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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      June 30, 2011   .
 
Commission file number:   0-23336
 
AROTECH CORPORATION
(Exact name of registrant as specified in its charter)
 
Delaware
 
95-4302784
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)

1229 Oak Valley Drive, Ann Arbor, Michigan
 
48108
(Address of principal executive offices)
 
(Zip Code)

(800) 281-0356
(Registrant’s telephone number, including area code)

                                                                                                                                           
(Former 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  T No  £
 
Indicate by check mark whether the registrant is large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition 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: £     
(Do not check if a smaller reporting company)
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 August 10, 2011 was 15,097,709.
 
 
 

 
TABLE OF CONTENTS
 
Item
 
Page
PART I - FINANCIAL INFORMATION
   
  3
 
3
 
5
 
6
 
8
 
14
 
20
 
20
     
PART II - OTHER INFORMATION
   
 
21
 
21
 
22
 
22
     
 
23

 
 
 

 
PART I
 
ITEM 1FINANCIAL STATEMENTS (UNAUDITED)
 
CONDENSED CONSOLIDATED BALANCE SHEETS
(U.S. Dollars)

   
June 30, 2011
   
December 31, 2010
 
   
(Unaudited)
       
ASSETS
           
CURRENT ASSETS:
           
Cash and cash equivalents
  $ 1,172,996     $ 6,335,307  
Available for sale securities
          399,449  
Restricted collateral deposits
    1,936,146       1,842,143  
Trade receivables (net of allowance for doubtful accounts in the amount of $46,000 as of June 30, 2011 and $47,000 as of December 31, 2010)
    13,671,736       13,812,906  
Unbilled receivables
    3,143,248       3,280,821  
Other accounts receivable and prepaid expenses
    1,469,648       852,935  
Inventories
    13,923,522       9,654,009  
Total current assets
    35,317,296       36,177,570  
LONG TERM ASSETS:
               
Deferred tax assets
    677,887       652,292  
Severance pay fund
    4,478,479       4,126,835  
Other long term assets and receivables
    348,644       381,517  
Property and equipment, net
    4,530,272       4,639,511  
Other intangible assets, net
    3,942,244       4,878,754  
Goodwill
    33,092,956       32,780,460  
Total long term assets
    47,070,482       47,459,369  
Total assets
  $ 82,387,778     $ 83,636,939  
 
The accompanying notes are an integral part of the Interim Condensed Consolidated Financial Statements.
 
CONDENSED CONSOLIDATED BALANCE SHEETS
(U.S. Dollars, except share data)
 
   
June 30, 2011
   
December 31, 2010
 
   
(Unaudited)
       
LIABILITIES AND STOCKHOLDERS’ EQUITY
           
CURRENT LIABILITIES:
           
Trade payables
  $ 7,062,654     $ 4,382,160  
Other accounts payable and accrued expenses
    5,503,680       6,527,347  
Current portion of capitalized leases
    23,887       39,181  
Current portion of long term debt
    559,324       1,417,543  
Short term bank credit
    4,836,170       2,488,206  
Deferred revenues
    4,947,432       5,926,460  
Total current liabilities
    22,933,147       20,780,897  
LONG TERM LIABILITIES:                
Accrued severance pay
    6,295,559       5,843,305  
Long term portion of capitalized leases
    3,343       11,549  
Long term debt
    998,861       1,023,008  
Deferred tax liability
    3,540,002       3,315,000  
Other long term liabilities
    23,415       178,811  
Total long term liabilities
    10,861,180       10,371,673  
STOCKHOLDERS’ EQUITY:
               
Share capital –
               
Common stock – $0.01 par value each;
Authorized: 50,000,000 shares as of June 30, 2011 and December 31, 2010; Issued and outstanding:
    15,107,309 shares and 14,842,283 shares as of June 30, 2011 and December 31, 2010, respectively
    151,073       148,423  
Preferred shares – $0.01 par value each;
Authorized: 1,000,000 shares as of June 30, 2011 and December 31, 2010; No shares issued and
    outstanding as of June 30, 2011 and December 31, 2010
           
Additional paid-in capital
    222,355,164       221,856,095  
Accumulated deficit
    (175,419,825 )     (170,705,241 )
Notes receivable from stockholders
    (954,647 )     (954,647 )
Accumulated other comprehensive income
    2,461,686       2,139,739  
Total stockholders’ equity
    48,593,451       52,484,369  
Total liabilities and stockholders’ equity
  $ 82,387,778     $ 83,636,939  
 
The accompanying notes are an integral part of the Interim Condensed Consolidated Financial Statements.
 
 
4

 
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(U.S. Dollars, except share data)

   
Six months ended June 30,
   
Three months ended June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Revenues
  $ 27,598,467     $ 40,054,254     $ 14,295,826     $ 18,903,860  
                                 
Cost of revenues, exclusive of amortization of intangibles
    21,272,536       28,610,458       10,747,967       13,283,807  
Research and development expenses
    1,012,853       1,578,497       462,413       764,016  
Selling and marketing expenses 
    2,832,267       2,597,294       1,459,469       1,436,635  
General and administrative expenses
    5,949,622       5,871,919       2,959,382       2,918,322  
Amortization of intangible assets and capitalized software
    961,299       838,906       481,655       417,258  
Total operating costs and expenses
    32,028,577       39,497,074       16,110,886       18,820,038  
                                 
Operating income (loss)
    (4,430,110 )     557,180       (1,815,060 )     83,822  
                                 
Other income (expense)
    (1,541 )     61,218       18,199       37,758  
Allowance for settlements, net
          500,000             500,000  
Financial expenses, net
    (1,687 )     (207,710 )     (133,956 )     (64,460 )
Total other income (expenses)
    (3,228 )     353,508       (115,757 )     473,298  
Income (loss) before income tax expenses
    (4,433,338 )     910,688       (1,930,817 )     557,120  
                                 
Income tax expenses
    (281,246 )     (459,140 )     (140,622 )     (197,120 )
Net income (loss)
  $ (4,714,584 )   $ 451,548     $ (2,071,439 )   $ 360,000  
                                 
Basic net income (loss) per share
  $ (0.34 )   $ 0.03     $ (0.15 )   $ 0.03  
Diluted net income (loss) per share   (0.34   0.03     (0.15   0.02  
                                 
Weighted average number of shares used in
   computing basic net income (loss) per share
    13,796,680       13,944,492       13,855,164       14,013,658  
Weighted average number of shares used in
   computing diluted net income (loss) per share
    13,796,680        14,547,232       13,855,164       14,616,398  

The accompanying notes are an integral part of the Interim Condensed Consolidated Financial Statements.
 
 
5

 
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(U.S. Dollars)
 
   
Six months ended June 30,
 
   
2011
   
2010
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net income (loss)
  $ (4,714,584 )   $ 451,548  
Adjustments required to reconcile net income (loss) to net cash provided by (used in) operating activities:
               
Depreciation
    603,819       622,345  
Amortization of intangible assets and capitalized software
    961,299       838,906  
Amortization of debt discount
    34,841       96,000  
Compensation related to shares issued to employees and directors
    132,919       302,096  
Adjustment to value of warrants and embedded features on the senior convertible notes
    (16,085 )     (195,647 )
Capital loss from sale of property and equipment
    50,507        
Deferred taxes
    199,407       274,220  
Changes in operating assets and liabilities:
               
Severance pay, net
    100,610       151,253  
Trade receivables
    141,170       281,997  
Other accounts receivable and prepaid expenses
    (583,840 )     (959,793 )
Inventories
    (4,269,513 )     1,358,761  
Unbilled receivables
    137,573       (2,728,350 )
Deferred revenues
    (979,028 )     1,394,620  
Trade payables
    2,680,494       318,054  
Other accounts payable and accrued expenses
    (1,162,979 )     (1,234,249 )
Net cash provided by (used in) operating activities
    (6,683,390 )     971,761  
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Purchase of property and equipment, net of investment grants received from the State of Israel
    (545,973 )     (337,414 )
Additions of capitalized software development
    (24,323 )     (231,516 )
Proceeds from sale of property and equipment
    886        
Sales of marketable securities
    399,449        
Decrease (increase) in restricted collateral deposits
    (94,003 )     100,340  
Net cash used in investing activities
  $ (263,964 )   $ (468,590 )
 
The accompanying notes are an integral part of the Interim Condensed Consolidated Financial Statements.
 
 
6

 
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(U.S. Dollars)

   
Six months ended June 30,
 
   
2011
   
2010
 
CASH FLOWS FROM FINANCING ACTIVITIES:
           
Repayment of long term debt
  $ (481,649 )   $ (527,389 )
Increase in short term bank credit
    2,347,964        
Purchase of treasury stock
    (90,257 )     (56,453 )
Net cash provided by (used in) financing activities
    1,776,058       (583,842 )
DECREASE IN CASH AND CASH EQUIVALENTS
    (5,171,296 )     (80,671 )
CASH ACCRETION (EROSION) DUE TO EXCHANGE RATE DIFFERENCES
    8,985       (43,001 )
CASH AND CASH EQUIVALENTS AT THE BEGINNING OF THE PERIOD
    6,335,307       1,901,525  
CASH AND CASH EQUIVALENTS AT THE END OF THE PERIOD
  $ 1,172,996     $ 1,777,853  
SUPPLEMENTARY INFORMATION ON NON-CASH TRANSACTIONS:
               
Interest paid during the period
  $ 146,718     $ 289,839  
Taxes on income paid during the period
  $ 8,296     $ 85,147  
Note conversion to common stock
  $ 459,058     $ 425,647  
 
The accompanying notes are an integral part of the Interim Condensed Consolidated Financial Statements.
 
 
7

 
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1:                      BASIS OF PRESENTATION
 
a.           Company:
 
Arotech Corporation (“Arotech”) and its wholly-owned subsidiaries (the “Company”) provide defense and security products for the military, law enforcement and homeland security markets, including multimedia interactive simulators/trainers, lightweight vehicle armoring, and advanced zinc-air and lithium batteries and chargers. The Company operates primarily through its wholly-owned subsidiaries FAAC Incorporated (“FAAC”), based in Ann Arbor, Michigan; MDT Protective Industries, Ltd. (“MDT”), based in Lod, Israel; MDT Armor Corporation (“MDT Armor”), based in Auburn, Alabama; Electric Fuel Battery Corporation (“EFB”), based in Auburn, Alabama; Electric Fuel Ltd. (“EFL”), based in Beit Shemesh, Israel, which the Company merged into its Epsilor subsidiary in July 2011; and Epsilor-EFL Ltd. (formerly Epsilor Electronic Industries, Ltd.) (“Epsilor”), based in Dimona, Israel. The Company’s former subsidiary Armour of America Incorporated (“AoA”) has been merged into MDT Armor. Additionally, IES Interactive Training (“IES”), and Realtime Technologies (“RTI”) were merged with FAAC to create Arotech’s Training and Simulation Division (“ATSD”).
 
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 June 30, 2011, its operating results for the six- and three-month periods ended June 30, 2011 and 2010, and its cash flow for the six-month periods ended June 30, 2011 and 2010.
 
The results of operations for the six and three months ended June 30, 2011 are not necessarily indicative of results that may be expected for any other interim period or for the full fiscal year ending December 31, 2011.
 
The balance sheet at December 31, 2010 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, 2010.
 
c.           Accounting for stock-based compensation:
 
For the six months ended June 30, 2011 and 2010, the compensation expense recorded related to restricted stock units and restricted shares was $132,919 and $302,096, respectively, all of which was for restricted stock units and restricted shares. The remaining total compensation cost related to non-vested stock options and non-vested restricted share awards not yet recognized in the income statement as of June 30, 2011 was $356,720, all of which was for restricted stock units and restricted shares. The weighted average period over which this compensation cost is expected to be recognized is approximately one and one-half years. Income tax expense was not impacted since the Company is in a net operating loss position. There were no new options issued in the first six months of 2011 and no options were exercised in the first six months of 2011. The Company’s directors received their annual restricted stock grants on April 1, 2011 in accordance with the terms of the directors’ stock compensation plan. Additionally, the corporate officers received their annual restricted stock grants on April 25, 2011.
 
d.           Reclassification:
 
Certain comparative data in these financial statements may have been reclassified to conform to the current year’s presentation.
 
e.           Anti-dilutive shares for EPS calculation:
 
All outstanding stock options, non-vested restricted stock units and restricted stock along with the warrants have been excluded from the calculation of the diluted net loss per share for 2011 because all such securities are anti-dilutive.  The Company has also excluded all outstanding stock options along with the warrants that are below market value for the calculation of the diluted net income per share for 2010. Additionally, the Company has excluded any restricted shares that will never vest under the current program. The total weighted average number of shares excluded from the calculations of diluted net income (loss) per share for the six-month periods ended June 30, 2011 and 2010 were 1,440,949 and 778,860, respectively.
 
 
8

 
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 reviews the raw material inventory levels along with the current and historical purchase prices of the inventory. Based on these reviews, 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 increased, from December 31, 2010, $572,691 in the Training and Simulation Division, $739,427 in the Battery Division and $2,957,395 in the Armor Division for the product required to fulfill the increased current backlog. Inventories are composed of the following:
 
   
June 30, 2011
   
December 31, 2010
 
   
(Unaudited)
       
Raw and packaging materials
  $ 9,139,775     $ 7,693,001  
Work in progress
    4,081,977       1,280,669  
Finished products
    701,770       680,339  
Total:
  $ 13,923,522     $ 9,654,009  
 
NOTE 3:                      IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
 
For information about previous new accounting pronouncements and the potential impact on the Company’s Consolidated Financial Statements, see Note 2 of the Notes to Consolidated Financial Statements in the Company’s 2010 Form 10-K. The Company has adopted both ASU 2009-13 and ASU 2009-14. Therefore, the Company has discontinued the use of the residual method and now bases its revenue allocations on estimated sales prices. The impact of adoption did not have a significant impact on its consolidated financial statements.
 
In June 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2011-05, “Comprehensive Income (Topic 220) — Presentation of Comprehensive Income.” ASU 2011-05 eliminates the current option to report other comprehensive income and its components in the statement of changes in stockholders’ equity and requires that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In addition, it requires entities to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statements where the components of net income and the components of other comprehensive income are presented. ASU 2011-05 will become effective for public entities for fiscal years, and interim periods within those years, beginning after December 15, 2011, with early adoption permitted. The standard will become effective for the Company in January 2012. The Company is currently evaluating the impact of ASU 2011-05 on its consolidated financial statements.
 
Other recent accounting pronouncements issued by the FASB did not or are not believed by management to have a material impact on the Company’s present or future financial statements.
 
NOTE 4:                      SEGMENT INFORMATION
 
a.           General:
 
The Company operates primarily in three operating segments. Additionally, the three segments are also treated by the Company as reporting units for goodwill impairment evaluation purposes. The goodwill amounts associated with each of these reporting units were determined and valued when the respective operations were purchased.
 
The Company’s reportable 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 statements. The Company evaluates performance based upon two primary factors, one is the segment’s net income and the other is the segment’s contribution to the Company’s future strategic growth.
 
 
9

 
b.           The following is information about reported segment revenues, income (losses) and total assets for the six and three months ended June 30, 2011 and 2010:
 
   
Training and
Simulation
Division
   
Battery and
Power Systems
Division
   
Armor
Division
   
Corporate
Expenses
   
Total
Company
 
Six months ended June 30, 2011
                             
Revenues from outside customers
  $ 14,710,601     $ 8,321,586     $ 4,566,280     $     $ 27,598,467  
Depreciation and amortization expenses (1)
    (929,685 )     (531,745 )     (74,127 )     (29,561 )     (1,565,118 )
Direct expenses (2) 
    (12,686,985 )     (8,566,513 )     (6,788,610 )     (2,422,892 )     (30,465,000 )
Segment income (loss)
    1,093,931       (776,672 )     (2,296,457 )     (2,452,453 )     (4,431,651 )
Financial income (expense)
    (473 )     155,062       8,418       (164,694 )     (1,687 )
Income tax benefit
    (56,244 )                 (225,002 )     (281,246 )
Net income (loss)
  $ 1,037,214     $ (621,610 )   $ (2,288,039 )   $ (2,842,149 )   $ (4,714,584 )
Segment assets (3) 
  $ 43,859,729     $ 24,959,595     $ 13,240,634     $ 327,820     $ 82,387,778  
Additions to long-lived assets
  $ 192,761     $ 275,508     $ 98,682     $ 3,345     $ 570,296  
Six months ended June 30, 2010
                                       
Revenues from outside customers
  $ 20,067,950     $ 8,888,141     $ 11,098,163     $     $ 40,054,254  
Depreciation and amortization expenses (1)
    (776,934 )     (507,378 )     (88,659 )     (88,280 )     (1,461,251 )
Direct expenses (2) 
    (16,165,345 )     (8,369,020 )     (10,947,268 )     (1,992,972 )     (37,474,605 )
Segment income (loss)
    3,125,671       11,743       62,236       (2,081,252 )     1,118,398  
Financial income (expense)
          (291,498 )     (65,752 )     149,540       (207,710 )
Income tax expense (benefit)
    (110,947 )     (68,898 )     704       (279,999 )     (459,140 )
Net income (loss)
  $ 3,014,724     $ (348,653 )   $ (2,812 )   $ (2,211,711 )   $ 451,548  
Segment assets (3) 
  $ 46,860,622     $ 23,530,636     $ 11,508,079     $ 3,049,929     $ 84,949,266  
Additions to long-lived assets
  $ 300,636     $ 245,649     $ 22,645     $     $ 568,930  
Three months ended June 30, 2011
                                       
Revenues from outside customers
  $ 6,460,199     $ 4,131,517     $ 3,704,110     $     $ 14,295,826  
Depreciation and amortization expenses (1)
    (466,076 )     (267,868 )     (36,478 )     (12,225 )     (782,646 )
Direct expenses (2) 
    (5,586,999 )     (4,204,977 )     (4,256,812 )     (1,261,252 )     (15,310,041 )
Segment income (loss)
    407,124       (341,328 )     (589,180 )     (1,273,477 )     (1,796,861 )
Financial income (expense)
    (156 )     97,077       (14,685 )     (216,192 )     (133,956 )
Income tax benefit
    (28,122 )                 (112,500 )     (140,622 )
Net income (loss)
  $ 378,846     $ (244,251 )   $ (603,865 )   $ (1,602,169 )   $ (2,071,439 )
Three months ended June 30, 2010
                                       
Revenues from outside customers
  $ 10,422,409     $ 3,935,109     $ 4,546,342     $     $ 18,903,860  
Depreciation and amortization expenses (1)
    (384,758 )     (253,512 )     (42,642 )     (44,032 )     (724,945 )
Direct expenses (2) 
    (8,227,587 )     (3,839,498 )     (4,754,216 )     (736,034 )     (17,557,335 )
Segment income (loss)
    1,810,063       (157,901 )     (250,516 )     (780,066 )     621,580  
Financial income (expense)
          (285,432 )     (32,662 )     253,634       (64,460 )
Income tax benefit
    (35,563 )     (21,551 )     (5 )     (140,001 )     (197,120 )
Net income (loss)
  $ 1,774,500     $ (464,884 )   $ (283,183 )   $ (666,433 )   $ 360,000  
 
(1)
Includes depreciation of property and equipment and amortization expenses of intangible assets.
 
(2)
Including, inter alia, sales and marketing, general and administrative and allowance for settlements.
 
(3)
Out of those amounts, goodwill in our Training and Simulation, Battery and Power Systems and Armor Divisions stood at $24,435,641, $6,697,163 and $1,960,152, respectively, as of June 30, 2011 and $24,435,641, $5,902,145 and $1,772,668, respectively, as of June 30, 2010. Subsequent to the 2004 purchase of AoA, the Company recorded an impairment charge in 2005 to fully impair related goodwill ($10.5 million) and intangible assets ($2.6 million). Additionally, due to an earnout on the same transaction, the Company recorded an additional $316,000 in goodwill in 2007 and immediately recorded an impairment of $316,000. The Company has not recorded any other goodwill impairment charges.
 
 
10

 
NOTE 5:                      COMPREHENSIVE LOSS
 
Comprehensive income (loss) for the six and three months ended June 30, 2011 and 2010 is summarized below:
 
   
Six Months Ended June 30,
   
Three Months Ended June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Net income (loss)
  $ (4,714,584 )   $ 451,548     $ (2,071,439 )   $ 360,000  
Foreign currency translation
    321,947       (332,681 )     186,049       499,381  
Total comprehensive income (loss)
  $ (4,392,637 )   $ 118,867     $ (1,885,390 )   $ 859,381  
 
NOTE 6:                      CONVERTIBLE NOTES AND DETACHABLE WARRANTS
 
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 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 in 2008 as equity based on relative fair value. The relative fair value of these warrants was determined in 2008 using the 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.
 
On June 30, 2011, the Company revalued its warrants, their embedded conversion options and their embedded put options and recorded an increase in expense of approximately $102,300 in the second quarter of 2011 in financial expense. The table below lists the variables used in the Black-Scholes calculation and the resulting fair values using significant unobservable inputs:
 
Variables
 
December 31, 2009
   
December 31, 2010
   
June 30, 2011
 
Stock price
  $ 1.70     $ 1.67     $ 2.18  
Risk free interest rate
    1.70 %     1.02 %     0.81 %
Volatility
    79.85 %     76.90 %     79.84 %
Dividend yield
    0.00 %     0.00 %     0.00 %
Contractual life
 
1.6 years
   
0.6 years
   
0.1 years
 
                   
Values
 
December 31, 2009
   
December 31, 2010
   
June 30, 2011
 
Warrants
  $ 298,570     $ 131,355     $ 123,401  
Conversion option
    88,156       28,822       21,733  
Puts
    7,371       1,162       119  
Total value
  $ 394,097     $ 161,339     $ 145,253  
 
The final principal payment of $454,545 is due on the convertible notes on August 15, 2011.
 
 
11

 
NOTE 7:                      FINANCING ACTIVITIES
 
Loan to DEI Services Corporation
 
Concurrent with the Securities Purchase Agreement dated August 14, 2008, the Company purchased a $2.5 million Senior Subordinated Convertible Note from an unaffiliated company, DEI Services Corporation (“DEI”). On August 10, 2010, DEI repaid the entire $2.5 million principal amount of the DEI Note, along with all outstanding earned and unpaid interest. Inasmuch as the Company had previously established an allowance of $500,000 in the third quarter 2009 on the DEI Note based on the Company’s expectation that the Company would not collect the entire DEI Note, the Company recognized the difference between the $2.0 million book value of the DEI Note and the $2.5 million that was actually collected during the second quarter of 2010 as a recovery under allowance for settlements on the Company’s financial statements. Additionally, the Company accrued unpaid interest on the DEI Note through June 30, 2010 in the amount of $140,000, which was recorded as a reduction of financial expenses and additionally recorded $11,000 in interest income in the third quarter of 2010. This transaction extinguished the Company’s conversion options and rights of first refusal with respect to DEI.
 
NOTE 8:                      FAIR VALUE MEASUREMENT
 
The following methods and assumptions were used by the Company in estimating their fair value disclosures for financial instruments using the required three-tier value hierarchy, which prioritizes the inputs used in measuring fair value as follows: (Level 1) observable inputs such as quoted prices in active markets; (Level 2) inputs other than the quoted prices in active markets that are observable either directly or indirectly; and (Level 3) unobservable inputs in which there is little or no market data, which may require the Company to develop its own assumptions.
 
The carrying amounts of cash and cash equivalents, restricted collateral deposits, trade and other receivables, short-term bank credit, and trade payables approximate their fair value due to the short-term maturity of such instruments.
 
The fair value of available for sale marketable securities is based on the quoted market price.
 
Long-term promissory notes are estimated by discounting the future cash flows using current interest rates for loans of similar terms and maturities. The carrying amount of the long-term liabilities approximates their fair value.
 
The Company uses the Black-Scholes valuation model and other factors to determine the fair value of the warrants, the value of the embedded conversion feature and the value of the embedded put options associated with the Company’s Senior Convertible Notes. (Level 3)
 
NOTE 9:                      COMMON STOCK REPURCHASE PROGRAM
 
In February of 2009, the Company authorized the repurchase in the open market or in privately negotiated transactions of up to $1.0 million of its common stock. Pursuant to this plan, the Company through June 30, 2011 had repurchased 625,337 shares of its common stock for $846,906 ($834,258 net of commissions), all of which was purchased after April 1, 2009. At June 30, 2011, the Company had remaining authorization for the repurchase of up to $165,742 in shares of its common stock. The repurchase program is subject to the discretion of the Company’s management.
 
NOTE 10:                    AFFILIATED PARTIES
 
The Company has a minority investment in an affiliated company, Concord Safety Solutions, Pvt. Ltd. (26% ownership). During the first quarter of 2011, the Company loaned Concord Safety Solutions approximately $250,000, recorded in other long-term receivables, for use as working capital.
 
 
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NOTE 11:                    LEGAL PROCEEDINGS

a.           Stockholders Derivative Complaint:
 
On May 6, 2009 a purported stockholders derivative complaint (the “Derivative Complaint”) was filed in the United States District Court for the Eastern District of New York against the Company and certain of the Company’s officers and directors related to its acquisition of Armour of America in 2005 and certain public statements made by the Company with respect to its business and prospects, including allegations that the Company did not have adequate systems of internal operational or financial controls, and that the Company’s financial statements and reports were not prepared in accordance with GAAP and SEC rules. The Company moved for dismissal of the Derivative Complaint in March of 2010, and the Derivative Complaint was dismissed without prejudice on March 31, 2011.
 
b.           NAVAIR Litigation:
 
On January 10, 2011, a judgment and decision was unsealed and issued for publication in respect of the lawsuit in the United States Court of Federal Claims by Armour of America, Incorporated (“AoA”), a subsidiary that the Company purchased in August 2004, against the United States Naval Air Systems Command (NAVAIR). The lawsuit, which was based on events that had occurred prior to the Company’s purchase of AoA, had sought 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. The court’s decision found against AoA and in favor of NAVAIR, and awarded NAVAIR reprocurement and administrative costs in the total amount of approximately $1.55 million. The Company filed a notice of appeal in respect of a substantial portion of the court’s decision. However, the Company has come to an agreement with NAVAIR under which the Company has agreed to pay the judgment in full in the third quarter of 2011.
 
In light of the judge’s decision in this case, the Company recorded a charge of approximately $1.55 million in our financial statements for the year ended December 31, 2010.
 
NOTE 12:                    SUBSEQUENT EVENTS
 
In July 2011, the Company merged its Israeli subsidiary Electric Fuel (E.F.L.) Ltd. (“EFL”) into its Israeli subsidiary Epsilor Electronic Industries, Ltd. (“Epsilor”), changing the name of the merged company to Epsilor-Electric Fuel Ltd. (the “Merged Company”). The purpose of this merger was to enable unified management and operation of these two Israeli battery companies and to achieve cost savings through elimination of duplications and inefficiencies. An agreement was reached with the Israeli tax authorities regarding the use of EFL’s loss carry forwards by the Merged Company, which for tax purposes is effective 6/30/2011. The Merged Company will continue to market Epsilor’s and EFL’s products under their respective trademarks, and, for so long as the Merged Company continues to make use of benefits granted to Epsilor by the Israel Investment Center, the Merged Company will continue to maintain separate books for the two business operations.
 
On July 22, 2011, the Company’s FAAC subsidiary purchased a 40,000 square foot building for $1.5 million containing both office and lab space.  The building was financed with a $1.1 million mortgage loan that was obtained through the Company’s primary bank.  The new building is located approximately three miles from FAAC’s main location and will house the new personnel and equipment needed to fulfill FAAC’s current backlog along with future space requirements.
 
 
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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 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” in our Annual Report on Form 10-K 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
 
We are a defense and security products and services company, engaged in three business areas: interactive simulation for military, law enforcement and commercial markets (Training and Simulation Division); batteries and charging systems for the military (Battery and Power Systems Division); and high-level armoring for military, paramilitary and commercial vehicles (Armor Division).
 
Overview of Results of Operations
 
Acquisitions
 
In the acquisition of subsidiaries, part of the purchase price is allocated to intangible assets and goodwill. Amortization of definite-lived 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 definite-lived intangible assets in the amount of a fraction (based on the useful life of the definite-lived intangible assets) of the amount recorded as intangible assets. Such amortization charges continued during the first six months of 2011. We are required to review long-lived intangible assets and goodwill for impairment at least annually or 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 the carrying amount of these assets has been impaired, we must record the impairment charge in our statement of operations.
 
Financings and Issuances of Warrants
 
The non-cash charges that relate to our financings occurred in connection with our issuance of convertible securities with warrants, and in connection with our repricing of certain warrants and grants of new warrants. When we issue convertible securities, we record a discount for a beneficial conversion feature that is amortized ratably over the life of the debenture.
 
 
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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 the securities purchase agreement, we issued to the purchasers of our 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 in 2008 as equity based on relative fair value. The relative fair value of these warrants was determined in 2008 using the 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 the original accounting for these convertible notes, we recorded a deferred debt discount on the balance sheet of $412,000 in 2008. The beneficial conversion feature and the discount arising from fair value allocation of the warrants is being amortized from the date of issuance to the stated redemption date – August 15, 2011.
 
On January 1, 2009 we adopted FASB ASC 815-40-15, “Determining Whether an Instrument is Indexed to an Entity’s Own Stock.” FASB ASC 815-40-15 required us to re-evaluate the warrants issued with the convertible notes and to also re-evaluate the embedded conversion option and embedded put options within the notes to determine if the previous accounting for these items would change. Upon this re-evaluation, we were required to reclassify the warrants along with the value of the embedded conversion feature from equity to a derivative liability. The embedded put options remained classified as derivative liabilities. We again used the Black-Scholes valuation model and other factors to determine the value of the warrants, the value of the embedded conversion feature and the value of the embedded put options associated with the convertible notes as of January 1, 2009. In accordance with the guidance of FASB ASC 815-40-15, a cumulative adjustment increasing January 1, 2009 retained earnings by $471,000 was made in the first quarter of 2009 to reflect this new accounting.
 
On June 30, 2011, we revalued these warrants, their embedded conversion option and their embedded put options and recorded an expense of approximately $102,000 in the second quarter in financial expense. The table below lists the variables used in the Black-Scholes calculation and the resulting fair values using significant unobservable inputs (Level 3):
 
Variables
 
December 31, 2009
   
December 31, 2010
   
June 30, 2011
 
Stock price
  $ 1.70     $ 1.67     $ 2.18  
Risk free interest rate
    1.70 %     1.02 %     0.81 %
Volatility
    79.85 %     76.90 %     79.84 %
Dividend yield
    0.00 %     0.00 %     0.00 %
Contractual life
 
1.6 years
   
0.6 years
   
0.1 years
 
                   
Values
 
December 31, 2009
   
December 31, 2010
   
June 30, 2011
 
Warrants
  $ 298,570     $ 131,355     $ 123,401  
Conversion option
    88,156       28,822       21,733  
Puts
    7,371       1,162       119  
Total value
  $ 394,097     $ 161,339     $ 145,253  
 
The final principal payment of $454,545 is due on the convertible notes on August 15, 2011.
 
 
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Concurrent with the Securities Purchase Agreement dated August 14, 2008, we purchased a $2.5 million Senior Subordinated Convertible Note from an unaffiliated company, DEI Services Corporation (“DEI”). On August 10, 2010, DEI repaid the entire $2.5 million principal amount of the DEI Note, along with all outstanding earned and unpaid interest. Inasmuch as we had previously established an allowance of $500,000 in the fourth quarter 2009 on the DEI Note based on our expectation that we would not collect the entire DEI Note, we recognized the difference between the $2.0 million book value of the DEI Note and the $2.5 million that we actually collected as a recovery under allowance for settlements on our financial statements. Additionally, we accrued unpaid interest on the DEI Note through June 30, 2010 in the amount of $140,000, which was booked as a reduction of financial expenses and additionally recorded $11,000 in interest income in the third quarter of 2010. This transaction extinguished our conversion options and rights of first refusal with respect to DEI.
 
Restricted Shares, Restricted Stock Units and Options
 
In accordance with FASB ASC 505-50, we incurred, for the six months ended June 30, 2011 and 2010, compensation expense related to restricted stock units and restricted shares of approximately $133,000 and $302,000, respectively. Our directors received their annual restricted stock grants on April 1, 2011 in accordance with the terms of the directors’ stock compensation plan. Additionally, the corporate officers received their annual restricted stock grants on April 25, 2011.
 
Overview of Operating Performance and Backlog
 
Overall, our loss before income tax expenses for the six months ended June 30, 2011 was $4.4 million on revenues of $27.6 million, compared to  income before income taxes of $911,000 on revenues of $40.1 million during the six months ended June 30, 2010. Our total backlog at June 30, 2011 was $109.1 million, compared to a backlog at June 30, 2010 of $40.4 million, an overall improvement of $68.7 million.
 
In our Training and Simulation Division, revenues decreased from approximately $20.1 million in the first six months of 2010 to $14.7 million in the first six months of 2011. As of June 30, 2011, our backlog for our Training and Simulation Division totaled $81.4 million, compared to a backlog at June 30, 2010 of $18.6 million.
 
In our Battery and Power Systems Division, revenues decreased from approximately $8.9 million in the first six months of 2010 to approximately $8.3 million in the first six months of 2011. As of June 30, 2011, our backlog for our Battery and Power Systems Division totaled $13.5 million, compared to a backlog at June 30, 2010 of $13.1 million.
 
In our Armor Division, revenues decreased from approximately $11.1 million during the first six months of 2010 to approximately $4.6 million during the first six months of 2011. As of June 30, 2011, our backlog for our Armor Division totaled $14.2 million, compared to a backlog at June 30, 2010 of $8.7 million.
 
The table below details the percentage of total recognized revenue by type of arrangement for the six months ended June 30, 2011 and 2010:
 
   
Six months ended June 30,
 
Type of Revenue
 
2011
   
2010
 
Sale of products
    91.8 %     94.6 %
Maintenance and support agreements
    5.2 %     3.5 %
Long term research and development contracts
    3.0 %     1.9 %
Total
    100.0 %     100.0 %
 
Common Stock Repurchase Program
 
In February of 2009, we authorized the repurchase in the open market or in privately negotiated transactions of up to $1.0 million of our common stock. Pursuant to this plan, through June 30, 2011 we have repurchased 625,337 shares of our common stock for $846,906 ($834,258 net of commissions), all of which was purchased after April 1, 2009. At June 30, 2011, we had remaining authorization for the repurchase of up to $165,742 in shares of our common stock. The repurchase program is subject to the discretion of our management.
 
 
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Recent Developments
 
Merger of Electric Fuel into Epsilor
 
In July 2011, we merged our Israeli subsidiary Electric Fuel (E.F.L.) Ltd. (“EFL”) into our Israeli subsidiary Epsilor Electronic Industries, Ltd. (“Epsilor”), changing the name of the merged company to Epsilor-Electric Fuel Ltd. (the “Merged Company”). The purpose of this merger was to enable unified management and operation of these two Israeli battery companies and to achieve cost savings through elimination of duplications and inefficiencies. An agreement was reached with the Israeli tax authorities regarding the use of EFL’s loss carry forwards by the Merged Company, which for tax purposes is effective 6/30/2011. The Merged Company will continue to market Epsilor’s and EFL’s products under their respective trademarks, and, for so long as the Merged Company continues to make use of benefits granted to Epsilor by the Israel Investment Center, the Merged Company will continue to maintain separate books for the two business operations.
 
Purchase of New Building by FAAC
 
On July 22, 2011, our FAAC subsidiary purchased a 40,000 square foot building for $1.5 million containing both office and lab space.  The building was financed with a $1.1 million mortgage loan that was obtained through our primary bank.  The new building is located approximately three miles from FAAC’s main location and will house the new personnel and equipment needed to fulfill our current backlog along with future space requirements.
 
Functional Currency
 
We consider the United States dollar to be the currency of the primary economic environment in which we and our Israeli subsidiary EFL operate and, therefore, both we and EFL have adopted and are using the United States dollar as our functional currency. Transactions and balances originally denominated in U.S. dollars are presented at the original amounts. Gains and losses arising from non-dollar transactions and balances are included in net income.
 
The majority of financial transactions of our Israeli subsidiaries MDT and Epsilor is in New Israel Shekels (“NIS”) and a substantial portion of MDT’s and Epsilor’s costs is incurred in NIS. Management believes that the NIS is the functional currency of MDT and Epsilor. Accordingly, the financial statements of MDT and Epsilor have been translated into U.S. dollars. All balance sheet accounts have been translated using the exchange rates in effect at the balance sheet date. Statement of operations amounts have been translated using the average exchange rate for the period. The resulting translation adjustments are reported as a component of accumulated other comprehensive income (loss) in stockholders’ equity.
 
Results of Operations
 
Three months ended June 30, 2011 compared to the three months ended June 30, 2010.
 
Revenues. Revenues for the three months ended June 30, 2011 totaled $14.3 million, compared to $18.9 million in the comparable period in 2010, a decrease of $4.6 million, or 24.4%. In the second quarter of 2011, revenues were $6.5 million for the Training and Simulation Division (compared to $10.4 million in the second quarter of 2010, a decrease of $4.0 million, or 38.0%, due primarily to a slowdown in Department of Defense spending and the completion of a simulator contract that produced significant revenue in the second quarter of 2010); $4.1 million for the Battery and Power Systems Division (compared to $3.9 million in the second quarter of 2010, an increase of $196,000, or 5.0%); and $3.7 million for the Armor Division (compared to $4.5 million in the second quarter of 2010, a decrease of $842,000, or 18.5%, due primarily to several significant contracts that were delayed and are now expected to ship in the third quarter).
 
Cost of revenues. Cost of revenues totaled $10.7 million during the second quarter of 2011, compared to $13.3 million in the second quarter of 2010, a decrease of $2.5 million, or 19.1%, due primarily to the reduction in sales. Cost of revenues were $3.4 million for the Training and Simulation Division (compared to $6.3 million in the second quarter of 2010, a decrease of $2.9 million, or 46.6%, due primarily to the reduction in sales); $3.8 million for the Battery and Power Systems Division (compared to $3.5 million in the second quarter of 2010, an increase of $274,000, or 7.9%, due primarily to the increase in sales); and $3.6 million for the Armor Division (compared to $3.5 million in the second quarter of 2010, an increase of $137,000, or 3.9%, due primarily to decreased operating efficiencies along with unfavorable variances in materials).
 
 
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Research and development expenses. Research and development expenses for the second quarter of 2011 were $462,000, compared to $764,000 during the second quarter of 2010, a decrease of $302,000, or 39.5%, due primarily to a reduction in spending of $472,000 in the Armor Division related to the Tiger vehicle.
 
Selling and marketing expenses. Selling and marketing expenses for the second quarter of 2011 were $1.5 million, compared to $1.4 million in the second quarter of 2010, an increase of $23,000, or 1.6%, due primarily to increased expenses in the Training and Simulation Division related to an increase in the sales force and increased participation in trade shows.
 
General and administrative expenses. General and administrative expenses for the second quarter of 2011 were $3.0 million, compared to $2.9 million in the second quarter of 2010, an increase of $41,000, or 1.4%, due primarily to an increase in expenses in the Battery and Power Systems Division offset by a reduction in expenses in the Armor Division.
 
Amortization of intangible assets. Amortization of intangible assets totaled $482,000 in the second quarter of 2011, compared to $417,000 in the second quarter of 2010, an increase of $64,000, or 15.4%, due primarily to the increase in amortization of capitalized software in our Training and Simulation Division.
 
Financial expense, net. Financial expenses totaled $134,000 in the second quarter of 2011, compared to $64,000 in the second quarter of 2010, an increase of $69,000, or 107.8%, due primarily to a increase in the corporate expenses associated with our warrants.
 
Income taxes. With respect to some of our subsidiaries that operated at a net income during 2011, we were able to offset federal taxes against our accumulated loss carry forward. We recorded a total of $141,000 in tax expense in the second quarter of 2011, compared to $197,000 in tax expense in the second quarter of 2010, a decrease of $56,000, or 28.7%, mainly concerning state and local taxes. This amount includes the required adjustment of taxes due to the deduction of goodwill “naked” credits for U.S. federal taxes, which totaled $113,000 and $140,000 in non-cash expenses in the second quarter of 2011 and 2010 respectively (“naked” credits occur when deferred tax liabilities that are created by indefinite-lived assets such as goodwill cannot be used as a source of taxable income to support the realization of deferred tax assets).
 
Net profit (loss). Due to the factors cited above, we went from net income of $360,000 in the second quarter of 2010 to a net loss of $2.1 million in the second quarter of 2011, a difference of $2.4 million.
 
Six months ended June 30, 2011 compared to the six months ended June 30, 2010.
 
Revenues. Revenues for the six months ended June 30, 2011 totaled $27.6 million, compared to $40.1 million in the comparable period in 2010, a decrease of $12.5 million, or 31.1%. In the first six months of 2011, revenues were $14.7 million for the Training and Simulation Division (compared to $20.1 million in the first six months of 2010, a decrease of $5.4 million, or 26.7%, due primarily to a slowdown in Department of Defense spending and the completion of a simulator contract that produced significant revenue ($6.4 million change) in the first six months of 2010); $8.3 million for the Battery and Power Systems Division (compared to $8.9 million in the first six months of 2010, a decrease of $567,000, or 6.4%, due primarily to several significant signed contracts that were delayed and are now expected to ship in the third quarter); and $4.6 million for the Armor Division (compared to $11.1 million in the first six months of 2010, a decrease of $6.5 million, or 58.9%, also due primarily to several significant contracts that were delayed and are now expected to ship in the third quarter).
 
Cost of revenues. Cost of revenues totaled $21.3 million during the first six months of 2011, compared to $28.6 million in the first six months of 2010, a decrease of $7.3 million, or 25.6%, due primarily to the reduction in sales. Cost of revenues were $8.3 million for the Training and Simulation Division (compared to $12.2 million in the first six months of 2010, a decrease of $3.9 million, or 31.8%, due primarily to the reduction in sales); $7.7 million for the Battery and Power Systems Division (compared to $7.6 million in the first six months of 2010, an increase of $36,000, or 0.5%, due primarily to decreased operating efficiencies); and $5.2 million for the Armor Division (compared to $8.7 million in the first six months of 2010, a decrease of $3.5 million, or 39.9%, due primarily to the reduction in sales and decreased operating efficiencies, along with unfavorable variances in materials).
 
Research and development expenses. Research and development expenses for the first six months of 2011 were $1.0 million, compared to $1.6 million during the first six months of 2010, a decrease of $566,000, or 35.8%, due primarily to a reduction in spending of $666,000 in the Armor Division related to the Tiger vehicle.
 
 
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Selling and marketing expenses. Selling and marketing expenses for the first six months of 2011 were $2.8 million, compared to $2.6 million in the first six months of 2010, an increase of $235,000, or 9.0%, due primarily to increased expenses in the Training and Simulation Division related to an increase in the sales force and increased participation in trade shows.
 
General and administrative expenses. General and administrative expenses for the first six months of 2011 were $5.9 million, compared to $5.8 million in the first six months of 2010, an increase of $78,000, or 1.3%, due primarily to an increase in expenses in the Battery and Power Systems Division offset by a reduction in general corporate expense related to stock compensation expense.
 
Amortization of intangible assets. Amortization of intangible assets totaled $961,000 in the first six months of 2011, compared to $839,000 in the first six months of 2010, an increase of $122,000, or 14.6%, due primarily to the increase in amortization of capitalized software in our Training and Simulation Division.
 
Financial expense, net. Financial expenses totaled $2,000 in the first six months of 2011, compared to $208,000 in the first six months of 2010, a decrease of $206,000, or 99.2%, due primarily to positive exchange rate adjustments in the Battery Division.
 
Income taxes. With respect to some of our subsidiaries that operated at a net income during 2011, we were able to offset federal taxes against our accumulated loss carry forward. We recorded a total of $281,000 in tax expense in the first six months of 2011, compared to $459,000 in tax expense in the first six months of 2010, a decrease of $178,000, or 38.7%, mainly concerning state and local taxes. This amount includes the required adjustment of taxes due to the deduction of goodwill “naked” credits for U.S. federal taxes, which totaled $225,000 and $280,000 in non-cash expenses in the first six months of 2011 and 2010, respectively (“naked” credits occur when deferred tax liabilities that are created by indefinite-lived assets such as goodwill cannot be used as a source of taxable income to support the realization of deferred tax assets).
 
Net profit (loss). Due to the factors cited above, we went from net income of $452,000 in the first six months of 2010 to a net loss of $4.7 million in the first six months of 2011, a difference of $5.2 million.
 
Liquidity and Capital Resources
 
As of June 30, 2011, we had $1.2 million in cash and cash equivalents and $1.9 million in restricted collateral deposits, as compared to December 31, 2010, when we had $6.3 million in cash and cash equivalents and $1.8 million in restricted collateral deposits. We also had $4.5 million in unused bank lines of credit with our main bank as of June 30, 2011, under a $10.0 million credit facility under our FAAC subsidiary, which is secured by our assets and the assets of our other subsidiaries and guaranteed by us. There was $4.5 million of available credit on this line as of June 30, 2011, based on our borrowing base calculations.
 
We used available funds in the six months ended June 30, 2011 primarily for working capital needs. We purchased approximately $544,000 of property and equipment during the six months ended June 30, 2011. Our net property and equipment amounted to $4.5 million at June 30, 2011.
 
Net cash (used in)/provided by operating activities from continuing operations for the six months ended June 30, 2011 and 2010 was $(6.7 million) and $972,000, respectively, a decrease of $7.7 million. This decrease in cash used was primarily due to the operating loss in 2011 and a decrease in working capital.
 
Net cash used in investing activities for the six months ended June 30, 2011 and 2010 was $(264,000) and $(469,000), an increase of $205,000. This increase was primarily the result the purchase of long lived assets offset by sales of marketable securities.
 
Net cash (used in)/provided by financing activities for the six months ended June 30, 2011 and 2010 was $1.8 million and $(584,000), respectively, an increase of $2.4 million. The 2011 cash provided by financing activities was due to the increase in short-term debt.
 
 
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As of June 30, 2011, we had approximately $4.8 million in short-term bank debt and $1.6 million in long-term debt outstanding. This is in comparison to $2.5 million in short-term bank debt and $2.4 million in long-term debt outstanding as of December 31, 2010.
 
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 next twelve months.
 
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 minor foreign exchange gains and losses to date, and do not expect to incur significant gains and losses in 2011. 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.
 
As of the end of the period covered by this report, an evaluation was carried out by the Company's management, with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that these disclosure controls and procedures were effective as of the end of the period covered by this report. In addition, no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
 
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PART II
 
ITEM 1.  LEGAL PROCEEDINGS.
 
Stockholders Derivative Complaint
 
On May 6, 2009 a purported stockholders derivative complaint (the “Derivative Complaint”) was filed in the United States District Court for the Eastern District of New York against us and certain of our officers and directors related to our acquisition of Armour of America in 2005 and certain public statements made by us with respect to our business and prospects, including allegations 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. We moved for dismissal of the Derivative Complaint in March of 2010, and the Derivative Complaint was dismissed without prejudice on March 31, 2011.
 
NAVAIR Litigation
 
On January 10, 2011, a judgment and decision was unsealed and issued for publication in respect of the lawsuit in the United States Court of Federal Claims by Armour of America, Incorporated (“AoA”), a subsidiary that we purchased in August 2004, against the United States Naval Air Systems Command (NAVAIR). The lawsuit, which was based on events that had occurred prior to our purchase of AoA, had sought 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. The court’s decision found against AoA and in favor of NAVAIR, and awarded NAVAIR reprocurement and administrative costs in the total amount of approximately $1.55 million. We filed a notice of appeal in respect of a substantial portion of the court’s decision. However, we have come to an agreement with NAVAIR under which we have agreed to pay the judgment in full in the third quarter of 2011.
 
In light of the judge’s decision in this case, we recorded a charge of approximately $1.55 million in our financial statements for the year ended December 31, 2010.
 
We do not believe that this judgment will adversely affect our current business relationship with NAVAIR, with which our various subsidiaries have conducted business subsequent to the events that formed the basis of this lawsuit.
 
ITEM 1A.  RISK FACTORS.
 
For information regarding our risk factors, please refer to Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2010. We do not believe that there have been any material changes in the risk factors disclosed in the Annual Report on Form 10-K.
 
 
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ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
 
In February of 2009, we authorized the repurchase in the open market or in privately negotiated transactions of up to $1.0 million of our common stock. Pursuant to this plan, through June 30, 2011 we have repurchased 625,337 shares of our common stock for $846,906 ($834,258 net of commissions), all of which was purchased after April 1, 2009. At June 30, 2011, we had remaining authorization for the repurchase of up to $165,742 in shares of our common stock. The repurchase program is subject to the discretion of our management. The following table shows information relating to the repurchase of our common stock during the three months ended June 30, 2011:
 
Period
 
Total Number of Shares Purchased
   
Average Price Paid Per Share(1)
   
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
   
Maximum Approximate Dollar Value of Shares that May Yet be Purchased Under the Plans
 
April 1, 2011 through April 30, 2011
    8,078     $ 1.42       8,078     $ 185,740  
May 1, 2011 through May 31, 2011
    15,853     $ 1.28       15,853     $ 165,742  
June 1, 2011 through June 30, 2011
    0     $       0     $ 165,742  
TOTAL THIS QUARTER
    23,931               23,931          
                                 
(1)Average price paid per share includes commissions and is rounded to the nearest two decimal places.
 
 
The repurchase program is subject to management’s discretion.
 
ITEM 6.  EXHIBITS.
 
The following documents are filed as exhibits to this report:
 
Exhibit Number
Description
31.1
31.2
32.1
32.2
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document
 
 
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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:    August 15, 2011

 
AROTECH CORPORATION
 
     
     
 
By:
/s/ Robert S. Ehrlich
   
Name:
Robert S. Ehrlich
   
Title:
Chairman and CEO
     
(Principal Executive Officer)

 
 
By:
/s/ Thomas J. Paup
   
Name:
Thomas J. Paup
   
Title:
Vice President – Finance and CFO
     
(Principal Financial Officer)
 
 
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