeting"), to be called and
held no later than June 19, 2004. In this connection, and as required under the
terms of the Purchase Agreement, certain of our shareholders have agreed to vote
their shares in favor of the approval of the transactions contemplated by the
Purchase Agreement at the Meeting, pursuant to separate voting agreements.
23
AROTECH CORPORATION
The foregoing description of our agreement with our debenture holders
is qualified in its entirety by reference to the agreements with our debenture
holders filed as exhibits to our Current Report on Form 8-K that we filed with
the SEC on October 3, 2003.
Acquisition of an Additional Interest in MDT
In October 2003, we announced that we had increased our holdings in
both of our vehicle armoring subsidiaries. We now hold 88% of MDT Armor
Corporation and 75.5% of MDT Protective Industries Ltd. We acquired the
additional stake in MDT in September 2003 from AGA Means of Protection and
Commerce Ltd. in exchange for the issuance to AGA of 126,000 shares of our
common stock.
Litigation
In October 2003, I.E.S. Group, the parent company of IES Electronics
Industries Ltd., the seller from which we purchased the assets of its IES
subsidiary, filed a lawsuit in Tel-Aviv District Court against us and certain of
our past and present officers. The complaint alleges breaches by us of certain
of our agreements with IES Electronics Industries Ltd. and claims monetary
damages in the amount of approximately $3 million. We believe that the lawsuit
brought by the I.E.S. Group is without merit and we intend to fully and
completely defend the claims vigorously. Although there can be no assurance, we
do not believe we have any material exposure in this matter.
FUNCTIONAL CURRENCY
We consider the United States dollar to be the currency of the primary
economic environment in which we and our Israeli subsidiary Electric Fuel
(E.F.L) Ltd. ("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 MDT is in New Israel Shekels
("NIS") and a substantial portion of MDT's costs is incurred in NIS. Management
believes that the NIS is the functional currency of MDT. Accordingly, the
financial statements of MDT have been translated into U.S. dollars. All balance
sheet accounts have been translated using the exchange rates in effect at the
balance sheet date. Statement of operations amounts has been translated using
the 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
PRELIMINARY NOTE
Results for the nine months ended September 30, 2003 include the
results of IES and MDT for such period as a result of our acquisitions of these
24
AROTECH CORPORATION
companies early in the third quarter of 2002. The results of IES and MDT were
not included in our operating results for the entire period of the nine months
ended September 30, 2002. Accordingly, the following period-to-period
comparisons should not necessarily be relied upon as indications of future
performance.
In addition, results are net of the operations of the retail consumer
battery products, which operations were discontinued in the third quarter of
2002.
THREE MONTHS ENDED SEPTEMBER 30, 2003, COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 2002.
REVENUES. Revenues from continuing operations for the three months
ended September 30, 2003 totaled $5.7 million, compared to $3.3 million in the
comparable period in 2002, an increase of $2.4 million, or 75%. This increase
was primarily attributable to the following factors:
>> Increased revenues from our IES subsidiary; and
>> Increased revenues from sales of our military batteries.
During the third quarter of 2003, we recognized revenues from two
divisions: Defense and Security Products, and Electric Fuel Batteries. Our
Defense and Security Products Division recognized revenues from the sale of
interactive use-of-force training systems (through our IES subsidiary) and from
providing armoring services under vehicle armoring contracts (through our MDT
subsidiary). Our Electric Fuel Batteries Division recognized revenues under
contracts with the U.S. Army's CECOM for deliveries of military batteries and
for design and procurement of production tooling and equipment, and from the
sale of lifejacket lights, as well as from subcontracting fees received in
connection with the United States Department of Transportation (DOT) program.
In the third quarter of 2003, revenues were $3.9 million for the
Defense and Security Products Division (compared to $2.6 million in the third
quarter of 2002, an increase of $1.2 million, or 46%), due primarily to
increased revenues from IES, and $1.8 million for the Electric Fuel Batteries
Division (compared to $622,000 in the third quarter of 2002, an increase of $1.2
million, or 196%), due primarily to increased sales of our military batteries.
COST OF REVENUES AND GROSS PROFIT. Cost of revenues totaled $3.3
million during the third quarter of 2003, compared to $1.7 million in the third
quarter of 2002, an increase of $1.6 million, or 95%, due primarily to increased
sales in all divisions.
Direct expenses for our two divisions during the third quarter of 2003
were $2.9 million for the Defense and Security Products Division (compared to
$2.2 million in the third quarter of 2002, an increase of $681,000, or 31%), due
primarily to increased sales by our IES subsidiary, and $1.6 million for the
Electric Fuel Batteries Division (compared to $929,000 in the third quarter of
2002, an increase of $652,000, or 70%), due primarily to an increase in sales
and activities related to CECOM batteries.
Gross profit was $2.5 million during the third quarter of 2003,
compared to $1.6 million during the third quarter of 2002, an increase of
$860,000, or 54%. This increase was the direct result of all factors presented
above, most notably the increase in IES and military battery revenues.
25
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
for the third quarter of 2003 were $252,000, compared to $161,000 during the
third quarter of 2002, an increase of $91,000, or 56%. This increase was the
result of the research and development activities that support the activities at
our CECOM facility in Auburn, Alabama.
SALES AND MARKETING EXPENSES. Sales and marketing expenses for the
third quarter of 2003 were $758,000, compared to $553,000 the third quarter of
2002, an increase of $205,000, or 37%. This increase was primarily attributable
to increased commissions related to the increase in IES's sales.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative
expenses for the third quarter of 2003 were $1.1 million compared to $1.4
million in the third quarter of 2002, a decrease of $273,000, or 20%. This
decrease was primarily attributable to lower management fees in our Defense and
Security Division.
FINANCIAL (EXPENSES) INCOME, NET. Financial (expenses) income, net of
interest expenses and exchange differentials, totaled approximately $101,000 in
financial expenses in the third quarter of 2003 compared to $23,000 in financial
income the third quarter of 2002, a difference of $124,000. This difference was
due primarily to $78,000 in interest expense on our debentures during the third
quarter of 2003, and amortization of compensation related to the issuance of our
debentures and the warrants that we issued in connection with our debentures in
the amount of $126,000, which expenses had no equivalent during the third
quarter of 2002.
INCOME TAXES. We and certain of our subsidiaries incurred net operating
losses in the past and, accordingly, were not required to make any provision for
income taxes. We have made provision for income taxes relating to MDT in the
amount of $31,000 ($24,000 after deduction of minority interest), compared to
tax expenses in the amount of $105,000 ($53,000 after deduction of minority
interest) in the third quarter of 2002.
AMORTIZATION OF INTANGIBLE ASSETS. Amortization of intangible assets
totaled $104,000 in the third quarter of 2003, compared to $252,000 the third
quarter of 2002, a decrease of $148,000, or 59%. $80,000 of this amortization
was attributable to IES and $23,000 was attributable to MDT.
NET PROFIT (LOSS) FROM CONTINUING OPERATIONS. Due to the factors cited
above, we reported a net profit from continuing operations of $77,000 in the
third quarter of 2003, compared to a net loss of $923,000 during the third
quarter of 2002, an increase of $1.0 million.
PROFIT (LOSS) FROM DISCONTINUED OPERATIONS. In the third quarter of
2002, we decided to discontinue operations relating to the retail sales of our
consumer battery products. Accordingly, all revenues and expenses related to
this segment have been presented in our consolidated statements of operations
for the three months ended September 30, 2003 and 2002 in an item entitled
"Profit (loss) from discontinued operations."
Loss from discontinued operations in the third quarter of 2003 was
$2,000, compared to a loss from discontinued operations of $8.7 million the
third quarter of 2002, a decrease of $8.7 million, or 100%.
26
AROTECH CORPORATION
NET PROFIT (LOSS). Due to the factors cited above, we reported a net
profit of $75,000 in the third quarter of 2003, compared to a net loss of $9.6
million the third quarter of 2002, an increase of $9.7 million.
NINE MONTHS ENDED SEPTEMBER 30, 2003, COMPARED TO THE NINE MONTHS ENDED
SEPTEMBER 30, 2002.
REVENUES. Revenues from continuing operations for the nine months ended
September 30, 2003 totaled $13.2 million, compared to $4.3 million for the
comparable period in 2002, an increase of $9.0 million, or 211%. This increase
was primarily the result of the inclusion of IES and MDT in our results for all
nine months of 2003 as opposed to one quarter only in 2002. An additional factor
was the increased sales of our military batteries.
During the first nine months of 2003, we recognized revenues from two
divisions: Defense and Security Products, and Electric Fuel Batteries. Our
Defense and Security Products Division recognized revenues from the sale of
interactive use-of-force training systems (through our IES subsidiary) and from
providing armoring services under vehicle armoring contracts (through our MDT
subsidiary). Our Electric Fuel Batteries Division recognized revenues under
contracts with the U.S. Army's CECOM for deliveries of military batteries and
for design and procurement of production tooling and equipment, and from the
sale of lifejacket lights, as well as from subcontracting fees received in
connection with the United States Department of Transportation (DOT) program.
In the first nine months of 2003, revenues were $8.5 million for the
Defense and Security Products Division (compared to $2.6 in the first nine
months of 2002, an increase of $5.9 million, or 223%), due primarily to the
inclusion of IES and MDT in our results in 2003, and $4.7 million for the
Electric Fuel Batteries Division (compared to $1.6 million in the first nine
months of 2002, an increase of $3.1 million, or 190%), due primarily to
increased sales of our military batteries.
Of the $5.9 million increase in Defense and Security Products revenues,
$4.5 million was attributable to the inclusion of IES in our results in the
first nine months of 2003 and $1.4 million was attributable to the inclusion of
MDT in our results in the first nine months of 2003.
COST OF REVENUES AND GROSS PROFIT. Cost of revenues totaled $8.4
million during the first nine months of 2003, compared to $2.4 million in the
first nine months of 2002, an increase of $5.9 million, or 244%, due primarily
to increased sales in all divisions.
Direct expenses for our two divisions during the first nine months of
2003 were $8.0 million for the Defense and Security Products Division (compared
to $2.2 million in the first nine months of 2002, an increase of $5.8 million,
or 266%), due primarily to the inclusion of IES and MDT in our results in 2003,
and $4.3 million for the Electric Fuel Batteries Division (compared to $1.9
million in the first nine months of 2002, an increase of $2.4 million, or 124%),
due primarily to increased sales of our military batteries.
Of the $5.8 million increase in Defense and Security Products direct
expenses, $3.6 million was attributable to the inclusion of IES in our results
in the first nine months of 2003 and $1.8 million was attributable to the
inclusion of MDT in our results in the first nine months of 2003.
27
AROTECH CORPORATION
Gross profit was $4.9 million during the first nine months of 2003,
compared to $1.8 million during the first nine months of 2002, an increase of
$3.0 million, or 166%. This increase was the direct result of all factors
presented above, most notably the inclusion of IES and MDT in our 2003 results.
In the first nine months of 2003, IES contributed $3.0 million to our gross
profit, MDT contributed $707,000, and our other product lines (primarily our
sales of military batteries) contributed $1.2 million.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
for the first nine months of 2003 were $763,000, compared to $380,000 the first
nine months of 2002, an increase of $383,000, or 101%. This increase was the
result of the research and development activities that support the activities at
our CECOM facility in Auburn, Alabama and the inclusion of IES and MDT in all
nine months of 2003 as opposed to one quarter only in 2002.
SALES AND MARKETING EXPENSES. Sales and marketing expenses for the
first nine months of 2003 were $2.4 million, compared to $713,000 the first nine
months of 2002, an increase of $1.7 million, or 236%. This increase was
primarily attributable to the following factors:
>> The inclusion of IES and MDT in all nine months of 2003 as
opposed to one quarter only in 2002, which contributed $1.1
million to this increase; and
>> Increased sales and marketing expenses related to sales of our
military batteries.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative
expenses for the first nine months of 2003 were $3.6 million compared to $3.3
million the first nine months of 2002, an increase of $231,000, or 7%. This
increase was primarily attributable to the inclusion of IES and MDT in all nine
months of 2003 as opposed to one quarter only in 2002, which was partially
offset by a decrease in general corporate overhead.
FINANCIAL (EXPENSES) INCOME, NET. Financial (expenses) income, net of
interest expenses and exchange differentials, totaled approximately $1.1 million
in financial expenses in the first nine months of 2003 compared to $140,000 in
financial income in the first nine months of 2002, a difference of $1.2 million,
or 874%. This difference was due primarily to $236,000 in interest expense on
our debentures during the first nine months of 2003, and amortization of
compensation related to the issuance of our debentures and the warrants that we
issued in connection with our debentures in the amount of $1.0 million, which
expenses had no equivalent during the first nine months of 2002.
INCOME TAXES. We and certain of our subsidiaries incurred net operating
losses during the first nine months of 2003 and 2002 and, accordingly, were not
required to make any provision for income taxes. We have made provision for
income taxes relating to MDT in the amount of $308,000 ($166,000 after deduction
of minority interest).
28
AROTECH CORPORATION
AMORTIZATION OF INTANGIBLE ASSETS. Amortization of intangible assets
totaled $727,000 in the first nine months of 2003, compared to $252,000 the
first nine months of 2002, an increase of $475,000, or 189%, due to amortization
of intangibles assets related to our purchase of IES and MDT in 2002. Of this
increase, $382,000 was attributable to amortization of intangibles assets
related to our purchase of IES and $93,000 was attributable to amortization of
intangibles assets related to our purchase of MDT.
NET PROFIT (LOSS) FROM CONTINUING OPERATIONS. Due to the factors cited
above, we reported a net loss from continuing operations of $3.9 million in the
first nine months of 2003, compared to a net loss of $2.9 million in the first
nine months of 2002, an increase of $936,000, or 32%.
PROFIT (LOSS) FROM DISCONTINUED OPERATIONS. In the third quarter of
2002, we decided to discontinue operations relating to the retail sales of our
consumer battery products. Accordingly, all revenues and expenses related to
this segment have been presented in our consolidated statements of operations
for the nine months ended September 30, 2003 in an item entitled "Loss from
discontinued operations."
Profit from discontinued operations in the first nine months of 2003
was $81,000, compared to a loss from discontinued operations of $12.7 million
the first nine months of 2002, a decrease in loss of $12.8 million.
NET PROFIT (LOSS). Due to the factors cited above, we reported a net
loss of $3.8 million in the first nine months of 2003, compared to a net loss of
$15.6 million the first nine months of 2002, a decrease of $11.8 million, or
76%.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2003, we had cash and cash equivalents of
approximately $2.7 million, compared to $1.5 million as of December 31, 2002, an
increase of $1.2 million. The increase in cash was primarily the result of the
issuance of convertible debentures in January 2003 and conversions of debentures
and exercises of warrants during 2003.
We used available funds in the third quarter of 2003 primarily for
sales and marketing, continued research and development expenditures, and other
working capital needs. We increased our investment in fixed assets during the
quarter ended September 30, 2003 by $147,000 over the investment as at June 30,
2003, primarily in the Electric Fuel Batteries Division. Our fixed assets
amounted to $2.4 million at quarter end.
Based on our internal forecasts, we believe that our cash position and
cash flows from operations as of the date of this report will be sufficient to
satisfy our estimated cash requirements for more than the next eighteen months.
This belief is based on certain assumptions that our management believes to be
reasonable, some of which are subject to the risk factors detailed below.
29
AROTECH CORPORATION
RISK FACTORS
The following factors, among others, could cause actual results to
differ materially from those contained in forward-looking statements made in
this Report and presented elsewhere by management from time to time.
BUSINESS-RELATED RISKS
WE HAVE HAD A HISTORY OF LOSSES AND MAY INCUR FUTURE LOSSES.
We were incorporated in 1990 and began our operations in 1991. We have
funded our operations principally from funds raised in each of the initial
public offering of our common stock in February 1994; through subsequent public
and private offerings of our common stock and equity and debt securities
convertible 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 periodically incurred significant operating losses since
our inception. Additionally, as of September 30, 2003, we had an accumulated
deficit of approximately $104.4 million. There can be no assurance that we will
be able to maintain profitability consistently or that our business will
continue to exist.
OUR EXISTING INDEBTEDNESS MAY ADVERSELY AFFECT OUR ABILITY TO OBTAIN
ADDITIONAL FUNDS AND MAY INCREASE OUR VULNERABILITY TO ECONOMIC OR BUSINESS
DOWNTURNS.
Our indebtedness aggregated approximately $6.6 million as of October
31, 2003. Accordingly, we are subject to the risks associated with indebtedness,
including:
o we must dedicate a portion of our cash flows from operations
to pay debt service costs and, as a result, we have less funds
available for operations, future acquisitions of consumer
receivable portfolios, and other purposes;
o it may be more difficult and expensive to obtain additional
funds through financings, if available at all;
o we are more vulnerable to economic downturns and fluctuations
in interest rates, less able to withstand competitive
pressures and less flexible in reacting to changes in our
industry and general economic conditions; and
o if we default under any of our existing debt instruments or if
our creditors demand payment of a portion or all of our
indebtedness, we may not have sufficient funds to make such
payments.
The occurrence of any of these events could materially adversely affect
our results of operations and financial condition and adversely affect our stock
price.
The agreements governing the terms of our debentures contain numerous
affirmative and negative covenants that limit the discretion of our management
with respect to certain business matters and place restrictions on us, including
obligations on our part to preserve and maintain our assets and restrictions on
our ability to incur or guarantee debt, to merge with or sell our assets to
another company, and to make significant capital expenditures without the
consent of the debenture holders. Our ability to comply with these and other
provisions of such agreements may be affected by changes in economic or business
conditions or other events beyond our control.
30
AROTECH CORPORATION
FAILURE TO COMPLY WITH THE TERMS OF OUR DEBENTURES COULD RESULT IN A
DEFAULT THAT COULD HAVE MATERIAL ADVERSE CONSEQUENCES FOR US.
A failure to comply with the obligations contained in our debenture
agreements could result in an event of default under such agreements which could
result in an acceleration of the debentures and the acceleration of debt under
other instruments evidencing indebtedness that may contain cross-acceleration or
cross-default provisions. If the indebtedness under the debentures or other
indebtedness were to be accelerated, there can be no assurance that our assets
would be sufficient to repay in full such indebtedness.
WE HAVE PLEDGED A SUBSTANTIAL PORTION OF OUR ASSETS TO SECURE OUR
BORROWINGS.
Our debentures are secured by a substantial portion of our assets. If
we default under the indebtedness secured by our assets, those assets would be
available to the secured creditor to satisfy our obligations to the secured
creditor, which could materially adversely affect our results of operations and
financial condition and adversely affect our stock price.
WE NEED SIGNIFICANT AMOUNTS OF CAPITAL TO OPERATE AND GROW OUR BUSINESS.
We require substantial funds to conduct the necessary research,
development and testing of our products; to establish commercial scale
manufacturing facilities; and to market our products. We continue to seek
additional funding, including through the issuance of equity or debt securities.
However, there can be no assurance that we will obtain any such additional
financing in a timely manner or on acceptable terms. If additional funds are
raised by issuing equity securities, stockholders may incur further dilution. If
additional funding is not secured, we will have to modify, reduce, defer or
eliminate parts of our anticipated future commitments and/or programs.
WE MAY NOT BE SUCCESSFUL IN OPERATING A NEW BUSINESS.
Prior to the IES and MDT acquisitions, our primary business was the
marketing and sale of products based on primary and refuelable Zinc-Air fuel
cell technology and advancements in battery technology for defense and security
products and other military applications, electric vehicles and consumer
electronics. As a result of the IES and MDT acquisitions, a substantial
component of our business will be the marketing and sale of hi-tech multimedia
and interactive digital solutions for training military, law enforcement and
security personnel and sophisticated lightweight materials and advanced
engineering processes used to armor vehicles. These are new businesses for us
and our management group has limited experience operating these types of
businesses. Although we have retained the management personnel at IES and MDT,
we cannot assure that such personnel will continue to work for us or that we
will be successful in managing this new business. If we are unable to
successfully operate these new businesses, especially the business of IES, our
business, financial condition and results of operations could be materially
impaired.
31
AROTECH CORPORATION
WE CANNOT ASSURE YOU OF MARKET ACCEPTANCE OF OUR MILITARY ZINC-AIR BATTERY
PRODUCTS AND ELECTRIC VEHICLE TECHNOLOGY.
Our batteries for the defense industry and a signal light powered by
water-activated batteries for use in life jackets and other rescue apparatus are
the only commercial Zinc-Air battery products we currently have available for
sale. Significant resources will be required to develop and produce additional
consumer products utilizing this technology on a commercial scale. Additional
development will be necessary in order to commercialize our technology and each
of the components of the Electric Fuel System for electric vehicles and defense
products. We cannot assure you that we will be able to successfully develop,
engineer or commercialize our Zinc-Air energy system, or that we will be able to
develop products for commercial sale or that, if developed, they can be produced
in commercial quantities or at acceptable costs or be successfully marketed. The
likelihood of our future success must be considered in light of the risks,
expenses, difficulties and delays frequently encountered in connection with the
operation and development of a relatively early stage business and with
development activities generally.
We believe that public pressure and government initiatives are
important factors in creating an electric vehicle market. However, there can be
no assurance that there will be sufficient public pressure or that further
legislation or other governmental initiatives will be enacted, or that current
legislation will not be repealed, amended, or have its implementation delayed.
In addition, we are subject to the risk that even if an electric fuel vehicle
market develops, a different form of zero emission or low emission vehicle will
dominate the market. In addition, we cannot assure you that other solutions to
the problem of containing emissions created by internal combustion engines will
not be invented, developed and produced. Any other solution could achieve
greater market acceptance than electric vehicles. The failure of a significant
market for electric vehicles to develop would have a material adverse effect on
our ability to commercialize this aspect of our technology. Even if a
significant market for electric vehicles develops, there can be no assurance
that our technology will be commercially competitive within that market.
OUR ACQUISITION STRATEGY INVOLVES VARIOUS RISKS.
Part of our strategy is to grow through the acquisition of companies
that will complement our existing operations or provide us with an entry into
markets we do not currently serve. Growth through acquisitions involves
substantial risks, including the risk of improper valuation of the acquired
business and the risk of inadequate integration. There can be no assurance that
suitable acquisition candidates will be available, that we will be able to
acquire or manage profitably such additional companies or that future
acquisitions will produce returns that justify our investments therein. In
addition, we may compete for acquisition and expansion opportunities with
companies that have significantly greater resources than we do. Furthermore,
acquisitions could disrupt our ongoing business, distract the attention of our
senior managers, make it difficult to maintain our operational standards,
controls and procedures and subject us to contingent and latent risks that are
different, in nature and magnitude, than the risks we currently face.
We may finance future acquisitions with cash from operations or
additional debt or equity financings. There can be no assurance that we will be
able to generate internal cash or obtain financing from external sources or
that, if available, such financing will be on terms acceptable to us. The
issuance of additional common stock to finance acquisitions may result in
substantial dilution to our stockholders. Any debt financing may significantly
increase our leverage and may involve restrictive covenants which limit our
operations.
32
AROTECH CORPORATION
WE MAY NOT SUCCESSFULLY INTEGRATE OUR NEW ACQUISITIONS.
In light of our recent acquisitions of IES and MDT, our success will
depend in part on our ability to manage the combined operations of these
companies and to integrate the operations and personnel of these companies along
with our other subsidiaries and divisions into a single organizational
structure. There can be no assurance that we will be able to effectively
integrate the operations of our subsidiaries and divisions and our
newly-acquired businesses into a single organizational structure. Integration of
these operations could also place additional pressures on our management as well
as on our key technical resources. The failure to successfully manage this
integration could have an adverse material effect on us.
If we are successful in acquiring additional businesses, we may
experience a period of rapid growth that could place significant additional
demands on, and require us to expand, our management, resources and management
information systems. Our failure to manage any such rapid growth effectively
could have a material adverse effect on our financial condition, results of
operations and cash flows.
IF WE ARE UNABLE TO MANAGE OUR GROWTH, OUR OPERATING RESULTS WILL BE
IMPAIRED.
We are currently experiencing a period of growth and development
activity which could place a significant strain on our personnel and resources.
Our activity has resulted in increased levels of responsibility for both
existing and new management personnel. Many of our management personnel have had
limited or no experience in managing growing companies. We have sought to manage
our current and anticipated growth through the recruitment of additional
management and technical personnel and the implementation of internal systems
and controls. However, our failure to manage growth effectively could adversely
affect our results of operations.
WE WILL NEED TO DEVELOP THE EXPERIENCE TO MANUFACTURE CERTAIN OF OUR
PRODUCTS IN COMMERCIAL QUANTITIES AND AT COMPETITIVE PRICES.
We currently have limited experience in manufacturing in commercial
quantities and have, to date, produced only limited quantities of military
batteries and components of the batteries for electric vehicles. In order for us
to be successful in the commercial market, these products must be manufactured
to meet high quality standards in commercial quantities at competitive prices.
The development of the necessary manufacturing technology and processes will
require extensive lead times and the commitment of significant amounts of
financial and engineering resources, which may not be available to us. We cannot
assure you that we will successfully develop this technology or these processes.
Moreover, we cannot assure you that we will be able to successfully implement
the quality control measures necessary for commercial manufacturing.
SOME OF THE COMPONENTS OF OUR TECHNOLOGY AND OUR PRODUCTS POSE POTENTIAL
SAFETY RISKS WHICH COULD CREATE POTENTIAL LIABILITY EXPOSURE FOR US.
Some of the components of our technology and our products contain
elements that are known to pose potential safety risks. Also, because electric
vehicle batteries contain large amounts of electrical energy, they may cause
33
AROTECH CORPORATION
injuries if not handled properly. In addition to these risks, and although we
incorporate safety procedures in our research, development and manufacturing
processes, there can be no assurance that accidents in our facilities will not
occur. Any accident, whether occasioned by the use of all or any part of our
products or technology or by our manufacturing operations, could adversely
affect commercial acceptance of our products and could result in significant
production delays or claims for damages resulting from injuries. Any of these
occurrences would materially adversely affect our operations and financial
condition.
WE MAY FACE PRODUCT LIABILITY CLAIMS.
To date, there have been no material claims or threatened claims
against us by users of our products, including the products manufactured by MDT,
based on a failure of our products to perform as specified. In the event that
any claims for substantial amounts were to be asserted against us, they could
have a materially adverse effect on our financial condition and results of
operations. We maintain general product liability insurance. However, there is
no assurance that the amount of our insurance 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.
SOME OF OUR BUSINESS IS DEPENDENT ON GOVERNMENT CONTRACTS.
Most of IES's customers 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 our sales to date of our battery products for the military
and defense sectors have been in the public sector in the United States. A
significant decrease in the overall level or allocation of defense spending or
law enforcement in the U.S. or other countries could have a material adverse
effect on our future results of operations and financial condition. MDT has
already experienced a slowdown in orders from the Ministry of Defense due to
budget constraints and a requirement of U.S. aid to Israel that a substantial
proportion of such aid be spent in the U.S., where MDT does not yet have a
factory in operation.
Sales to public sector customers are subject to a multiplicity of
detailed regulatory requirements and public policies as well as to changes in
training and purchasing priorities. Contracts with public sector customers may
be conditioned upon the continuing availability of public funds, which in turn
depends upon lengthy and complex budgetary procedures, and may be subject to
certain pricing constraints. Moreover, U.S. government contracts and those of
many international government customers may generally be terminated for a
variety of factors when it is in the best interests of the government and
contractors may be suspended or debarred for misconduct at the discretion of the
government. There can be no assurance that these factors or others unique to
government contracts or the loss or suspension of necessary regulatory licenses
will not have a material adverse effect on our future results of operations and
financial condition.
OUR FIELDS OF BUSINESS ARE HIGHLY COMPETITIVE.
The competition to develop defense and security products and electric
vehicle battery systems, and to obtain funding for the development of these
products, is, and is expected to remain, intense.
34
AROTECH CORPORATION
Our defense and security products compete with other manufacturers of
specialized training systems, including Firearms Training Systems, Inc., a
producer of interactive simulation systems designed to provide training in the
handling and use of small and supporting arms. In addition, we compete with
manufacturers and developers of armor for cars and vans, including O'Gara-Hess &
Eisenhardt, a division of Armor Holdings, Inc.
Our battery technology competes with other battery technologies, as
well as other Zinc-Air technologies. The competition in this area of our
business consists of development stage companies, major international companies
and consortia of such companies, including battery manufacturers, automobile
manufacturers, energy production and transportation companies, consumer goods
companies and defense contractors. Many of our competitors have financial,
technical, marketing, sales, manufacturing, distribution and other resources
significantly greater than ours.
Various battery technologies are being considered for use in electric
vehicles and defense and safety products by other manufacturers and developers,
including the following: lead-acid, nickel-cadmium, nickel-iron, nickel-zinc,
nickel-metal hydride, sodium-sulfur, sodium-nickel chloride, zinc-bromine,
lithium-ion, lithium-polymer, lithium-iron sulfide, primary lithium,
rechargeable alkaline and Zinc-Air.
If we are unable to compete successfully in each of our operating
areas, especially in the defense and security products area of our business, our
business and results of operations could be materially adversely affected.
FAILURE TO RECEIVE REQUIRED REGULATORY PERMITS OR TO COMPLY WITH VARIOUS
REGULATIONS TO WHICH WE ARE SUBJECT COULD ADVERSELY AFFECT OUR BUSINESS.
Regulations in Europe, Israel, the United States and other countries
impose various controls and requirements relating to various components of our
business. While we believe that our current and contemplated operations conform
to those regulations, we cannot assure you that we will not be found to be in
non-compliance. We have applied for, and received, the necessary permits under
the Israel Dangerous Substances Law, 5753-1993, required for the use of
potassium hydroxide and zinc metal. However, there can be no assurance that
changes in these regulations or the adoption of new regulations will not impose
costly compliance requirements on us, subject us to future liabilities, or
restrict our ability to operate our business.
OUR BUSINESS IS DEPENDENT ON PATENTS AND OTHER 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. We hold patents, provisional patents, or
patent applications, covering elements of our technology in the United States
and in Europe. In addition, we have patent applications pending in the United
States and in foreign countries, including the European Community, Israel and
Japan. We intend to continue to file patent applications covering important
features of our technology. We cannot assure you, however, that patents will
issue from any of these pending applications or, if patents issue, that the
claims allowed will be sufficiently broad to protect our technology. In
addition, we cannot assure you that any of our patents will not be challenged or
invalidated, that any of our issued patents will afford protection against a
competitor or that third parties will not make infringement claims against us.
35
AROTECH CORPORATION
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. The invalidation of patents owned by or licensed
to us could have a material adverse effect on our business. In addition, patent
applications filed in foreign countries are subject to laws, rules and
procedures that differ from those of the United States. Therefore, there can be
no assurance that foreign patent applications related to patents issued in the
United States will be granted. Furthermore, even if these patent applications
are granted, some foreign countries provide significantly less patent protection
than the United States. 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 require a license under such patents to develop and market our
patents.
Despite our efforts to safeguard and maintain our proprietary rights,
we may not be successful in doing so. In addition, competition is intense, and
there can be no assurance that our competitors will not independently develop or
patent technologies that are substantially equivalent or superior to our
technology. Moreover, in the event of patent litigation, we cannot assure you
that a court would determine that we were the first creator of inventions
covered by our issued patents or pending patent applications or that we were the
first to file patent applications for those inventions. If existing or future
third-party patents containing broad claims were upheld by the courts or if we
were found to infringe third party patents, we may not be able to obtain the
required licenses from the holders of such patents on acceptable terms, if at
all. Failure to obtain these licenses could cause delays in the introduction of
our products or necessitate costly attempts to design around such patents, or
could foreclose the development, manufacture or sale of our products. We could
also incur substantial costs in defending ourselves in patent infringement suits
brought by others and in prosecuting patent infringement suits against
infringers.
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, strategic partners and potential strategic
partners. 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 certain members of our management and
engineering staff, and the loss of the services of one or more of these persons
could adversely affect us. We are especially dependent on the services of our
Chairman, President and Chief Executive Officer, Robert S. Ehrlich. The loss of
36
AROTECH CORPORATION
Mr. Ehrlich could have a material adverse effect on us. We are party to an
employment agreement with Mr. Ehrlich, which agreement expires at the end of
2005. We do not have key-man life insurance on Mr. Ehrlich.
THERE ARE RISKS INVOLVED WITH THE INTERNATIONAL NATURE OF OUR BUSINESS.
A significant portion of our sales are made to customers located
outside the U.S., primarily in Europe and Asia. In 2000, 2001 and 2002, without
taking account of revenues derived from discontinued operations, 45%, 49%, and
56%, respectively, of our revenues, including, in the case of 2002, the revenues
of IES and MDT, were derived from sales to customers located outside the U.S. We
expect that our international customers will continue to account for a
substantial portion of our revenues in the near future. Sales to international
customers may be subject to political and economic risks, including political
instability, currency controls, exchange rate fluctuations, foreign taxes,
longer payment cycles and changes in import/export regulations and tariff rates.
In addition, various forms of protectionist trade legislation have been and in
the future may be proposed in the U.S. and certain other countries. Any
resulting changes in current tariff structures or other trade and monetary
policies could adversely affect our sales to international customers.
INVESTORS SHOULD NOT PURCHASE OUR COMMON STOCK WITH THE EXPECTATION OF
RECEIVING CASH DIVIDENDS.
We currently intend to retain any future earnings for funding growth
and, as a result, do not expect to pay any cash dividends in the foreseeable
future.
MARKET-RELATED RISKS
THE PRICE OF OUR COMMON STOCK IS VOLATILE.
The market price of our common stock has been volatile in the past and
may change rapidly in the future. The following factors, among others, may cause
significant volatility in our stock price:
o Announcements by us, our competitors or our customers;
o The introduction of new or enhanced products and services by
us or our competitors;
o Changes in the perceived ability to commercialize our
technology compared to that of our competitors;
o Rumors relating to our competitors or us;
o Actual or anticipated fluctuations in our operating results;
and
o General market or economic conditions.
IF OUR SHARES WERE TO BE DELISTED, OUR STOCK PRICE MIGHT DECLINE FURTHER
AND WE MIGHT BE UNABLE TO RAISE ADDITIONAL CAPITAL.
Our common stock trades on the Nasdaq National Market, which specifies
certain requirements for the continued listing of common stock. One of these
requirements, codified in Marketplace Rule 4450(a)(3), states that a Maintenance
37
AROTECH CORPORATION
Standard 1 company, like us, must maintain stockholders' equity of at least $10
million. Although our stockholders' equity as of September 30, 2003 stood at
$11.4 million, as a result of conversions of our debentures and exercises of our
warrants in May and June 2003, our stockholders' equity has fallen below $10
million from time to time. Continued compliance with the $10 million
stockholders' equity requirement will be dependant in great part upon our
ability to become profitable, which would cause our retained earnings to
increase, thereby increasing the amount of stockholders' equity. Additional
warrant exercises, debenture conversions and/or sales of our common stock would
also positively impact our stockholders' equity. Conversely, failure to become
profitable may be expected to have a negative impact on stockholders' equity.
Another of the continued listing standards for our stock on the Nasdaq
National Market is the maintenance of a $1.00 bid price. Our stock price has
periodically traded below $1.00 in the recent past. If our bid price were to go
and remain below $1.00 for 30 consecutive business days, Nasdaq could notify us
of our failure to meet the continued listing standards, after which we would
have 180 calendar days to correct such failure or be delisted from the Nasdaq
National Market.
Although we would have the opportunity to appeal any potential
delisting, there can be no assurances that this appeal would be resolved
favorably. As a result, there can be no assurance that our common stock will
remain listed on the Nasdaq National Market. If our common stock were to be
delisted from the Nasdaq National Market, we might apply to be listed on the
Nasdaq SmallCap market; however, there can be no assurance that we would be
approved for listing on the Nasdaq SmallCap market, which has the same $1.00
minimum bid and other similar requirements as the Nasdaq National Market,
although with a lower stockholders' equity requirement of $2.5 million. If we
were to move to the Nasdaq SmallCap market, current Nasdaq regulations would
give us the opportunity to obtain an additional 180-day grace period and an
additional 90-day grace period after that if we meet certain net income,
stockholders' equity or market capitalization criteria. While our stock would
continue to trade on the over-the-counter bulletin board following any delisting
from the Nasdaq, any such delisting of our common stock could have an adverse
effect on the market price of, and the efficiency of the trading market for, our
common stock. Also, if in the future we were to determine that we need to seek
additional equity capital, it could have an adverse effect on our ability to
raise capital in the public equity markets.
In addition, if we fail to maintain Nasdaq listing for our securities,
and no other exclusion from the definition of a "penny stock" under the Exchange
Act 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.
38
AROTECH CORPORATION
WE ARE SUBJECT TO SIGNIFICANT INFLUENCE BY SOME STOCKHOLDERS THAT MAY
HAVE THE EFFECT OF DELAYING OR PREVENTING A CHANGE IN CONTROL.
As of October 31, 2003, our directors, executive officers and principal
stockholders and their affiliates (including Leon S. Gross (8.2%) and Robert S.
Ehrlich (4.7%)) collectively are deemed beneficially to own approximately 12.6%
of the outstanding shares of our common stock, including options exercisable
within 60 days of October 31, 2003. As a result, these stockholders are able to
exercise significant influence over matters requiring stockholder approval,
including the election of directors and approval of significant corporate
transactions. This concentration of ownership may also have the effect of
delaying, preventing or discouraging a change in control of Arotech.
Pursuant to a voting rights agreement dated September 30, 1996, as
amended, between Leon S. Gross, Robert S. Ehrlich, Yehuda Harats and us,
Lawrence M. Miller, Mr. Gross's advisor, is entitled to be nominated to serve on
our board of directors so long as Mr. Gross, his heirs or assigns retain
beneficial ownership of at least 1,375,000 shares of common stock. In addition,
under the voting rights agreement, Mr. Gross and Messrs. Ehrlich and Harats
agreed to vote and take all necessary action so that Messrs. Ehrlich, Harats and
Miller shall serve as members of the board of directors until the earlier of
December 28, 2004 or our fifth annual meeting of stockholders after December 28,
1999. Mr. Harats resigned as a director in 2002; however, we believe that Mr.
Harats must continue to comply with the terms of this agreement.
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 October 31, 2003, we had 42,724,203 shares
of common stock issued and outstanding. Of these shares, most are freely
transferable without restriction under the Securities Act of 1933, and a
substantial portion of the remaining shares may be sold subject to the volume
restrictions, manner-of-sale provisions and other conditions of Rule 144 under
the Securities Act of 1933.
In connection with a stock purchase agreement dated September 30, 1996
between Leon S. Gross and us, we also entered into a registration rights
agreement with Mr. Gross dated September 30, 1996, setting forth registration
rights with respect to the shares of common stock issued to Mr. Gross in
connection with the offering. These rights include the right to make two demands
for the registration of the shares of our common stock owned by Mr. Gross. In
addition, Mr. Gross was granted unlimited rights to "piggyback" on registration
statements that we file for the sale of our common stock. Mr. Gross presently
owns 3,488,534 shares, of which 1,538,462 have never been registered.
39
AROTECH CORPORATION
In addition, pursuant to the terms of their employment agreements with
us, both Yehuda Harats and Robert S. Ehrlich have a right to demand registration
of their shares. Of the 551,835 shares owned by Mr. Harats, 435,404 shares have
never been registered, and of the 688,166 shares owned by Mr. Ehrlich, 453,933
shares have never been registered.
EXERCISE OF OUR WARRANTS, OPTIONS AND CONVERTIBLE DEBT COULD ADVERSELY
AFFECT OUR STOCK PRICE AND WILL BE DILUTIVE.
As of September 30, 2003, there were outstanding warrants to purchase a
total of 6,534,058 shares of our common stock at a weighted average exercise
price of $1.99 per share, options to purchase a total of 8,974,289 shares of our
common stock at a weighted average exercise price of $1.51 per share, of which
5,592,582 were vested and exercisable within 60 days of such date, at a weighted
average exercise price of $2.00 per share, and outstanding debentures
convertible into a total of 3,125,000 shares of our common stock at a weighted
average conversion price of $0.64 per share. Holders of our options, warrants
and convertible debt will probably exercise or convert them only at a time when
the price of our common stock is higher than their respective exercise or
conversion prices. Accordingly, we may be required to issue shares of our common
stock at a price substantially lower than the market price of our stock. This
could adversely affect our stock price. In addition, if and when these shares
are issued, the percentage of our common stock that existing stockholders own
will be diluted.
OUR CERTIFICATE OF INCORPORATION AND BYLAWS AND DELAWARE LAW CONTAIN
PROVISIONS THAT COULD DISCOURAGE A TAKEOVER.
Provisions of our amended and restated certificate of incorporation may
have the effect of making it more difficult for a third party to acquire, or of
discouraging a third party from attempting to acquire, control of us. These
provisions could limit the price that certain investors might be willing to pay
in the future for shares of our common stock. These provisions:
o divide our board of directors into three classes serving
staggered three-year terms;
o only permit removal of directors by stockholders "for cause,"
and require the affirmative vote of at least 85% of the
outstanding common stock to so remove; and
o allow us to issue preferred stock without any vote or further
action by the stockholders.
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 two of our principal subsidiaries, EFL
and MDT, are located in Israel (in Beit Shemesh and Lod, respectively, both of
which are within Israel's pre-1967 borders). We conduct research and development
40
AROTECH CORPORATION
activities through EFL, and most of our senior management is located at EFL's
facilities. Although we expect that most of our sales will be made to customers
outside Israel, we are nonetheless directly affected by economic, political and
military conditions in that country. Accordingly, any major hostilities
involving Israel or the interruption or curtailment of trade between Israel and
its present trading partners could have a material adverse effect on our
operations. Since the establishment of the State of Israel in 1948, a number of
armed conflicts have taken place between Israel and its Arab neighbors and a
state of hostility, varying in degree and intensity, has led to security and
economic problems for Israel.
Historically, Arab states have boycotted any direct trade with Israel
and to varying degrees have imposed a secondary boycott on any company carrying
on trade with or doing business in Israel. Although in October 1994, the states
comprising the Gulf Cooperation Council (Saudi Arabia, the United Arab Emirates,
Kuwait, Dubai, Bahrain and Oman) announced that they would no longer adhere to
the secondary boycott against Israel, and Israel has entered into certain
agreements with Egypt, Jordan, the Palestine Liberation Organization and the
Palestinian Authority, Israel has not entered into any peace arrangement with
Syria or Lebanon. Moreover, since September 2000, there has been a significant
deterioration in Israel's relationship with the Palestinian Authority, and a
significant increase in terror and violence. Efforts to resolve the problem have
failed to result in an agreeable solution. Continued hostilities between the
Palestinian community and Israel and any failure to settle the conflict may have
a material adverse effect on our business and us. Moreover, the current
political and security situation in the region has already had an adverse effect
on the economy of Israel, which in turn may have an adverse effect on us.
Many of our employees are currently obligated to perform annual reserve
duty in the Israel Defense Forces and are subject to being called for active
military duty at any time. No assessment can be made of the full impact of such
requirements on us in the future, particularly if emergency circumstances occur,
and no prediction can be made as to the effect on us of any expansion of these
obligations. However, further deterioration of hostilities with the Palestinian
community into a full-scale conflict might require more widespread military
reserve service by some of our employees, which could have a material adverse
effect on our business.
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 49%
of our assets are located outside the United States. In addition, two of our
directors and all of our executive officers are residents of Israel and all or a
substantial 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. However, subject to certain
time limitations and other conditions, Israeli courts may enforce final
judgments of United States courts for liquidated amounts in civil matters,
including judgments based upon the civil liability provisions of the Securities
Act and the Exchange Act. As a result, it may not be possible for investors to
enforce or effect service of process upon these directors and executive officers
41
AROTECH CORPORATION
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.
OUR GRANTS FROM THE ISRAELI GOVERNMENT IMPOSE CERTAIN RESTRICTIONS ON US.
Between 1992 and 2001, our Israeli subsidiary, EFL, received funding
from the Office of the Chief Scientist of the Israel Ministry of Industry and
Trade relating to the development of our Zinc-Air battery products, such as our
electric vehicle and our batteries and chargers for consumer products. Between
1998 and 2000, we have also received funds from the Israeli-U.S. Bi-National
Industrial Research and Development (BIRD) Foundation. Through the end of 2002,
we had received an aggregate of $9.9 million (net of royalties paid) from grants
from the Chief Scientist and $772,000 from grants from BIRD, and we may receive
future grants, the amounts of which would be determined at the time of
application. The funding from the Chief Scientist prohibits the transfer or
license of know-how and the manufacture of resulting products outside of Israel
without the permission of the Chief Scientist. Although we believe that the
Chief Scientist does not unreasonably withhold this permission if the request is
based upon commercially justified circumstances and any royalty obligations to
the Chief Scientist are sufficiently assured, the matter is solely within the
discretion of the Chief Scientist, and we cannot be sure that such consent, if
requested, would be granted upon terms satisfactory to us or granted at all.
Without such consent, we would be unable to manufacture any products developed
by this research outside of Israel, even if it would be less expensive for us to
do so. Additionally, current regulations require that, in the case of the
approved transfer of manufacturing rights out of Israel, the maximum amount to
be repaid through royalty payments would be increased to between 120% and 300%
of the amount granted, depending on the extent of the manufacturing to be
conducted outside of Israel, and that an increased royalty rate of up to 5%
would be applied. These restrictions could adversely affect our potential
revenues and net income from the sale of such products.
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 significant 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.
SOME OF OUR AGREEMENTS ARE GOVERNED BY ISRAELI LAW.
Israeli law governs both our agreement with IES and our agreement with
MDT, as well as certain other agreements, such as our lease agreements on our
subsidiaries' premises in Israel. 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.
42
AROTECH CORPORATION
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We are exposed to the impact of interest rate changes and foreign
currency fluctuations due to our international sales, production and funding
requirements.
Certain of our activities are carried out by our wholly-owned
subsidiaries EFL and MDT, at their facilities in Israel, and we market some of
our products in Israel; accordingly we have sales and expenses in New Israeli
Shekels. However, the majority of our sales are made outside Israel in U.S.
dollars, and a substantial portion of our costs are incurred in U.S. dollars or
in New Israeli Shekels linked to the U.S. dollar. Therefore, our functional
currency is the U.S. dollar.
ITEM 4. CONTROLS AND PROCEDURES.
As of the end of the period covered by this report, we performed an
evaluation, with the participation of our management, including the CEO and CFO,
of the effectiveness of our disclosure controls and procedures pursuant to Rule
13a-15 promulgated under the Securities Exchange Act of 1934. Based on that
evaluation, our management, including the CEO and CFO, concluded that our
disclosure controls and procedures are effective in ensuring that information
that we are required to disclose in the reports that we file or submit under the
Securities Exchange Act is recorded, processed, summarized and reported, within
the time periods specified in the SEC's rules and forms.
There have been no changes in our internal controls over financial
reporting that occurred during the fiscal quarter to which this report relates
that have materially affected, or are reasonably likely to materially affect,
our internal control over financial reporting.
43
AROTECH CORPORATION
PART II
ITEM 1. LEGAL PROCEEDINGS.
On October 29, 2003, I.E.S. Group, the parent company of IES
Electronics Industries Ltd., the seller from which we purchased the assets of
its IES subsidiary, filed a lawsuit in Tel-Aviv District Court against us and
certain of our past and present officers, entitled IES Electronic Industries
Ltd. et al. v. Arotech Corporation et al. The complaint alleges breaches by us
of certain of our agreements with IES Electronics Industries Ltd. and claims
monetary damages in the amount of approximately $3 million. We believe that the
lawsuit brought by the I.E.S. Group is without merit and we intend to fully and
completely defend the claims vigorously. Although there can be no assurance, we
do not believe we have any material exposure in this matter.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
Sale of Debentures
Pursuant to the terms of a Securities Purchase Agreement dated
September 30, 2003 (the "Purchase Agreement") by and between Arotech Corporation
and six institutional investors (the "Investors"), we issued and sold to the
Investors (i) an aggregate principal amount of $5,000,000 in 8% secured
convertible debentures due September 30, 2006 (the "Initial Debentures"),
convertible into shares of our common stock at any time after January 1, 2004 at
a conversion price of $1.15 per share, and (ii) three-year warrants to purchase
up to an aggregate of 1,250,000 shares of our common stock at any time after
January 1, 2004 (the "Initial Warrants") at an exercise price of $1.4375 per
share.
The Investors also have the right, at their option, at any time prior
to September 30, 2006, to purchase up to an additional $6,000,000 in debentures
(the "Additional Debentures" and, together with the Initial Debentures, the
"Debentures") convertible into shares of our common stock at any time after
January 1, 2004 at a conversion price of $1.45 per share, and to receive
warrants to purchase up to an aggregate of 1,500,000 shares of our common stock
at any time after January 1, 2004 (the "Additional Warrants" and, together with
the Initial Warrants, the "Warrants") at an exercise price of $1.8125 per share.
Under the terms of the Purchase Agreement, we have granted the
Investors (i) a first position security interest in the stock of MDT Armor
Corporation and in any assets that we acquire in future Acquisitions (as defined
in the Purchase Agreement), (ii) a second position security interest in the
assets of our IES Interactive Training, Inc. subsidiary and in the stock of our
subsidiaries other than IES Interactive Training, Inc. and M.D.T. Protective
Industries, Ltd. (junior to the security interest of the holders of our 9%
secured convertible debentures due June 30, 2005), and (iii) a third position
security interest in the stock of our subsidiaries I.E.S. Defense Services,
Inc., IES Interactive Training, Inc. and M.D.T. Protective Industries, Ltd.
(junior to the security interest of the holders of our 9% secured convertible
debentures due June 30, 2005 and to the security interest of I.E.S. Electronics
Industries, Ltd.), all pursuant to the terms of separate security agreements.
Under the terms of the Debentures and Notes, we are not obligated to
issue shares of our common stock upon conversion of a Debenture or exercise of a
Warrant if the issuance of such shares of common stock would exceed that number
of shares of common stock that we may issue without breaching our obligations
under applicable Nasdaq Marketplace Rules unless and until we obtain the
approval of our shareholders to the extent required by applicable Nasdaq
Marketplace Rules.
44
AROTECH CORPORATION
The foregoing description of our agreement with our debenture holders
is qualified in its entirety by reference to the agreements with our debenture
holders filed as exhibits to our Current Report on Form 8-K that we filed with
the SEC on October 3, 2003.
Acquisition of an Additional Interest in MDT
In October 2003, we announced that we had increased our holdings in
both of our vehicle armoring subsidiaries. We now hold 88% of MDT Armor
Corporation and 75.5% in MDT Protective Industries Ltd. We acquired the
additional stake in MDT in September 2003 from AGA Means of Protection and
Commerce Ltd. in exchange for the issuance to AGA of 126,000 shares of our
common stock.
Issuance of Shares to a Consultant
Under the terms of an independent contractor agreement between us and
InteSec Group LLC, we pay InteSec a commission in stock of 5% of the military
battery sales that InteSec brings to us from U.S. and NATO defense, security and
military entities and U.S. defense contractors. Pursuant to the terms of this
agreement, in July 2003, we issued 215,294 shares to InteSec.
We issued all of the above securities in reliance on the exemption from
registration provided by Section 4(2) of the Securities Act as transactions by
an issuer not involving a public offering. The issuance of these securities was
without the use of an underwriter, and the shares of common stock currently bear
restrictive legends permitting transfer thereof only upon registration or an
exemption under the Act.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
We held our 2003 Annual Meeting of Stockholders on September 15, 2003.
At that meeting, the stockholders voted on the following matters with the
following results:
1. Fixing the number of Class I Directors at two:
VOTES FOR VOTES AGAINST ABSTENTIONS SHARES NOT VOTING
--------- ------------- ----------- -----------------
32,800,789 717,296 0 0
2. Election of Class I Directors:
VOTES FOR VOTES AGAINST ABSTENTIONS SHARES NOT VOTING
--------- ------------- ----------- -----------------
Dr. Jay M. Eastman................ 32,800,789 717,296 0 0
Steven Esses......................... 32,800,949 717,136 0 0
(Directors whose terms of office continued after the meeting were
Robert S. Ehrlich, Jack Rosenfeld, Lawrence M. Miller, and Bert W.
Wasserman)
3. Amending the terms of the Company's Amended and Restated Certificate of
Incorporation to change the name of the Company from "Electric Fuel
Corporation" to "Arotech Corporation":
VOTES FOR VOTES AGAINST ABSTENTIONS SHARES NOT VOTING
--------- ------------- ----------- -----------------
33,266,440 169,681 81,964 0
45
AROTECH CORPORATION
ITEM 5. OTHER INFORMATION.
We held our 2003 Annual Meeting of Stockholders on September 15, 2003.
We anticipate holding our 2004 Annual Meeting of Stockholders on Monday, June
14, 2004.
In light of the foregoing and in accordance with Rules 14a-5(f) and
14a-8(e)(2) under the Securities Exchange Act of 1934, as amended, we will
consider stockholder proposals submitted in connection with our 2004 Annual
Meeting to have been submitted in a timely fashion if such proposals are
received by us at our principal offices no later than January 7, 2004. If a
proposal is received after January 7, 2004, the proxies designated by the Board
of Directors of the Company will have discretionary authority to vote on the
proposal under circumstances consistent with the proxy rules of the Securities
and Exchange Commission.
We expect to mail our Annual Report to Shareholders for the year ended
December 31, 2003 along with the Notice and Proxy Statement of the 2004 Annual
Meeting on or about May 5, 2004.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) The following documents are filed as exhibits to this report:
EXHIBIT NUMBER DESCRIPTION
-------------- -----------
31.1 Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
(b) The following reports on Form 8-K were filed during the third
quarter of 2003 and thereafter:
DATE FILED ITEM REPORTED
---------- -------------
July 17, 2003 Item 5 - Other Events and Regulation FD Disclosure
and Item 7 - Financial Statements, Pro Forma
Financial Information and Exhibits
August 7, 2003 Item 7 - Financial Statements, Pro Forma Financial
Information and Exhibits and Item 12 - Results of
Operations and Financial Condition
September 17, 2003 Item 5 - Other Events and Regulation FD Disclosure
September 30, 2003 Item 5 - Other Events and Regulation FD Disclosure
October 3, 2003 Item 5 - Other Events and Regulation FD Disclosure
and Item 7 - Financial Statements, Pro Forma
Financial Information and Exhibits
46
AROTECH CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Dated: November 11, 2003
AROTECH CORPORATION
By: /s/ Robert S. Ehrlich
------------------------------------------
Name: Robert S. Ehrlich
Title: Chairman, President and CEO
(Principal Executive Officer)
/s/ Avihai Shen
------------------------------------------
Name: Avihai Shen
Title: Vice President - Finance
(Principal Financial Officer)
47
AROTECH CORPORATION
EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION
-------------- -----------
31.1 Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
48