arotech10q-2008q3.htm
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|
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Expires:
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|
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
T
|
QUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY
PERIOD
ENDED September
30, 2008 .
|
Commission
file number: 0-23336
|
(Exact
name of registrant as specified in its
charter)
|
Delaware
|
|
95-4302784
|
(State
or other jurisdiction of
incorporation
or organization)
|
|
(I.R.S.
Employer
Identification
No.)
|
1229 Oak Valley Drive, Ann Arbor,
Michigan
|
|
48108
|
(Address
of principal executive offices)
|
|
(Zip
Code)
|
(800) 281-0356
|
(Registrant’s
telephone number, including area
code)
|
|
(Former
name, former address and former fiscal year, 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 T No £
Indicate
by check mark whether the registrant is large accelerated filer, an accelerated
filer, or a non-accelerated filer. See the definitions of “large accelerated
filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.
Large accelerated
filer: £ Accelerated
filer: £ Non-accelerated
filer: £ Smaller
reporting company: T
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes £
No T
The
number of shares outstanding of the issuer’s common stock as of November 12,
2008 was 13,637,639.
Potential
persons who are to respond to the collection of
information
contained in this form are not required to respond
unless
the form displays a currently valid OMB control
number.
|
INDEX
PART
I - FINANCIAL INFORMATION
|
Item 1 – Financial
Statements (Unaudited):
|
|
Condensed
Consolidated Balance Sheets at September 30, 2008 and December 31,
2007
|
3
|
|
Condensed
Consolidated Statements of Operations for the Nine and Three Months Ended
September 30, 2008 and 2007
|
5
|
|
Condensed
Consolidated Statements of Cash Flows for the Nine and Three Months Ended
September 30, 2008 and 2007
|
6
|
|
Notes
to the Interim Condensed Consolidated Financial Statements
|
8
|
|
Item 2 – Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
16
|
|
Item 3 – Quantitative
and Qualitative Disclosures about Market Risk
|
24
|
|
Item 4T – Controls and
Procedures
|
25
|
|
PART
II - OTHER INFORMATION
|
|
|
Item 1 – Legal
Proceedings
|
26
|
|
Item 1A – Risk
Factors
|
26
|
|
Item 6 –
Exhibits
|
30
|
|
SIGNATURES
|
31
|
|
ITEM
1.
|
FINANCIAL
STATEMENTS (UNAUDITED)
|
(U.S.
Dollars)
|
|
September
30, 2008
|
|
|
December
31, 2007
|
|
ASSETS
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
CURRENT
ASSETS:
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
1,641,173 |
|
|
$ |
3,447,671 |
|
Restricted
collateral deposits
|
|
|
163,292 |
|
|
|
320,454 |
|
Escrow
receivable
|
|
|
– |
|
|
|
1,479,826 |
|
Available-for-sale
marketable securities
|
|
|
53,650 |
|
|
|
47,005 |
|
Trade
receivables (net of allowance for doubtful accounts in the amount of $0 as
of September 30, 2008 and $25,000 as of December 31, 2007)
|
|
|
13,930,931 |
|
|
|
14,583,213 |
|
Unbilled
receivables
|
|
|
2,822,609 |
|
|
|
3,271,594 |
|
Other
accounts receivable and prepaid expenses
|
|
|
1,562,742 |
|
|
|
1,614,614 |
|
Inventories
|
|
|
10,673,903 |
|
|
|
7,887,820 |
|
Total
current assets
|
|
|
30,848,300 |
|
|
|
32,652,197 |
|
DEFERRED
TAX ASSETS
|
|
|
101,786 |
|
|
|
77,709 |
|
SEVERANCE
PAY FUND
|
|
|
3,161,644 |
|
|
|
2,815,040 |
|
OTHER
LONG-TERM RECEIVABLES
|
|
|
2,712,529 |
|
|
|
309,190 |
|
PROPERTY
AND EQUIPMENT, NET
|
|
|
5,214,135 |
|
|
|
5,079,796 |
|
INVESTMENT
IN AFFILIATED COMPANY
|
|
|
90,957 |
|
|
|
352,168 |
|
OTHER
INTANGIBLE ASSETS, NET
|
|
|
7,609,397 |
|
|
|
7,837,076 |
|
GOODWILL
|
|
|
33,078,441 |
|
|
|
31,358,131 |
|
|
|
$ |
82,817,189 |
|
|
$ |
80,481,307 |
|
The
accompanying notes are an integral part of the Condensed Consolidated Financial
Statements.
3
CONDENSED
CONSOLIDATED BALANCE SHEETS
(U.S.
Dollars, except share data)
|
|
September
30, 2008
|
|
|
December
31, 2007
|
|
|
|
(Unaudited)
|
|
|
|
|
LIABILITIES
AND SHAREHOLDERS’ EQUITY
|
|
|
|
|
|
|
CURRENT
LIABILITIES:
|
|
|
|
|
|
|
Trade
payables
|
|
$ |
4,311,859 |
|
|
$ |
4,233,288 |
|
Other
accounts payable and accrued expenses
|
|
|
4,097,633 |
|
|
|
4,889,729 |
|
Current
portion of capitalized leases
|
|
|
72,391 |
|
|
|
67,543 |
|
Current
portion of promissory notes due to purchase of
subsidiaries
|
|
|
– |
|
|
|
151,450 |
|
Current
portion of long-term debt
|
|
|
1,477,791 |
|
|
|
103,844 |
|
Short
term bank credit
|
|
|
2,755,674 |
|
|
|
4,557,890 |
|
Deferred
revenues
|
|
|
2,887,839 |
|
|
|
2,903,166 |
|
Total
current liabilities
|
|
|
15,603,187 |
|
|
|
16,906,910 |
|
Accrued
severance pay
|
|
|
5,501,106 |
|
|
|
4,853,231 |
|
Long-term
portion of capitalized leases
|
|
|
133,598 |
|
|
|
86,989 |
|
Long-term
portion of long-term debt
|
|
|
4,293,608 |
|
|
|
1,088,498 |
|
Other
long-term liabilities
|
|
|
157,136 |
|
|
|
110,255 |
|
Deferred
taxes
|
|
|
1,020,000 |
|
|
|
1,020,000 |
|
Total
long-term liabilities
|
|
|
11,105,448 |
|
|
|
7,158,973 |
|
MINORITY
INTEREST
|
|
|
– |
|
|
|
83,816 |
|
SHAREHOLDERS’
EQUITY:
|
|
|
|
|
|
|
|
|
Share
capital –
|
|
|
|
|
|
|
|
|
Common
stock – $0.01 par value each;
|
|
|
|
|
|
|
|
|
Authorized:
250,000,000 shares as of September 30, 2008 and December 31, 2007; Issued
and outstanding: 13,637,639 and 13,544,819 shares as of September 30, 2008
and December 31, 2007, respectively
|
|
|
136,377 |
|
|
|
135,448 |
|
Preferred
shares – $0.01 par value each;
|
|
|
|
|
|
|
|
|
Authorized:
1,000,000 shares as of September 30, 2008 and December 31, 2007; No shares
issued and outstanding as of September 30, 2008 and December 31,
2007
|
|
|
– |
|
|
|
– |
|
Additional
paid-in capital
|
|
|
219,925,303 |
|
|
|
218,551,110 |
|
Accumulated
deficit
|
|
|
(165,486,191 |
) |
|
|
(162,522,558 |
) |
Notes
receivable from shareholders
|
|
|
(1,345,147 |
) |
|
|
(1,333,833 |
) |
Accumulated
other comprehensive loss
|
|
|
2,878,212 |
|
|
|
1,501,441 |
|
Total
shareholders’ equity
|
|
|
56,108,554 |
|
|
|
56,331,608 |
|
|
|
$ |
82,817,189 |
|
|
$ |
80,481,307 |
|
The
accompanying notes are an integral part of the Condensed Consolidated Financial
Statements.
4
(U.S.
Dollars, except share data)
|
|
Nine
months ended September 30,
|
|
|
Three
months ended September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Revenues
|
|
$ |
45,074,091 |
|
|
$ |
40,011,014 |
|
|
$ |
19,216,509 |
|
|
$ |
15,453,124 |
|
Cost
of revenues, exclusive of amortization of intangibles
|
|
|
33,256,814 |
|
|
|
27,764,509 |
|
|
|
13,484,314 |
|
|
|
11,079,269 |
|
Research
and development
|
|
|
1,231,530 |
|
|
|
1,413,852 |
|
|
|
398,658 |
|
|
|
491,597 |
|
Selling
and marketing expenses
|
|
|
3,290,499 |
|
|
|
2,999,226 |
|
|
|
1,003,504 |
|
|
|
905,725 |
|
General
and administrative expenses
|
|
|
10,025,658 |
|
|
|
9,221,310 |
|
|
|
3,199,878 |
|
|
|
3,309,628 |
|
Amortization
of intangible assets
|
|
|
1,362,251 |
|
|
|
1,481,764 |
|
|
|
377,230 |
|
|
|
307,871 |
|
Escrow
adjustment – credit
|
|
|
(1,448,074 |
) |
|
|
– |
|
|
|
– |
|
|
|
– |
|
Total
operating costs and expenses
|
|
|
47,718,678 |
|
|
|
42,880,661 |
|
|
|
18,463,584 |
|
|
|
16,094,090 |
|
Operating
income (loss)
|
|
|
(2,644,587 |
) |
|
|
(2,869,647 |
) |
|
|
752,925 |
|
|
|
(640,966 |
) |
Other
income
|
|
|
670,483 |
|
|
|
75,452 |
|
|
|
11,334 |
|
|
|
6,333 |
|
Financial
expenses, net
|
|
|
(341,632 |
) |
|
|
(707,225 |
) |
|
|
(288,680 |
) |
|
|
(80,412 |
) |
Income
(loss) before minority interest in earnings of a subsidiary, earnings from
affiliated company and income tax expenses
|
|
|
(2,315,736 |
) |
|
|
(3,501,420 |
) |
|
|
475,579 |
|
|
|
(715,045 |
) |
Income
tax expenses
|
|
|
(386,690 |
) |
|
|
(298,193 |
) |
|
|
(374,862 |
) |
|
|
(123,287 |
) |
Loss
from affiliated company
|
|
|
(261,207 |
) |
|
|
(139,725 |
) |
|
|
(145,121 |
) |
|
|
(27,546 |
) |
Minority
interest in loss (earnings) of subsidiaries
|
|
|
– |
|
|
|
(27,402 |
) |
|
|
– |
|
|
|
82,929 |
|
Net
loss
|
|
$ |
(2,963,633 |
) |
|
$ |
(3,966,740 |
) |
|
$ |
(44,404 |
) |
|
$ |
(782,949 |
) |
Basic
and diluted net loss per share
|
|
$ |
(0.24 |
) |
|
$ |
(0.35 |
) |
|
$ |
(0.00 |
) |
|
$ |
(0.06 |
) |
Weighted
average number of shares used in computing basic net loss per
share
|
|
|
12,595,987 |
|
|
|
11,315,676 |
|
|
|
12,604,715 |
|
|
|
12,161,564 |
|
The
accompanying notes are an integral part of the Condensed Consolidated Financial
Statements.
5
|
|
|
|
Nine
months ended September 30,
|
|
|
|
2008
|
|
|
2007
|
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
|
Net
loss
|
|
$ |
(2,963,633 |
) |
|
$ |
(3,966,740 |
) |
Adjustments
required to reconcile net loss to net cash used in operating
activities:
|
|
|
|
|
|
|
|
|
Minority
interest in loss of subsidiary
|
|
|
– |
|
|
|
27,402 |
|
Loss
from affiliated company
|
|
|
261,211 |
|
|
|
139,725 |
|
Depreciation
|
|
|
957,590 |
|
|
|
1,495,194 |
|
Amortization
of intangible assets and capitalized software costs
|
|
|
1,362,252 |
|
|
|
1,481,764 |
|
Amortization
of debt discount
|
|
|
17,179 |
|
|
|
– |
|
Accrued
severance pay, net
|
|
|
301,271 |
|
|
|
259,402 |
|
Compensation
related to shares issued to employees, consultants and
directors
|
|
|
853,139 |
|
|
|
1,258,464 |
|
Financial
expense relating to warrants issued to the holders of convertible
debentures and beneficial conversion feature
|
|
|
– |
|
|
|
280,382 |
|
Amortization
of deferred charges related to convertible debenture
issuance
|
|
|
– |
|
|
|
62,999 |
|
Escrow
adjustment
|
|
|
(1,845,977 |
) |
|
|
– |
|
Decrease
(increase) in trade receivables and notes receivable
|
|
|
845,096 |
|
|
|
(2,217,231 |
) |
Decrease
(increase) in other accounts receivable and prepaid
expenses
|
|
|
48,866 |
|
|
|
(82,348 |
) |
Decrease
(increase) in deferred tax assets
|
|
|
(24,077 |
) |
|
|
12,772 |
|
Increase
in inventories
|
|
|
(2,755,889 |
) |
|
|
(1,344,215 |
) |
Decrease
in unbilled receivables
|
|
|
514,286 |
|
|
|
244,378 |
|
Decrease
(increase) in deferred revenues
|
|
|
(15,327 |
) |
|
|
239,353 |
|
Decrease
in trade payables
|
|
|
67,611 |
|
|
|
1,723,774 |
|
Decrease
in other accounts payable and accrued expenses
|
|
|
(881,249 |
) |
|
|
(499,603 |
) |
Net
cash used in operating activities
|
|
|
(3,257,651 |
) |
|
|
(884,528 |
) |
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Purchase
of property and equipment
|
|
|
(982,905 |
) |
|
|
(1,235,407 |
) |
Convertible
loan
|
|
|
(2,500,000 |
) |
|
|
– |
|
Proceeds
from escrow settlement
|
|
|
3,325,803 |
|
|
|
– |
|
Acquisition
of subsidiary, net of cash acquired
|
|
|
(1,037,884 |
) |
|
|
– |
|
Acquisition
of minority interest
|
|
|
(660,500 |
) |
|
|
– |
|
Repayment
of promissory notes related to acquisition of subsidiaries
|
|
|
(151,450 |
) |
|
|
(227,175 |
) |
Decrease
in restricted cash
|
|
|
150,517 |
|
|
|
397,464 |
|
Net
cash used in investing activities
|
|
|
(1,856,419 |
) |
|
|
(1,065,118 |
) |
FORWARD
|
|
$ |
(5,114,070 |
) |
|
$ |
(1,949,646 |
) |
The
accompanying notes are an integral part of the Condensed Consolidated Financial
Statements.
6
CONSOLIDATED
STATEMENT OF CASH FLOWS (UNAUDITED) (U.S. Dollars)
|
|
Nine
months ended September 30,
|
|
|
|
2008
|
|
|
2007
|
|
FORWARD
|
|
$ |
(5,114,070 |
) |
|
$ |
(1,949,646 |
) |
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Proceeds
from exercise of options
|
|
|
– |
|
|
|
37,642 |
|
Accrued
interest – financing activities
|
|
|
62,500 |
|
|
|
– |
|
Repayment
of long term loans
|
|
|
(88,322 |
) |
|
|
(13,894 |
) |
Increase
(decrease) in short term bank credit
|
|
|
(1,802,216 |
) |
|
|
1,236,396 |
|
Increase
in senior convertible note
|
|
|
5,000,000 |
|
|
|
– |
|
Net
cash used in financing activities
|
|
|
3,171,962 |
|
|
|
1,260,144 |
|
DECREASE
IN CASH AND CASH EQUIVALENTS
|
|
|
(1,942,108 |
) |
|
|
(689,502 |
) |
CASH
ACCRETION (EROSION) DUE TO EXCHANGE RATE DIFFERENCES
|
|
|
135,610 |
|
|
|
(21,396 |
) |
CASH
AND CASH EQUIVALENTS AT THE BEGINNING OF THE PERIOD
|
|
|
3,447,671 |
|
|
|
2,368,872 |
|
CASH
AND CASH EQUIVALENTS AT THE END OF THE PERIOD
|
|
$ |
1,641,173 |
|
|
$ |
1,657,974 |
|
SUPPLEMENTARY
INFORMATION ON NON-CASH TRANSACTIONS:
|
|
|
|
|
|
|
|
|
Stock
issued for acquisition
|
|
$ |
100,000 |
|
|
$ |
– |
|
Assets
recorded for capital lease addition
|
|
$ |
109,025 |
|
|
$ |
– |
|
Interest
paid
|
|
$ |
253,590 |
|
|
$ |
271,953 |
|
Mortgage
note payable (seller financed) issued for purchase of
building
|
|
$ |
– |
|
|
$ |
1,115,000 |
|
The
accompanying notes are an integral part of the Condensed Consolidated Financial
Statements.
7
NOTE
1: BASIS
OF PRESENTATION
a. Company:
Arotech
Corporation (“Arotech” or the “Company”), and its wholly-owned subsidiaries
provide defense and security products for the military, law enforcement and
homeland security markets, including advanced zinc-air and lithium batteries and
chargers, multimedia interactive simulators/trainers and lightweight vehicle
armoring. The Company is primarily operating through its wholly-owned
subsidiaries FAAC Corporation (“FAAC”) and FAAC’s division IES Industries
(“IES”), both based in Ann Arbor, Michigan, and FAAC’s subsidiary Realtime
Technologies, Inc. (“RTI”), which is based in Royal Oak, Michigan; Electric Fuel
Battery Corporation (“EFB”), based in Auburn, Alabama; Electric Fuel Ltd.
(“EFL”), based in Beit Shemesh, Israel; Epsilor Electronic Industries, Ltd.
(“Epsilor”), based in Dimona, Israel; MDT Protective Industries, Ltd. (“MDT”),
based in Lod, Israel; MDT Armor Corporation (“MDT Armor”), based in Auburn,
Alabama; and Armour of America, Incorporated (“AoA”), based in Auburn,
Alabama.
b. Basis
of presentation:
The
accompanying interim condensed consolidated financial statements have been
prepared by Arotech Corporation in accordance with generally accepted accounting
principles for interim financial information, with the instructions to Form 10-Q
and with Article 10 of Regulation S-X, and include the accounts of Arotech
Corporation and its subsidiaries. Certain information and footnote disclosures,
normally included in complete financial statements prepared in accordance with
generally accepted accounting principles, have been condensed or omitted. In the
opinion of the Company, the unaudited financial statements reflect all
adjustments (consisting only of normal recurring adjustments) necessary for a
fair presentation of its financial position at September 30, 2008, its operating
results for the three- and nine-month periods ended September 30, 2008 and 2007,
and its cash flow for the nine-month periods ended September 30, 2008 and
2007.
The
results of operations for the three and nine months ended September 30, 2008 are
not necessarily indicative of results that may be expected for any other interim
period or for the full fiscal year ending December 31, 2008.
The
balance sheet at December 31, 2007 has been derived from the audited financial
statements at that date but does not include all the information and footnotes
required by generally accepted accounting principles for complete financial
statements. These condensed consolidated financial statements should be read in
conjunction with the audited financial statements included in the Company’s
Annual Report on Form 10-K for the year ended December 31, 2007.
c. Accounting
for stock-based compensation:
For the
three months ended September 30, 2008 and 2007 the compensation expense recorded
related to stock options and restricted shares was $221,792 and $1,258,464,
respectively, of which $17,331 and $145,170, respectively, was for stock options
and $204,461 and $1,113,294, respectively, was for restricted shares. The
remaining total compensation cost related to non-vested stock options and
restricted share awards not yet recognized in the income statement
as
of September
30, 2008 was $1,222,944 of which $40,989 was for stock options and $1,181,955
was for restricted shares. The weighted average period over which this
compensation cost is expected to be recognized is approximately two years.
Income tax expense was not impacted since the Company is in a net operating loss
position. There were no new options or restricted stock issued in the first nine
months of 2008 and no options were exercised in the first nine months of 2008.
The Company’s directors received their annual restricted stock grants on April
1, 2008 in accordance with the terms of the directors’ stock compensation
plan.
d. Reclassification:
Certain
comparative data in these financial statements have been reclassified to conform
with the current year’s presentation.
e. Anti-dilutive
shares for EPS calculation
All
outstanding stock options, non-vested restricted stock and warrants have been
excluded from the calculation of the diluted net loss per common share because
all such securities are anti-dilutive for the periods presented. The total
weighted average number of shares related to the outstanding options, restricted
stock and warrants excluded from the calculations of diluted net loss per share
for the periods ended September 30, 2008 and 2007 were 2,058,922 and 1,643,974,
respectively.
NOTE
2: INVENTORIES
Inventories
are stated at the lower of cost or market value. Cost is determined using the
average cost method or the FIFO method. The Company periodically evaluates the
quantities on hand relative to current and historical selling prices and
historical and projected sales volume. Based on these evaluations, provisions
are made in each period to write down inventory to its net realizable value.
Inventory write-offs are provided to cover risks arising from slow-moving items,
technological obsolescence, excess inventories, and for market prices lower than
cost. Inventories are composed of the following:
|
|
September
30, 2008
|
|
|
December
31, 2007
|
|
|
|
(Unaudited)
|
|
|
|
|
Raw
and packaging materials
|
|
$ |
8,453,053 |
|
|
$ |
6,043,170 |
|
Work-in-progress
|
|
|
1,924,009 |
|
|
|
1,583,790 |
|
Finished
goods
|
|
|
296,841 |
|
|
|
260,860 |
|
|
|
$ |
10,673,903 |
|
|
$ |
7,887,820 |
|
NOTE
3: IMPACT
OF RECENTLY ISSUED ACCOUNTING STANDARDS
In
December 2007, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 141(R), Business Combinations, to
further enhance the accounting and financial reporting related to business
combinations. SFAS No. 141(R) establishes principles and requirements for how
the acquirer in a business combination (1) recognizes and measures in its
financial statements the identifiable assets acquired, the liabilities assumed,
and any noncontrolling interest in the acquiree, (2) recognizes and measures the
goodwill acquired in the business combination or a gain from a bargain purchase,
and (3) determines what information
to
disclose to enable users of the financial statements to evaluate the nature and
financial effects of the business combination. SFAS No. 141(R) applies
prospectively to business combinations for which the acquisition date is on or
after the beginning of the first annual reporting period beginning on or after
December 15, 2008. Therefore, the effects of the Company’s adoption of SFAS No.
141(R) will depend upon the extent and magnitude of acquisitions after December
31, 2008.
In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This
Statement defines fair value, establishes a framework for measuring fair value
and expands disclosures about fair value measurements. SFAS No. 157 applies to
other accounting pronouncements that require or permit fair value measurements,
the Board having previously concluded in those accounting pronouncements that
fair value is the relevant measurement attribute. The Statement does not require
any new fair value measurements and was initially effective for the Company
beginning January 1, 2008. In February 2008, the FASB issued FASB Staff Position
(FSP) FAS 157-2. FSP FAS 157-2 defers the effective date of SFAS No. 157 until
January 1, 2009 for nonfinancial assets and nonfinancial liabilities except
those items recognized or disclosed at fair value on an annual or more
frequently recurring basis. On January 1, 2008, we adopted the provisions of
SFAS No. 157 for our financial assets and liabilities. The adoption of the
standard did not have a material impact on our financial statements. We elected
to defer the adoption of SFAS No. 157 for our non-financial assets and
liabilities until January 1, 2009. We are currently evaluating the impact that
the deferred provisions of this standard will have on our financial
statements.
In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities. This Statement permits entities to
choose to measure eligible items at fair value at specified election dates. For
items for which the fair value option has been elected, unrealized gains and
losses are to be reported in earnings at each subsequent reporting date. The
fair value option is irrevocable unless a new election date occurs, may be
applied instrument by instrument, with a few exceptions, and applies only to
entire instruments and not to portions of instruments. SFAS No. 159 provides an
opportunity to mitigate volatility in reported earnings caused by measuring
related assets and liabilities differently without having to apply complex hedge
accounting. SFAS No. 159 was effective for the Company beginning January 1,
2008. The adoption of the standard did not have a material impact on the
Company’s financial statements.
In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements – an amendment of ARB No. 51, to create
accounting and reporting standards for the noncontrolling interest in a
subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 establishes
accounting and reporting standards that require (1) the ownership interest in
subsidiaries held by parties other than the parent to be clearly identified and
presented in the consolidated balance sheet within equity, but separate from the
parent’s equity, (2) the amount of consolidated net income attributable to the
parent and the noncontrolling interest to be clearly identified and presented on
the face of the consolidated statement of income, (3) changes in a parent’s
ownership interest while the parent retains its controlling financial interest
in its subsidiary to be accounted for consistently, (4) when a subsidiary is
deconsolidated, any retained noncontrolling equity investment in the former
subsidiary to be initially measured at fair value, and (5) entities to provide
sufficient disclosures that clearly identify and distinguish between the
interests of the parent and the interests of the noncontrolling owners. SFAS No.
160 applies to fiscal years, and interim periods within those fiscal years,
beginning on or after December 15, 2008, and prohibits
early
adoption. Management has not completed its review of the new guidance; however,
the effect of the Statement’s implementation is not expected to be material to
the Company’s results of operations or financial position.
In March
2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities. SFAS No.161 requires expanded
disclosures regarding the location and amounts of derivative instruments in an
entity’s financial statements, how derivative instruments and related hedged
items are accounted for under SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, and how derivative instruments and
related hedged items affect an entity’s financial position, operating results
and cash flows. SFAS No. 161 is effective for fiscal years beginning after
November 15, 2008. Since SFAS No. 161 affects only disclosures, it is not
expected to impact the Company’s financial position or results of operations
upon adoption.
In
May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted
Accounting Principles.” SFAS No. 162 is intended to improve financial
reporting by identifying a consistent framework, or hierarchy, for selecting
accounting principles to be used in preparing financial statements that are
presented in conformity with generally accepted accounting principles in the
United States for non-governmental entities. SFAS No. 162 is effective 60
days following approval by the SEC of the Public Company Accounting Oversight
Board’s amendments to AU Section 411, “The Meaning of Present Fairly in
Conformity With Generally Accepted Accounting Principles.” The Company
does not expect that the adoption of SFAS No. 162 will impact its financial
position or results of operations.
In
May 2008, the FASB issued FASB Staff Position No. APB 14-1, “Accounting for Convertible Debt
Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash
Settlement)” (“FSP No. APB 14-1”). FSP No. APB 14-1 clarifies
that convertible debt instruments that may be settled in cash upon conversion
(including partial cash settlement) are not addressed by paragraph 12 of APB
Opinion No. 14, “Accounting for Convertible Debt and
Debt Issued with Stock Purchase Warrants.” Additionally, FSP No. APB
14-1 specifies that issuers of such instruments should separately account for
the liability and equity components in a manner that will reflect the entity’s
nonconvertible debt borrowing rate when interest cost is recognized in
subsequent periods. FSP No. APB 14-1 is effective for financial statements
issued for fiscal years and interim periods beginning after December 15,
2008. The Company does not expect the adoption of this pronouncement will impact
its financial position or results of operations.
In
June 2008, the Financial Accounting Standards Board (“FASB”) ratified the
consensus reached on Emerging Issues Task Force Issue No. 07-05, “Determining Whether an Instrument
(or Embedded Feature) Is Indexed to an Entity’s Own Stock” (“EITF Issue
No. 07-5”). EITF Issue No. 07-05 clarifies the determination of whether an
instrument (or an embedded feature) is indexed to an entity’s own stock, which
would qualify as a scope exception under SFAS No. 133, “Accounting for Derivative
Instruments and Hedging Activities.” EITF Issue No. 07-05 is
effective for financial statements issued for fiscal years beginning after
December 15, 2008. Early adoption for an existing instrument is not
permitted. The Company does not expect the adoption of this pronouncement to
materially impact its financial position or results of operations.
NOTE
4: SEGMENT
INFORMATION
a. General:
The
Company and its subsidiaries operate primarily in three business segments and
follow the requirements of SFAS No. 131.
The
Company’s reportable operating segments have been determined in accordance with
the Company’s internal management structure, which is organized based on
operating activities. The accounting policies of the operating segments are the
same as those used by the Company in the preparation of its annual financial
statement. The Company evaluates performance based upon two primary factors, one
is the segment’s operating income and the other is the segment’s contribution to
the Company’s future strategic growth.
b. The
following is information about reported segment revenues, income (losses) and
total assets for the nine and three months ended September 30, 2008 and
2007:
|
|
Training
and
Simulation
|
|
|
Battery
and
Power
Systems
|
|
|
Armor
|
|
|
All
Others
|
|
|
Total
|
|
Nine
months ended September 30, 2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
from outside customers
|
|
$ |
23,093,720 |
|
|
$ |
9,705,039 |
|
|
$ |
12,275,332 |
|
|
$ |
– |
|
|
$ |
45,074,091 |
|
Depreciation,
amortization and impairment expenses (1)
|
|
|
(1,235,206 |
) |
|
|
(778,558 |
) |
|
|
(124,719 |
) |
|
|
(181,359 |
) |
|
|
(2,319,842 |
) |
Direct
expenses (2)
|
|
|
(19,047,945 |
) |
|
|
(9,901,501 |
) |
|
|
(13,119,221 |
) |
|
|
(3,307,583 |
) |
|
|
(45,376,250 |
) |
Segment
income (loss)
|
|
$ |
2,810,569 |
|
|
$ |
(975,020 |
) |
|
$ |
(968,608 |
) |
|
$ |
(3,488,942 |
) |
|
$ |
(2,622,001 |
) |
Financial
income (expense)
|
|
|
(63,091 |
) |
|
|
(33,527 |
) |
|
|
(46,341 |
) |
|
|
(198,673 |
) |
|
|
(341,632 |
) |
Net
income (loss)
|
|
$ |
2,747,478 |
|
|
$ |
(1,008,547 |
) |
|
$ |
(1,014,949 |
) |
|
$ |
(3,687,615 |
) |
|
$ |
(2,963,633 |
) |
Segment
assets (3),
(4)
|
|
$ |
42,829,421 |
|
|
$ |
24,654,308 |
|
|
$ |
11,906,762 |
|
|
$ |
3,426,698 |
|
|
$ |
82,817,189 |
|
Nine
months ended September 30, 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
from outside customers
|
|
$ |
17,836,204 |
|
|
$ |
8,118,285 |
|
|
$ |
14,056,525 |
|
|
$ |
– |
|
|
$ |
40,011,014 |
|
Depreciation,
amortization and impairment expenses (1)
|
|
|
(1,663,693 |
) |
|
|
(717,189 |
) |
|
|
(413,093 |
) |
|
|
(182,983 |
) |
|
|
(2,976,958 |
) |
Direct
expenses (2)
|
|
|
(14,313,219 |
) |
|
|
(7,688,329 |
) |
|
|
(12,995,643 |
) |
|
|
(5,296,380 |
) |
|
|
(40,293,571 |
) |
Segment
income (loss)
|
|
$ |
1,859,292 |
|
|
$ |
(287,233 |
) |
|
$ |
647,789 |
|
|
$ |
(5,479,363 |
) |
|
$ |
(3,259,515 |
) |
Financial
income (expense)
|
|
|
4,124 |
|
|
|
(12,288 |
) |
|
|
(35,057 |
) |
|
|
(664,004 |
) |
|
|
(707,225 |
) |
Net
income (loss)
|
|
$ |
1,863,416 |
|
|
$ |
(299,521 |
) |
|
$ |
612,732 |
|
|
$ |
(6,143,367 |
) |
|
$ |
(3,966,740 |
) |
Segment
assets (3),
(4)
|
|
$ |
44,383,057 |
|
|
$ |
19,725,033 |
|
|
$ |
10,835,160 |
|
|
$ |
2,148,703 |
|
|
$ |
77,091,953 |
|
Three
months ended September 30, 2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
from outside customers
|
|
$ |
8,373,813 |
|
|
$ |
4,387,518 |
|
|
$ |
6,455,178 |
|
|
$ |
– |
|
|
$ |
19,216,509 |
|
Depreciation,
amortization and impairment expenses(1)
|
|
|
(340,326 |
) |
|
|
(277,485 |
) |
|
|
(46,768 |
) |
|
|
(60,318 |
) |
|
|
(724,897 |
) |
Direct
expenses(2)
|
|
|
(6,765,345 |
) |
|
|
(4,064,306 |
) |
|
|
(5,699,623 |
) |
|
|
(1,718,062 |
) |
|
|
(18,247,336 |
) |
Segment
income (loss)
|
|
$ |
1,268,142 |
|
|
$ |
45,727 |
|
|
$ |
708,787 |
|
|
$ |
(1,778,380 |
) |
|
$ |
244,276 |
|
Financial
expense
|
|
|
(74,147 |
) |
|
|
(64,299 |
) |
|
|
(53,565 |
) |
|
|
(96,669 |
) |
|
|
(288,680 |
) |
Net
income (loss)
|
|
$ |
1,193,995 |
|
|
$ |
(18,572 |
) |
|
$ |
655,222 |
|
|
$ |
(1,875,049 |
) |
|
$ |
(44,404 |
) |
|
|
Training
and
Simulation
|
|
|
Battery
and
Power
Systems
|
|
|
Armor
|
|
|
All
Others
|
|
|
Total
|
|
Three
months ended September 30, 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
from outside customers
|
|
$ |
8,440,458 |
|
|
$ |
3,033,757 |
|
|
$ |
3,978,908 |
|
|
$ |
– |
|
|
$ |
15,453,123 |
|
Depreciation,
amortization and impairment expenses (1)
|
|
|
(230,272 |
) |
|
|
(237,402 |
) |
|
|
(86,638 |
) |
|
|
(64,805 |
) |
|
|
(619,117 |
) |
Direct
expenses (2)
|
|
|
(6,669,473 |
) |
|
|
(2,969,914 |
) |
|
|
(4,539,103 |
) |
|
|
(1,358,053 |
) |
|
|
(15,536,543 |
) |
Segment
income (loss)
|
|
$ |
1,540,713 |
|
|
$ |
(173,559 |
) |
|
$ |
(646,833 |
) |
|
$ |
(1,422,858 |
) |
|
$ |
(702,537 |
) |
Financial
income (expense)
|
|
|
3,700 |
|
|
|
41,148 |
|
|
|
(30,744 |
) |
|
|
(94,516 |
) |
|
|
(80,412 |
) |
Net
income (loss)
|
|
$ |
1,544,413 |
|
|
$ |
(132,411 |
) |
|
$ |
(677,577 |
) |
|
$ |
(1,517,374 |
) |
|
$ |
(782,949 |
) |
(1)
|
Includes
depreciation of property and equipment, amortization expenses of
intangible assets and impairment of goodwill and other intangible
assets.
|
(2)
|
Including,
inter alia, sales
and marketing, general and administrative and tax
expenses.
|
(3)
|
Consisting
of all assets.
|
(4)
|
Out
of those amounts, goodwill in our Training and Simulation, Battery and
Power Systems and Armor Divisions stood at $24,435,641, $6,685,417 and
$1,957,385 respectively, as of September 30, 2008 and $24,235,419,
$5,485,923 and $1,084,946, respectively, as of September 30,
2007.
|
NOTE
5: COMPREHENSIVE
LOSS
Comprehensive
loss for the nine and three months ended September 30, 2008 and 2007 is
summarized below:
|
|
Nine
Months Ended September 30,
|
|
|
Three
Months Ended September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Net
loss
|
|
$ |
(2,963,633 |
) |
|
$ |
(3,966,740 |
) |
|
$ |
(44,404 |
) |
|
$ |
(782,949 |
) |
Foreign
currency translation
|
|
|
1,376,771 |
|
|
|
92,396 |
|
|
|
(265,233 |
) |
|
|
299,287 |
|
Total
comprehensive loss
|
|
$ |
(1,586,862 |
) |
|
$ |
(3,874,344 |
) |
|
$ |
(309,637 |
) |
|
$ |
(483,662 |
) |
NOTE
6: ACQUISITIONS
Purchase
of the Minority Interest in MDT Israel and MDT Armor
In
January 2008, the Company purchased the minority shareholder’s 24.5% interest in
MDT Protective Industries Ltd. (“MDT Israel”) and the 12.0% interest in MDT
Armor Corporation (“MDT Armor”), as well as settling all outstanding disputes
regarding severance payments, in exchange for a total of $1.0 million that was
paid in cash. The purchase was treated as a step acquisition using the purchase
method of accounting. The Company evaluated the purchase price and identified
$607,100 in goodwill and workforce intangibles with an indefinite life. The
Company also identified $53,400 as an intangible asset related to its customer
list with a useful life of four years. The purchase price included a payment of
$241,237 to the former president of MDT Israel as compensation for a right
granted to him by MDT Armor that potentially would have given him the right to
receive 5% of MDT Armor’s annual profit. The payment for this right was recorded
as general and administrative expense in the first quarter.
Purchase of
Realtime Technologies, Inc.
In
February 2008 the Company’s FAAC subsidiary acquired all of the outstanding
stock of Realtime Technologies, Inc. (RTI), a privately-owned corporation
headquartered in Royal Oak, Michigan, for a total of $1,375,000, including
$1,250,000 in cash, $100,000 in Company stock (54,348 shares) and approximately
$37,000 in acquisition costs with a 2008 earnout (maximum of $250,000) based on
2008 net profit. RTI specializes in multi-body vehicle dynamics modeling
and
graphical
simulation solutions. RTI’s product portfolio provides FAAC with the opportunity
to economically add new features to the driver training products marketed by
FAAC.
RTI’s
operating results will be included in the Company’s Training and Simulation
Division as of January 1, 2008 and the effect on operations is not expected to
be material.
Listed
below is the purchase price allocation:
Current
assets acquired, net of liabilities
|
|
$ |
433,389 |
|
Technology
and Patents - 7 year life
|
|
|
663,000 |
|
Trademark/Trade
Names - 10 year life
|
|
|
28,000 |
|
Customer
relationships - 10 year life
|
|
|
62,000 |
|
Goodwill
- indefinite life(1)
|
|
|
200,222 |
|
Equity
Value
|
|
$ |
1,386,611 |
|
_____________________________
(1)
The full amount of the goodwill is expected to be deductible for U.S. tax
purposes.
|
NOTE
7: ARBITRATION
In
connection with the Company’s acquisition of AoA, the Company had a contingent
earnout obligation in an amount equal to the revenues AoA realized from certain
specific programs that were identified by the Company and the seller of AoA
(“Seller”) as appropriate targets for revenue increases. As of December 31,
2006, the Company had reduced the $3.0 million escrow held by the Seller by
approximately $1,520,000 for a putative claim against such escrow in respect of
such earnout obligation.
On March
20, 2007, the Company filed a Demand for Arbitration with the American
Arbitration Association against the Seller. In February 2008, the arbitration
panel issued a decision denying the Seller’s counterclaims, granting the
Seller’s counterclaim for $70,000 in compensation, awarding the Company the
entire $3.0 million escrow (less the $70,000 in compensation (with simple
interest but without statutory penalties)), awarding the Company $135,000 in
attorneys’ fees, and interest of approximately $325,000. This award was paid to
the Company in April 2008, and the time for the Seller to move to vacate or
modify this award has now expired. In the first quarter of 2008, the Company
adjusted the escrow receivable to reflect the updated amount of the escrow due
to the arbitration panel’s decision and final resolution of the remaining legal
questions.
NOTE
8: CONVERTIBLE
NOTES AND DETACHABLE WARRANTS
a. 10%
Senior Convertible Notes due August 15, 2011
Pursuant
to the terms of a Securities Purchase Agreement dated August 14, 2008, the
Company issued and sold to a group of institutional investors 10% senior
convertible notes in the aggregate principal amount of $5.0 million due August
15, 2011. These notes are convertible at any time prior to August 15, 2011 at a
conversion price of $2.24 per share. As part of our analysis of the convertible
debt and related warrants, we reviewed and followed the guidance of SFAS No. 150
and EITF Issues No. 00-19, 00-27 and 05-2.
As part
of the securities purchase agreement, the Company issued to the purchasers of
its 10% senior convertible notes due August 15, 2011, warrants to purchase an
aggregate of 558,036
shares of
common stock at any time prior to August 15, 2011 at a price of $2.24 per share.
The warrants were classified as equity based on relative fair
value.
The
relative fair value of these warrants was determined using Black-Scholes pricing
model, assuming a risk-free interest rate of 2.78%, a volatility factor 75%,
dividend yields of 0% and a contractual life of 3.0 years.
In
connection with these convertible notes, the Company recorded a deferred debt
discount of $412,000 with respect to the beneficial conversion feature and the
discount arising from fair value allocation of the warrants according to APB No.
14, which is being amortized from the date of issuance to the stated redemption
date – August 15, 2011 – or to the actual conversion date, if earlier, as
financial expenses using the effective interest method.
Principle
payments are due on the convertible notes as follows:
Year
|
|
Amount
|
|
2009
|
|
$ |
1,818,180 |
|
2010
|
|
|
1,818,180 |
|
2011
|
|
|
1,363,640 |
|
|
|
$ |
5,000,000 |
|
NOTE
9: FINANCING
ACTIVITIES
Concurrent
with the Securities Purchase Agreement dated August 14, 2008, the Company
purchased a $2,500,000 Senior Subordinated Convertible Note from an unaffiliated
company. This 10% Senior Subordinated Convertible Note is due December 31, 2009.
The note is convertible at maturity at the Company’s option into such number of
shares of the unaffiliated company’s common stock, no par value per share, as
shall be equal at the time of conversion to twelve percent (12%) of the
unaffiliated company’s outstanding common stock.
Interest
on the outstanding principal amount of this note commenced accruing on the
issuance date and is payable quarterly, in arrears, on November 15, February 15,
May 15 and August 15 of each year with the first payment due November 15,
2008.
Interest
on this note will be recognized as a reduction of financial expenses and will be
shown on an accrual basis. Related fees and costs will be recorded as general
and administrative expense.
ITEM
2.
|
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
|
This
report contains forward-looking statements made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. These
statements involve inherent risks and uncertainties. When used in this
discussion, the words “believes,” “anticipated,” “expects,” “estimates” and
similar expressions are intended to identify such forward-looking statements.
Such statements are subject to certain risks and uncertainties. Readers are
cautioned not to place undue reliance on these forward-looking statements, which
speak only as of the date hereof. We undertake no obligation to publicly release
the result of any revisions to these forward-looking statements that may be made
to reflect events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events. Our actual results could differ materially
from those anticipated in these forward-looking statements as a result of
certain factors including, but not limited to, those set forth elsewhere in this
report. Please see “Risk Factors,” below, and in our other filings with the
Securities and Exchange Commission.
Arotech™
is a trademark and Electric Fuel® is a
registered trademark of Arotech Corporation. All company and product names
mentioned may be trademarks or registered trademarks of their respective
holders. Unless the context requires otherwise, all references to us refer
collectively to Arotech Corporation and its subsidiaries.
We
make available through our internet website free of charge our annual report on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K,
amendments to such reports and other filings made by us with the SEC, as soon as
practicable after we electronically file such reports and filings with the SEC.
Our website address is www.arotech.com. The information contained in this
website is not incorporated by reference in this report.
The
following discussion and analysis should be read in conjunction with the interim
financial statements and notes thereto appearing elsewhere in this Quarterly
Report. We have rounded amounts reported here to the nearest thousand, unless
such amounts are more than 1.0 million, in which event we have rounded such
amounts to the nearest hundred thousand.
Executive
Summary
Divisions
and Subsidiaries
We are a
defense and security products and services company, engaged in three business
areas: interactive simulation for military, law enforcement and commercial
markets; batteries and charging systems for the military; and high-level
armoring for military, paramilitary and commercial vehicles. We operate in three
business units:
Ø
|
we
develop, manufacture and market advanced high-tech multimedia and
interactive digital solutions for use-of-force and driving training of
military, law enforcement, security and other personnel (our Training
and Simulation Division);
|
Ø
|
we
provide aviation armor kits and we utilize sophisticated lightweight
materials and advanced engineering processes to armor vehicles (our Armoring
Division); and
|
Ø
|
we
develop, manufacture and market primary Zinc-Air batteries, rechargeable
batteries and battery chargers for defense and security products and other
military applications (our Battery and
Power Systems Division).
|
Overview
of Results of Operations
We
incurred significant operating losses for the year ended December 31, 2007 and
for the first nine months of 2008. While we expect to continue to derive
revenues from the sale of products that our subsidiaries manufacture and the
services that they provide, there can be no assurance that we will be able to
achieve or maintain profitability on a consistent basis.
A portion
of our operating loss during 2007 and the first nine months of 2008 arose as a
result of non-cash charges. These charges were primarily related to our
acquisitions, financings and issuances of restricted shares and options to
employees. To the extent that we continue these activities during the remainder
of 2008, we would expect to continue to incur such non-cash charges in the
future.
Acquisitions
In
acquisition of subsidiaries, part of the purchase price is allocated to
intangible assets and goodwill. Amortization of intangible assets related to
acquisition of subsidiaries is recorded based on the estimated expected life of
the assets. Accordingly, for a period of time following an acquisition, we incur
a non-cash charge related to amortization of intangible assets in the amount of
a fraction (based on the useful life of the intangible assets) of the amount
recorded as intangible assets. Such amortization charges continued during 2008.
We are required to review intangible assets for impairment whenever events or
changes in circumstances indicate that carrying amount of the assets may not be
recoverable. If we determine, through the impairment review process, that
intangible asset has been impaired, we must record the impairment charge in our
statement of operations. We incurred non-cash charges for amortization of
intangible assets in the amount of $1,362,000 during the first nine months of
2008.
In the
case of goodwill, the assets recorded as goodwill are not amortized; instead, we
are required to perform an annual impairment review. If we determine, through
the impairment review process, that goodwill has been impaired, we must record
the impairment charge in our statement of operations. We have completed our
impairment review, which is done annually at the end of the second quarter. We
have determined that the fair value of the respective reporting units exceeds
their respective carrying values, and therefore, there will be no impairment
charges relating to goodwill. Although the cumulative book value of our
reporting units exceeds our market value as of the impairment review, management
still believes that the goodwill is not impaired. Several factors confirm this
judgment: the long term horizon of the valuation process versus a short term
valuation using current market conditions; and the valuation by individual
business segments versus the market share value based on the Company as a whole.
Also, our stock is thinly traded and management feels that in the current
market, our stock is undervalued, especially when compared to the estimated
future cash flows of the underlying entities.
Financings
The
non-cash charges that relate to our financings arise when we sell convertible
debentures or notes and warrants. When we issue warrants in connection with
convertible debentures or notes, we record the debt discount associated with the
transaction that is amortized ratably over the term of the convertible
debentures or notes; when the convertible debentures or notes are converted, the
entire remaining unamortized financial expense is immediately recognized in the
quarter in which the conversion occurs. As and to the extent that our remaining
convertible debentures or notes are converted, we would incur similar non-cash
charges going forward.
As a
result of the application of the above accounting rule, we incurred non-cash
debt discount amortization related to our financings in the amount of $17,179
during the first nine months of 2008.
During
the third quarter of 2008 and pursuant to the terms of a Securities Purchase
Agreement dated August 14, 2008, we issued and sold to a group of institutional
investors 10% senior convertible notes in the aggregate principal amount of $5.0
million due August 15, 2011. These notes are convertible at any time prior to
August 15, 2011 at a conversion price of $2.24 per share. As part of our
analysis of the convertible debt and related warrants, we reviewed and followed
the guidance of SFAS No. 150 and EITF Issues No. 00-19, 00-27 and
05-2.
As part
of the securities purchase agreement, the Company issued to the purchasers of
its 10% secured convertible notes due August 15, 2011, warrants to purchase an
aggregate of 558,036 shares of common stock at any time prior to August 15, 2011
at a price of $2.24 per share. The warrants were classified as equity based on
relative fair value.
The
relative fair value of these warrants was determined using Black-Scholes pricing
model, assuming a risk-free interest rate of 2.78%, a volatility factor 75%,
dividend yields of 0% and a contractual life of 3.0 years.
In
connection with these convertible notes, we calculated a deferred debt discount
of $412,000 with respect to the warrants and the discount arising from fair
value allocation of the warrants according to APB No. 14, which is being
amortized from the date of issuance to the stated redemption date – August 15,
2011 – or to the actual conversion date, if earlier, as financial
expenses.
Issuances
of Restricted Shares and Options
During
2007, we issued options and restricted shares to certain employees along with
restricted shares to our directors in 2007 and 2008. These options and shares
were issued as bonuses, and generally vest over a period of two or three years
from the date of issuance. Relevant accounting rules provide that the aggregate
amount of the difference between the purchase price of the restricted shares (in
this case, generally zero) and the market price of the shares on the date of
grant is taken as a general and administrative expense, amortized over the life
of the period of the restriction.
As a
result of the application of the above accounting rules, we incurred, for the
nine months ended September 30, 2008 and 2007, compensation expense related to
stock options and restricted shares of approximately $853,000 and $1.3 million,
respectively, of which $52,000 and $145,000, respectively, was for stock options
and $801,000 and $1.1 million, respectively, was for restricted
shares.
Overview
of Operating Performance and Backlog
Overall,
our net loss before minority interest earnings, earnings from affiliated company
and tax expenses for the nine months ended September 30, 2008 was $2.3 million
on revenues of $45.1 million, compared to a net loss of $3.5 million on revenues
of $40.0 million during the nine months ended September 30, 2007. As of
September 30, 2008, our overall backlog totaled $41.7 million.
In our
Training and Simulation Division, revenues increased from $17.8 million in the
first nine months of 2007 to $23.1 million in the first nine months of 2008. As
of September 30, 2008, our backlog for our Training and Simulation Division
totaled $15.3 million.
In our
Battery and Power Systems Division, revenues increased from $8.1 million in the
first nine months of 2007 to $9.7 million in the first nine months of 2008. As
of September 30, 2008, our backlog for our Battery and Power Systems Division
totaled $13.7 million.
In our
Armor Division, revenues decreased from $14.1 million during the first nine
months of 2007 to $12.3 million during the first nine months of 2008. As of
September 30, 2008, our backlog for our Armor Division totaled $12.7
million.
Functional
Currency
We
consider the United States dollar to be the currency of the primary economic
environment in which we and our Israeli subsidiary EFL operate and, therefore,
both we and EFL have adopted and are using the United States dollar as our
functional currency. Transactions and balances originally denominated in U.S.
dollars are presented at the original amounts. Gains and losses arising from
non-dollar transactions and balances are included in net income.
The
majority of financial transactions of our Israeli subsidiaries MDT and Epsilor
are in New Israel Shekels (“NIS”) and a substantial portion of MDT’s and
Epsilor’s costs is incurred in NIS. Management believes that the NIS is the
functional currency of MDT and Epsilor. Accordingly, the financial statements of
MDT and Epsilor have been translated into U.S. dollars. All balance sheet
accounts have been translated using the exchange rates in effect at the balance
sheet date. Statement of operations amounts have been translated using the
average exchange rate for the period. The resulting translation adjustments are
reported as a component of accumulated other comprehensive loss in shareholders’
equity.
Results
of Operations
Three
months ended September 30, 2008 compared to the three months ended September 30,
2007.
Revenues. During the three months
ended September 30, 2008, we (through our subsidiaries) recognized revenues as
follows:
Ø
|
FAAC,
IES and RTI recognized revenues from the sale of multimedia interactive
simulators, interactive use-of-force training systems, and from the
provision of maintenance services in connection with such
systems.
|
Ø
|
MDT,
MDT Armor and AoA recognized revenues from payments under vehicle armoring
contracts, for service and repair of armored vehicles, and on the sale of
armoring products.
|
Ø
|
EFB
and Epsilor recognized revenues from the sale of batteries, chargers and
adapters to the military, and under certain development contracts with the
U.S. Army.
|
Ø
|
EFL
recognized revenues from the sale of water-activated battery (WAB)
lifejacket lights.
|
Revenues
for the three months ended September 30, 2008 totaled $19.2 million, compared to
$15.5 million in the comparable period in 2007, an increase of $3.7 million, or
24.4%. In the third quarter of 2008, revenues were $8.4 million for the Training
and Simulation Division (compared to $8.4 million in the third quarter of
2007, unchanged,
due to level sales of military vehicle simulators and use of force simulators);
$4.4 million for the Battery and Power Systems Division (compared to $3.0
million in the third quarter of 2007, an increase of $1.4
million, or 44.6%, due primarily to increased sales of our battery products at
Epsilor and EFB); and $6.5 million for the Armor Division (compared to $4.0
million in the third quarter of 2007, an increase of $2.5
million, or 62.2%, due primarily to
increased revenues from AoA for personal protection devices along with increased
revenues (albeit with lower margins) from MDT and MDT Armor in respect of the
completion of orders for the “David” Armored Vehicle).
Cost of
revenues. Cost of revenues totaled
$13.5 million during the third quarter of 2008, compared to $11.1 million in the
third quarter of 2007, an increase of $2.4
million, or 21.7%, due primarily to
increased sales in our Battery and Power Systems and Armor
divisions.
Direct
expenses for our three divisions during the third quarter of 2008 were $6.8
million for the Training and Simulation Division (compared to $6.7 million in
the third quarter of 2007, an increase of $96,000,
or 1.4%, due
primarily to slight increases in material costs); $4.1 million for the Battery
and Power Systems Division (compared to $3.0 million in the third quarter of
2007, an increase
of $1.1 million, or 36.8%, due primarily to increased revenues); and $5.7
million for the Armor Division (compared to $4.5 million in the third quarter of
2007, an increase
of $1.2 million, or 25.6%, due primarily to
increased production of the “David” Armored Vehicle).
Amortization of
intangible assets. Amortization of intangible
assets totaled $377,000 in the third quarter of 2008, compared to $308,000 in
the third quarter of 2007, an increase of
$69,000,
or 22.5%, due primarily to an increase in amortization of capitalized technology
in our Training and Simulation Division along with an increase in identified
intangibles due to the acquisition of RTI.
Research and
development expenses. Research and development
expenses for the third quarter of 2008 were $399,000, compared to $492,000
during the third quarter of 2007, a decrease of $93,000, or 18.9%. This decrease
was primarily attributable to a minor reduction in research and development
activity in each of the three divisions.
Selling and
marketing expenses. Selling and marketing
expenses for the third quarter of 2008 were $1.0 million, compared to $906,000
in the third quarter of 2007, an increase of $98,000, or 10.8%. This increase
was primarily attributable to the overall increase in revenues and their
associated sales and marketing expenses.
General and
administrative expenses. General and administrative
expenses for the third quarter of 2008 were $3.2 million, compared to $3.3
million in the third quarter of 2007, a decrease of $110,000, or 3.3%. This
decrease was primarily attributable to a reduction in corporate stock
compensation expenses compared to the previous year.
Financial
expenses, net.
Financial expenses totaled approximately $289,000 in the third quarter of 2008,
compared to $80,000 in the third quarter of 2007, an increase of $208,000, or
259.0%. The difference was due primarily to interest on convertible debt and
increased interest expense as a result of higher line of credit balances
outstanding in 2008 compared to the previous year.
Income
taxes. We
and certain of our subsidiaries incurred net operating losses during the three
months ended September 30, 2008 and accordingly, no provision for income taxes
was recorded in this quarter. With respect to some of our subsidiaries that
operated at a net profit during 2008, we were able to offset federal taxes
against our accumulated loss carry forward. We recorded a total of $375,000 in
tax expense in the third quarter of 2008, compared to $123,000 in tax expense in
the third quarter of 2007, an increase of $252,000, or 204.1%, mainly concerning
state and local taxes.
Net loss.
Due to the factors cited above, we recognized a net loss of $44,000 in 2008,
compared to a net loss of $783,000 in 2007, an improvement of $739,000, or
94.3%.
Nine
months ended September 30, 2008 compared to the nine months ended September 30,
2007.
Revenues. During the nine months ended
September 30, 2008, we (through our subsidiaries) recognized revenues as
follows:
Ø
|
FAAC,
IES and RTI recognized revenues from the sale of multimedia interactive
simulators, interactive use-of-force training systems, and from the
provision of maintenance services in connection with such
systems.
|
Ø
|
MDT,
MDT Armor and AoA recognized revenues from payments under vehicle armoring
contracts, for service and repair of armored vehicles, and on the sale of
armoring products.
|
Ø
|
EFB
and Epsilor recognized revenues from the sale of batteries, chargers and
adapters to the military, and under certain development contracts with the
U.S. Army.
|
Ø
|
EFL
recognized revenues from the sale of water-activated battery (WAB)
lifejacket lights.
|
Revenues
for the nine months ended September 30, 2008 totaled $45.1 million, compared to
$40.0 million in the comparable period in 2007, an increase of $5.1 million, or
12.7%. In the first nine months of 2008, revenues were $23.1 million for the
Training and Simulation Division (compared to $17.8 million in the first nine
months of 2007, an
increase of $5.3 million, or 29.5%, due primarily to increased sales of military
vehicle simulators and use of force simulators); $9.7 million for the Battery
and Power Systems Division (compared to $8.1 million in the first nine months of
2007, an increase
of $1.6 million, or 19.5%, due primarily to increased sales of our battery
products at Epsilor and EFB); and $12.3 million for the Armor Division (compared
to $14.1 million in the first nine months of 2007, a decrease of $1.8
million, or 12.7%, due primarily to
decreased revenues from MDT and MDT Armor, mostly in respect of the completion
of orders for the “David” Armored Vehicle).
Cost of
revenues. Cost of revenues totaled
$33.3 million during the first nine months of 2008, compared to $27.8 million in
the first nine months of 2007, an increase of $5.5
million, or 19.8%, due primarily to
increased sales in our Training and Simulation and our Battery and Power Systems
divisions and to some extent by erosion of the margin in our Armor
Division.
Direct
expenses for our three divisions during the first nine months of 2008 were $19.0
million for the Training and Simulation Division (compared to $14.3 million in
the first nine months of 2007, an increase of $4.7
million, or 33.1%, due primarily to
increased sales of FAAC); $9.9 million for the Battery and Power Systems
Division (compared to $7.7 million in the first nine months of 2007, an increase of $2.2
million, or 28.8%, due primarily to increased revenues and increased prices for
materials); and $13.1 million for the Armor Division (compared to $13.0 million
in the first nine months of 2007, an increase of $124,000,
or 1.0%, due
primarily to increased production of the “David” Armored Vehicle).
Amortization of
intangible assets. Amortization of intangible
assets totaled $1.4 million in the first nine months of 2008, compared to $1.5
million in the first nine months of 2007, a decrease of $120,000, or 8.1%, due
primarily to an increase in amortization of capitalized technology in our
Training and Simulation Division along with an increase in identified
intangibles due to the acquisition of RTI, offset by fully amortized
intangibles.
Research and
development expenses. Research and development
expenses for the first nine months of 2008 were $1.2 million, compared to $1.4
million during the first nine months of 2007, a decrease of $182,000, or 12.9%.
This decrease was primarily attributable to a minor reduction in research and
development activity in each of the three divisions.
Selling and
marketing expenses. Selling and marketing
expenses for the first nine months of 2008 were $3.3 million, compared to $3.0
million in the first nine months of 2007, an increase of $291,000, or 9.7%. This
increase was primarily attributable to the overall increase in revenues and
their associated sales and marketing expenses.
General and
administrative expenses. General and administrative
expenses for the first nine months of 2008 were $10.0 million, compared to $9.2
million in the first nine months of 2007, an increase of $804,000, or $8.7%.
This increase was primarily attributable to increases in expenses in our
Simulation division due to the additional expenses related to our new entity,
Realtime Technologies, Inc.
Financial
expenses, net.
Financial expenses totaled approximately $342,000 in the first nine months of
2008, compared to $707,000 in the first nine months of 2007, a decrease of
$366,000, or 51.7%. The difference was due primarily to decreased interest
expense as a result of lower line of credit balances outstanding in 2008
compared to the previous year.
Income
taxes. We
and certain of our subsidiaries incurred net operating losses during the nine
months ended September 30, 2008 and accordingly, no provision for income taxes
was recorded in this quarter. With respect to some of our subsidiaries that
operated at a net profit during 2008, we were able to offset federal taxes
against our accumulated loss carry forward. We recorded a total of $387,000 in
tax expense in the first nine months of 2008, compared to $298,000 in tax
expense in the first nine months of 2007, an increase of $88,000, or 29.7%,
mainly concerning state and local taxes.
Net loss.
Due to the factors cited above, net loss decreased from $4.0 million in 2007 to
$3.0 million in 2008, a decrease of $1.0 million, or 25.3%.
Liquidity
and Capital Resources
As of
September 30, 2008, we had $1.6 million in cash, $163,000 in restricted
collateral securities and restricted held-to-maturity securities due within one
year, and $54,000 in available-for-sale marketable securities, as compared to
December 31, 2007, when we had $3.4 million in cash, $320,000 in restricted
collateral securities, $1.5 million in an escrow receivable and $47,000 in
available-for-sale marketable securities.
We used
available funds in the nine months ended September 30, 2008 primarily for sales
and marketing, continued research and development expenditures, and other
working capital needs. We increased our investment in fixed assets during the
nine months ended September 30, 2008 by $983,000 over the investment as at
December 31, 2007. Our net fixed assets amounted to $5.2 million at quarter
end.
Net cash
used in operating activities from continuing operations for the nine months
ended September 30, 2008 and 2007 was $3.3 million and $885,000, respectively,
an increase of $2.4 million. This increase in cash used was primarily the result
of the payment of the judgment in the AoA arbitration, part of which we had
previously carried as an escrow receivable, and an increase in inventories in
all divisions.
Net cash
used in investing activities for the nine months ended September 30, 2008 and
2007 was $1.9 million and $1.1 million, an increase of $791,000. This increase
was primarily the result of the payment of the judgment in the AoA arbitration,
our issuance of a convertible loan to DEI, the RTI acquisition and the purchase
of the minority interest in MDT.
Net cash
provided by financing activities for the nine months ended September 30, 2008
and 2007 was $3.2 million and $1.3 million, respectively, an increase of $1.9
million, primarily due to the new senior notes offset by the reduction in
short-term bank debt.
As of
September 30, 2008, we have approximately $2.8 million in bank debt and $5.0
million in long term senior subordinated notes outstanding, compared to $4.6
million in bank debt as of December 31, 2007.
Subject
to all of the reservations regarding “forward-looking statements” set forth
above, we believe that our present cash position, anticipated cash flows from
operations and lines of credit should be sufficient to satisfy our current
estimated cash requirements through the remainder of the year. In this
connection, we note that from time to time our working capital needs are
partially dependent on our subsidiaries’ lines of credit. In the event that we
are unable to continue to make use of our subsidiaries’ lines of credit for
working capital on economically feasible terms, our business, operating results
and financial condition could be adversely affected.
Over the
long term, we need to sustain profitability, at least on a cash-flow basis, to
avoid future capital requirements. Additionally, we would need to raise
additional capital in order to fund any future acquisitions.
ITEM
3.
|
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK.
|
Interest
Rate Risk
It is our
policy not to enter into interest rate derivative financial instruments, except
for hedging of foreign currency exposures discussed below. We do not currently
have any significant interest rate exposure.
Foreign
Currency Exchange Rate Risk
Since a
significant part of our sales and expenses are denominated in U.S. dollars, we
have experienced only insignificant foreign exchange gains and losses to date,
and do not expect to incur significant gains and losses in 2008. Certain of our
research, development and production activities are carried out by our Israeli
subsidiary, EFL, at its facility in Beit Shemesh, and accordingly we have sales
and expenses in NIS. Additionally, our MDT and Epsilor subsidiaries operate
primarily in NIS. However, the majority of our sales are made outside Israel in
U.S. dollars, and a substantial portion of our costs are incurred in U.S.
dollars. Therefore, our functional currency is the U.S. dollar.
While we
conduct our business primarily in U.S. dollars, some of our agreements are
denominated in foreign currencies, which could have an adverse effect on the
revenues that we incur
in
foreign currencies. We do not hold or issue derivative financial instruments for
trading or speculative purposes.
ITEM
4T.
|
CONTROLS
AND PROCEDURES.
|
Evaluation
of Disclosure Controls and Procedures
As of
September 30, 2008, our management, including the principal executive officer
and principal financial officer, evaluated our disclosure controls and
procedures related to the recording, processing, summarization, and reporting of
information in our periodic reports that we file with the SEC. These disclosure
controls and procedures are intended to ensure that material information
relating to us, including our subsidiaries, is made known to our management,
including these officers, by other of our employees, and that this information
is recorded, processed, summarized, evaluated, and reported, as applicable,
within the time periods specified in the SEC’s rules and forms. Due to the
inherent limitations of control systems, not all misstatements may be detected.
These inherent limitations include the realities that judgments in
decision-making can be faulty and that breakdowns can occur because of simple
error or mistake. Any system of controls and procedures, no matter how well
designed and operated, can at best provide only reasonable assurance that the
objective of the system are met and management necessarily is required to apply
its judgment in evaluating the cost benefit relationship of possible controls
and procedures. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management
override of the control. Our controls and procedures are intended to provide
only reasonable, not absolute, assurance that the above objectives have been
met.
Based on
their evaluations, our principal executive officer and principal financial
officer were able to conclude that our disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act
of 1934) were effective as of September 30, 2008 to ensure that the information
required to be disclosed by us in the reports that we file or submit under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in SEC rules and forms.
Changes
in Internal Controls Over Financial Reporting
There
have been no changes in our internal control over financial reporting that
occurred during our last fiscal quarter to which this Quarterly Report on Form
10-Q relates that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
PART
II
Class
Action Litigation
In May
2007, two purported class action complaints (the “Complaint”) were filed in the
United States District Court for the Eastern District of New York against us and
certain of our officers and directors. These two cases were consolidated in June
2007. A similar case filed in the United States District Court for the Eastern
District of Michigan in March 2007 was withdrawn by the plaintiff in June 2007.
The Complaint seeks class status on behalf of all persons who purchased our
securities between November 9, 2004 and November 14, 2005 (the “Period”) and
alleges violations by us and certain of our officers and directors of Sections
10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5
thereunder, primarily related to our acquisition of Armour of America in 2005
and certain public statements made by us with respect to our business and
prospects during the Period. The Complaint also alleges that we did not have
adequate systems of internal operational or financial controls, and that our
financial statements and reports were not prepared in accordance with GAAP and
SEC rules. The Complaint seeks an unspecified amount of damages. A lead
plaintiff has been named, and the plaintiff’s consolidated amended complaint was
filed in September 2007. Our motion to dismiss was filed in November 2007, but a
decision on our motion is not expected until later in 2008, oral argument on the
motion having concluded on July 21, 2008.
Although
the ultimate outcome of this matter cannot be determined with certainty, we
believe that the allegations stated in the Complaint are without merit and we
and our officers and directors named in the Complaint intend to defend ourselves
vigorously against such allegations.
NAVAIR
Litigation
In
December 2004, AoA filed an action in the United States Court of Federal Claims
against the United States Naval Air Systems Command (NAVAIR), seeking
approximately $2.2 million in damages for NAVAIR’s alleged improper termination
of a contract for the design, test and manufacture of a lightweight armor
replacement system for the United States Marine Corps CH-46E rotor helicopter.
NAVAIR, in its answer, counterclaimed for approximately $2.1 million in alleged
reprocurement and administrative costs. Trial in this matter has concluded, but
closing briefs have not yet been filed, nor has any decision yet been rendered.
We are unable to make any prediction or assessment as to what the ultimate
outcome of this case will be.
The
following factors, among others, which contain material changes from risk
factors as previously disclosed in our Form 10-K for the fiscal year ended
December 31, 2007 and our Forms 10-Q for the quarters ended March 31, 2008 and
June 30, 2008, 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
Our
existing indebtedness may adversely affect our ability to obtain additional
funds and may increase our vulnerability to economic or business
downturns.
Our and
our subsidiaries’ bank and certificated indebtedness (short and long term)
aggregated approximately $7.8 million principal amount as of September 30, 2008
(not including trade payables, other account payables, seller-financed mortgages
and accrued severance pay), of which $5.0 million is in respect of our
subordinated convertible notes and $2.8 million is bank working capital lines of
credit. In addition, we may incur additional indebtedness in the future.
Accordingly, we are subject to the risks associated with significant
indebtedness, including:
·
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we
must dedicate a portion of our cash flows from operations to pay principal
and interest and, as a result, we may have less funds available for
operations and other purposes;
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·
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it
may be more difficult and expensive to obtain additional funds through
financings, if available at all;
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·
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we
are more vulnerable to economic downturns and fluctuations in interest
rates, less able to withstand competitive pressures and less flexible in
reacting to changes in our industry and general economic conditions;
and
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·
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if
we default under any of our existing debt instruments, including paying
the outstanding principal when due, and if our creditors demand payment of
a portion or all of our indebtedness, we may not have sufficient funds to
make such payments.
|
The
occurrence of any of these events could materially adversely affect our results
of operations and financial condition and adversely affect our stock
price.
The
agreements governing the terms of our notes that mature between 2009 and 2011
contain numerous affirmative and negative covenants that limit the discretion of
our management with respect to certain business matters and place restrictions
on us, including obligations on our part to preserve and maintain our assets and
restrictions on our ability to incur or guarantee debt, to merge with or sell
our assets to another company, and to make significant capital expenditures
without the consent of the note holders. Our ability to comply with these and
other provisions of such agreements may be affected by changes in economic or
business conditions or other events beyond our control.
Failure
to comply with the terms of our indebtedness could result in a default that
could have material adverse consequences for us.
A failure
to comply with the obligations contained in the agreements governing our
indebtedness could result in an event of default under such agreements which
could result in an acceleration of the notes and the acceleration of debt under
other instruments evidencing indebtedness that may contain cross-acceleration or
cross-default provisions. If the indebtedness under the
notes or
other indebtedness were to be accelerated, there can be no assurance that our
future cash flow or assets would be sufficient to repay in full such
indebtedness.
We
may not generate sufficient cash flow to service all of our debt
obligations.
Our
ability to make payments on and to refinance our indebtedness and to fund our
operations depends on our ability to generate cash in the future. Our future
operating performance is subject to market conditions and business factors that
are beyond our control. Consequently, we cannot assure you that we will generate
sufficient cash flow to pay the principal and interest on our debt. If our cash
flows and capital resources are insufficient to allow us to make scheduled
payments on our debt, we may have to reduce or delay capital expenditures, sell
assets, seek additional capital or restructure or refinance our debt. We cannot
assure you that the terms of our debt will allow for these alternative measures
or that such measures would satisfy our scheduled debt service obligations. In
addition, in the event that we are required to dispose of material assets or
restructure or refinance our debt to meet our debt obligations, we cannot assure
you as to the terms of any such transaction or how quickly such transaction
could be completed. Our ability to refinance our indebtedness or obtain
additional financing will depend on, among other things:
·
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our
financial condition at the time;
|
·
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restrictions
in the agreements governing our other indebtedness;
and
|
·
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other
factors, including the condition of the financial markets and our
industry.
|
The
payment by us of our subordinated convertible notes in stock or the conversion
of such notes by the holders could result in substantial numbers of additional
shares being issued, with the number of such shares increasing if and to the
extent our market price declines, diluting the ownership percentage of our
existing stockholders.
In August
2008, we issued $5.0 million in subordinated convertible notes due August 15,
2011. The notes are convertible at the option of the holders at a fixed
conversion price of $2.24. The principal amount of the notes is payable over a
period of three years, with the principal amount being amortized in eleven
payments payable at our option in cash and/or stock, by requiring the holders to
convert a portion of their notes into shares of our common stock, provided
certain conditions were met. The failure to meet such conditions could make us
unable to pay our notes, causing us to default. If the price of our common stock
is above $2.24, the holders of our notes will presumably convert their notes to
stock when payments are due, or before, resulting in the issuance of additional
shares of our common stock.
Principal
payments of $454,545 are due on each of February 13, 2009, May 15, 2009, August
14, 2009, November 13, 2009, February 15, 2010, May 14, 2010, August 13, 2010,
November 15, 2010, February 15, 2011, May 13, 2011 and August 15, 2011, either
in cash or by requiring the holder to convert the principal payment into shares
of our common stock. In the event we elect to make payments of principal on our
convertible notes in stock by requiring the holders to convert a portion of
their Notes, either because our cash position at the time makes it necessary or
we otherwise deem it advisable, the price used to determine the number of shares
to be issued on conversion will be calculated using an 8% discount to the
average trading price of our
common
stock during 17 of the 20 consecutive trading days ending two days before the
payment date. Accordingly, the lower the market price of our common stock at the
time at which we make payments of principal in stock, the greater the number of
shares we will be obliged to issue and the greater the dilution to our existing
stockholders.
In either
case, the issuance of the additional shares of our common stock could adversely
affect the market price of our common stock.
We can
require the holder of our Notes to convert a portion of their Notes into shares
of our common stock at the time principal payments are due only if such shares
are registered for resale and certain other conditions are met. If our stock
price were to decline, we might not have a sufficient number of shares of our
stock registered for resale in order to continue requiring the holders to
convert a portion of their Notes. As a result, we would need to file an
additional registration statement with the SEC to register for resale more
shares of our common stock in order to continue requiring conversion of our
Notes upon principal payment becoming due. Any delay in the registration
process, including through routine SEC review of our registration statement or
other filings with the SEC, could result in our having to pay scheduled
principal repayments on our Notes in cash, which would negatively impact our
cash position and, if we do not have sufficient cash to make such payments in
cash, could cause us to default on our Notes.
We have purchased
a $2.5 million note from an unaffiliated company, which may have an impact on
our financial results and cash position if they do not pay the interest and
principal within the terms of the note.
In August
2008, we purchased a $2,500,000 10% Senior Subordinated Convertible Note from an
unaffiliated company. This 10% Senior Subordinated Convertible Note is due
December 31, 2009. The issuer is required to pay interest on a quarterly basis
starting in November, 2008 and pay the entire principal by December 31, 2009. If
the payments are not made in a timely manner, this may impact our cash position
and financial results.
Our earnings may
decline if we write off additional goodwill and other intangible
assets.
As of
December 31, 2007, we had recorded goodwill of $31.4 million. On January 1,
2002, we adopted SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No.
142 requires goodwill to be tested for impairment on adoption of the Statement,
at least annually thereafter, and between annual tests in certain circumstances,
and written down when impaired, rather than being amortized as previous
accounting standards required. Goodwill is tested for impairment by comparing
the fair value of our reportable units with their carrying value. Fair value is
determined using discounted cash flows. Significant estimates used in the
methodologies include estimates of future cash flows, future short-term and
long-term growth rates, weighted average cost of capital and estimates of market
multiples for the reportable units. We performed the required annual impairment
test of goodwill, based on our projections and using expected future discounted
operating cash flows.
Our most
recent evaluation of our goodwill did not identify any impairment. We based this
determination in part on our belief that our “break-up value” (the value that we
could realize by selling off our assets or divisions separately) substantially
exceeds our market capitalization, and
that our
market capitalization is artificially depressed by our stock being
thinly-traded. We also believe that our market capitalization more reflects
short-term trading assessments than longer-term assessment of
value.
We will
continue to assess the fair value of our goodwill annually or earlier if events
occur or circumstances change that would more likely than not reduce the fair
value of our goodwill below its carrying value. These events or circumstances
would include a significant change in business climate, including a significant,
sustained decline in our market value, legal factors, operating performance
indicators, competition, sale or disposition of a significant portion of the
business, or other factors. If we determine that significant impairment has
occurred, we would be required to write off the impaired portion of goodwill.
Impairment charges could have a material adverse effect on our financial
condition and results.
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 Chef Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
|
32.2
|
Certification
of Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
|
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
Dated: November
14, 2008
|
AROTECH
CORPORATION
|
|
|
By:
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/s/
Robert S. Ehrlich
|
|
|
Name:
|
Robert
S. Ehrlich
|
|
|
Title:
|
Chairman
and CEO
|
|
|
|
(Principal
Executive Officer)
|
|
By:
|
/s/
Thomas J. Paup
|
|
|
Name:
|
Thomas
J. Paup
|
|
|
Title:
|
Vice
President – Finance and CFO
|
|
|
|
(Principal
Financial Officer)
|
Exhibit
Number
|
Description
|
31.1
|
Certification
of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
|
31.2
|
Certification
of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
|
32.1
|
Certification
of Chef 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
|