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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K/A
(Amendment No. 2)
 
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED      DECEMBER 31, 2005   .
 
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ______.
 
Commission File Number:  0-23336 
 
AROTECH CORPORATION
(Exact name of registrant as specified in its charter)
 
Delaware
(State or other jurisdiction of incorporation or organization)
95-4302784
(I.R.S. Employer Identification No.)
 
1229 Oak Valley Drive, Ann Arbor, Michigan
(Address of principal executive offices)
48108
(Zip Code)
 
(800) 281-0356
(Registrant’s telephone number, including area code)
 
Securities registered pursuant to Section 12(b) of the Act:
 
Title of each class
None
Name of each exchange on which registered
Not applicable
 
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.01 par value
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes o No x
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act).
Yes o No x
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes x No o 
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o 
 
Indicate by check mark whether the registrant is large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer: o 
  Accelerated filer: x
Non-accelerated filer: o 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
 
The aggregate market value of the registrant’s voting stock held by non-affiliates of the registrant as of June 30, 2005 was approximately $84,064,177 (based on the last sale price of such stock on such date as reported by The Nasdaq National Market and assuming, for the purpose of this calculation only, that all of the registrant’s directors and executive officers are affiliates).
 
(Applicable only to corporate registrants) Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date: 8,468,957 as of 7/5/06
 
Documents incorporated by reference: None
 


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.
 

 
PRELIMINARY NOTE
 
Arotech Corporation is filing this Amendment No. 2 to its Annual Report on Form 10-K for the year ended December 31, 2005, as filed with the Securities and Exchange Commission on March 31, 2006, and as amended by Amendment No. 1 as filed with the Securities and Exchange Commission on June 16, 2006. The sole purpose of this amendment is to re-file the following document under Item 8, “Financial Statements and Supplementary Data,” which document was previously filed under Item 9A, “Controls and Procedures”:
 
·
the report on internal control over financial reporting from Kost, Forer, Gabbay & Kasierer, a member of Ernst & Young Global, Independent Registered Public Accounting Firm.
 
The foregoing documents does not contain any changes from the version of such document most recently filed with the Securities and Exchange Commission.
 
We are also filing a new version of our financial statements giving effect to a one-for-fourteen reverse stock split effected on June 21, 2006. As a result, we are filing the following documents under Item 8, “Financial Statements and Supplementary Data”:
 
·
the report of Kost, Forer, Gabbay & Kasierer, a member of Ernst & Young Global, Independent Registered Public Accounting Firm;
 
·
the report of Stark Winter Schenkein & Co., LLP, Independent Registered Public Accounting Firm; and
 
·
Arotech Corporation’s financial statements for the year ended December 31, 2005.
 
None of the foregoing documents contains any changes from the versions of such documents most recently filed with the Securities and Exchange Commission, except that the financial statements have been restated to give effect to a one-for-fourteen reverse stock split effected on June 21, 2006. Except in respect of the reverse stock split, the restated financial statements do not reflect the restatement of any previously reported financial statements, results of operations or any other related financial disclosures.
 
Additionally, as required by SEC regulations, we are:
 
·
Providing additional Consents of Kost, Forer, Gabbay & Kasierer, a member of Ernst & Young Global, and Stark Winter Schenkein & Co., LLP, Independent Registered Public Accounting Firms; and
 
·
Replacing the Section 302 and Section 906 certifications from the Chairman and Chief Executive Officer and the Vice President Finance and Chief Financial Officer.
 

 
PART II
 
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
Index to Financial Statements
 
 
Page
Consolidated Financial Statements
 
Reports of Independent Registered Public Accounting Firms 
F-1
Consolidated Balance Sheets 
F-8
Consolidated Statements of Operations 
  F-10
Statements of Changes in Shareholders’ Equity 
  F-11
Consolidated Statements of Cash Flows 
  F-14
Notes to Consolidated Financial Statements 
  F-17
Supplementary Financial Data
 
Quarterly Financial Data (unaudited) forthe two years ended December 31, 2005 
  F-64
Financial Statement Schedule
 
Schedule II – Valuation and Qualifying Accounts 
  F-65
 
The financial statements have been restated to give effect to a one-for-fourteen reverse stock split effected on June 21, 2006.
 
-2-

 
 
ernstyoung logo
 n Kost Forer Gabbay & Kasierer
         3  Aminadav St.
         Tel-Aviv 67067, Israel
n Phone: 972-3-6232525
        Fax:      972-3-5622555
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Stockholders of
 
AROTECH CORPORATION
 
We have audited the accompanying consolidated balance sheets of Arotech Corporation (the “Company”) and its subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of operations, changes in stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedule listed in Item 15(a)(2) of the Company’s 10-K. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We did not audit the financial statements of “Armor of America Incorporated”, a wholly-owned subsidiary of the Company, financial statements of which reflect total assets of 2.8% of the consolidated assets of the Company as of December 31, 2005, and total revenues of 8.8% of the consolidated revenues of the Company for the year then ended, or of “IES Interactive Training, Inc.”, a wholly-owned subsidiary of the Company, financial statements of which reflect total assets of 3.5% of the consolidated assets of the Company as of December 31, 2005, and total revenues of 11.8% of the consolidated revenues of the Company for the year then ended. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the data included for this subsidiary, is based solely on the report of the other auditors.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion based on our audits and the other auditors the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company and its subsidiaries as of December 31, 2005 and 2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. Additionally, in our opinion the related financial statement schedule, when considered in relation to the basic financial statements and schedule taken as a whole, present fairly in all material respects the information set forth therein.
 
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated June 15, 2006 expressed an unqualified opinion on management’s assessment of and an adverse opinion on the effectiveness of internal control over financial reporting.
 
     
   
/s/ Kost, Forer, Gabbay & Kasierer
 
Tel Aviv, Israel
March 30, 2006,
except for the final paragraph above,
as to which the date is June 15, 2006
and for Note 13.h.,
as to which the date
is July 24, 2006

KOST, FORER, GABBAY & KASIERER
A Member of Ernst & Young Global
 
F-1

 
ernstyoung logo
 n Kost Forer Gabbay & Kasierer
         3  Aminadav St.
         Tel-Aviv 67067, Israel
n Phone: 972-3-6232525
        Fax:      972-3-5622555
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
The Board of Directors and Shareholders of
 
AROTECH CORPORATION
 
We have audited management’s assessment, included in the accompanying “Management’s Report on Internal Control Over Financial Reporting,” that Arotech Corporation (“Arotech” or “Company”) did not maintain effective internal control over financial reporting as of December 31, 2005, because of the effect of the material weakness related to revenue recognition identified in management’s assessment, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Arotech’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit. We did not examine the effectiveness of internal control over financial reporting of Armor of America Incorporated or IES Interactive Training Inc., wholly owned subsidiaries, whose financial statements in the aggregate reflect total assets and revenues constituting 6.3% and 20.6%, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2005. The effectiveness of Armor of America Incorporated’s and IES Interactive Training Inc.’s internal control over financial reporting was audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to the effectiveness of Armor of America Incorporated’s and IES Interactive Training Inc.’s internal control over financial reporting, is based solely on the reports of the other auditors.
 
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit and the reports of the other auditors provide a reasonable basis for our opinion
 
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
 
F-2

 
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
In our report dated March 30, 2006, we disclaimed an opinion on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005, because management had not yet completed its assessment of the Company’s internal control over financial reporting. Management has subsequently completed its assessment of internal control over financial reporting as of December 31, 2005. Accordingly, our present report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005, as presented herein, is different from our previous report dated March 30, 2006.
 
A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weakness has been identified and included in management’s assessment: The Company did not maintain effective controls over the monitoring, review and approval of revenue recognition calculations at FAAC INC. Specifically, these calculations were not being reviewed by appropriate accounting personnel at FAAC INC. to determine that revenue is recognized in accordance with company policy and generally accepted accounting principles. This material weakness affects the Company’s revenue and unbilled receivable accounts. This material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2005 financial statements, and this report does not affect our report dated March 30, 2006, except for the final paragraph of our report as to which the date is June 15, 2006, on those financial statements.
 
In our opinion, based on our audit and the reports of the other auditors, management’s assessment that Arotech did not maintain effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the COSO control criteria. Also, in our opinion, based on our audit and the reports of the other auditors, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, Arotech has not maintained effective internal control over financial reporting as of December 31, 2005, based on the COSO control criteria.
 
     
    
/s/ Kost, Forer, Gabbay & Kasierer
 
Tel Aviv, Israel
June 15, 2006

KOST, FORER, GABBAY & KASIERER
A Member of Ernst & Young Global
 
F-3

 
sws logo
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors
IES Interactive Training, Inc. and Subsidiary

We have audited the accompanying consolidated balance sheets of IES Interactive Training, Inc. and Subsidiary as of December 31, 2005, and the related consolidated statements of operations, stockholder’s (deficit) and cash flows for the year ended December 31, 2005. We also have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that IES Interactive Training, Inc. and Subsidiary maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). IES Interactive Training, Inc. and Subsidiary’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on these consolidated financial statements, an opinion on management’s assessment, and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
 
7535 EAST HAMPDEN AVENUE  SUITE 109  DENVER, COLORADO 80231
PHONE: 303.694.6700 ♦ FAX: 303.694.6761 ♦ TOLL FREE: 888.766.3985 ♦ WWW.SWSCPAS.COM
 
F-4

 
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of IES Interactive Training, Inc. and Subsidiary as of December 31, 2005, and the results of its operations and its cash flows for the year ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, management’s assessment that IES Interactive Training, Inc. and Subsidiary maintained effective internal control over financial reporting as of December 31, 2005 is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Furthermore, in our opinion, IES Interactive Training, Inc. and Subsidiary maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

denver logo
 
Denver, Colorado
March 10, 2006
 
STARK WINTER SCHENKEIN & CO., LLP Certified Public Accountants  Financial Consultants
7535 EAST HAMPDEN AVENUE  SUITE 109  DENVER, COLORADO 80231
PHONE: 303.694.6700 ♦ FAX: 303.694.6761 ♦ TOLL FREE: 888.766.3985 ♦ WWW.SWSCPAS.COM
 
F-5

 
sws logo
 
Report of Independent Registered Public Accounting Firm
 
To the Shareholder
Armour of America, Inc.
Gardena, California
 
We have audited the accompanying balance sheet of Armour of America, Inc. as of December 31, 2005, and the related statements of operations, stockholder’s equity and cash flows for the period August 11, 2004 to December 2004 and the year ended December 31, 2005. We also have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting , that Armour of America, Inc. maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Armour of America, Inc.’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on these financial statements, an opinion on management’s assessment, and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
 
STARK WINTER SCHENKEIN & CO., LLP Certified Public Accountants  Financial Consultants
7535 EAST HAMPDEN AVENUE  SUITE 109  DENVER, COLORADO 80231
PHONE: 303.694.6700 ♦ FAX: 303.694.6761 ♦ TOLL FREE: 888.766.3985 ♦ WWW.SWSCPAS.COM
 
F-6


Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Armour of America, Inc. as of December 31, 2005, and the related statements of operations, stockholder’s equity and cash flows for the period August 11, 2004 to December 2004 and the year ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, management’s assessment that Armour of America, Inc. maintained effective internal control over financial reporting as of December 31, 2005 is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Furthermore, in our opinion, Armour of America, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

denver logo
Denver, Colorado
January 31, 2006
 
7535 EAST HAMPDEN AVENUE  SUITE 109  DENVER, COLORADO 80231
PHONE: 303.694.6700 ♦ FAX: 303.694.6761 ♦ TOLL FREE: 888.766.3985 ♦ WWW.SWSCPAS.COM
 
F-7



AROTECH CORPORATION AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS 

In U.S. dollars
 
   
December 31,
 
   
2005
 
2004
 
           
ASSETS
         
           
CURRENT ASSETS:
         
Cash and cash equivalents
 
$
6,150,652
 
$
6,734,512
 
Restricted collateral deposits and restricted held-to-maturity securities
   
3,897,113
   
6,962,110
 
Available for sale marketable securities
   
35,984
   
135,568
 
Trade receivables (net of allowance for doubtful accounts in the amounts of $176,180 and $55,394 as of December 31, 2005 and 2004, respectively)
   
11,747,876
   
8,266,880
 
Unbilled receivables
   
5,228,504
   
2,881,468
 
Other accounts receivable and prepaid expenses
   
2,264,331
   
1,339,393
 
Inventories
   
7,815,806
   
7,277,301
 
               
Total current assets
   
37,140,266
   
33,597,232
 
               
SEVERANCE PAY FUND
   
2,072,034
   
1,980,047
 
               
RESTRICTED DEPOSITS
   
779,286
   
4,000,000
 
               
PROPERTY AND EQUIPMENT, NET
   
4,252,931
   
4,600,691
 
               
INVESTMENT IN AFFILIATED COMPANY
   
37,500
   
 
               
OTHER INTANGIBLE ASSETS, NET
   
11,027,499
   
14,368,701
 
               
GOODWILL
   
29,559,157
   
39,745,516
 
               
   
$
84,868,673
 
$
98,292,187
 

The accompanying notes are an integral part of the consolidated financial statements.
 
F-8

 

AROTECH CORPORATION AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS 

In U.S. dollars
 
 
 
   
December 31,
 
   
2005
 
2004
 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY
         
           
CURRENT LIABILITIES:
         
Trade payables
 
$
5,830,820
 
$
6,177,546
 
Other accounts payable and accrued expenses
   
5,630,108
   
5,818,188
 
Current portion of promissory notes due to purchase of subsidiaries
   
603,764
   
13,585,325
 
Short term bank credit and current portion of long term loans
   
2,036,977
   
181,352
 
Deferred revenues
   
603,022
   
618,229
 
Convertible debenture
   
11,492,238
   
 
Liabilities of discontinued operations
   
120,000
   
 
               
Total current liabilities
   
26,316,929
   
26,380,640
 
               
LONG TERM LIABILITIES
             
Accrued severance pay
   
3,657,328
   
3,422,951
 
Convertible debenture
   
8,590,233
   
1,754,803
 
Deferred revenues
   
   
163,781
 
Long term loan
   
   
20,891
 
Long-term portion of promissory note due to purchase of subsidiaries
   
   
980,296
 
               
Total long-term liabilities
   
12,247,561
   
6,342,722
 
               
COMMITMENTS AND CONTINGENT LIABILITIES (Note 11)
             
               
MINORITY INTEREST
   
38,927
   
95,842
 
               
STOCKHOLDERS’ EQUITY:
             
Share capital -
             
Common stock - $0.01 par value each;
             
Authorized: 250,000,000 shares as of December 31, 2004 and 2003; Issued: 6,221,194 shares and 5,759,786 shares as of December 31, 2005 and 2004, respectively; Outstanding - 6,181,527 shares and 5,720,119 shares as of December 31, 2005 and 2004, respectively
   
870,969
   
806,370
 
Preferred shares - $0.01 par value each;
             
Authorized: 1,000,000 shares as of December 31, 2005 and 2004; No shares issued and outstanding as of December 31, 2005 and 2004
   
   
 
Additional paid-in capital
   
193,949,882
   
189,266,103
 
Accumulated deficit
   
(142,996,964
)
 
(118,953,553
)
Deferred stock compensation
   
(389,303
)
 
(1,258,295
)
Treasury stock, at cost (common stock - 39,667 shares as of December 31, 2005 and 2004)
   
(3,537,106
)
 
(3,537,106
)
Notes receivable from stockholders
   
(1,256,777
)
 
(1,222,871
)
Accumulated other comprehensive income
   
(375,445
)
 
372,335
 
               
Total stockholders’ equity
   
46,265,256
   
65,472,983
 
               
   
$
84,868,673
 
$
98,292,187
 
 
The accompanying notes are an integral part of the consolidated financial statements.
 
F-9

 
 
AROTECH CORPORATION AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS 

In U.S. dollars
 
   
Year ended December 31,
 
   
2005
 
2004
 
2003
 
               
Revenues
 
$
49,044,595
 
$
49,953,846
 
$
17,326,641
 
                     
Cost of revenues
   
34,383,736
   
34,011,094
   
11,087,840
 
                     
Gross profit
   
14,660,859
   
15,942,752
   
6,238,801
 
                     
Operating expenses:
                   
Research and development, net
   
1,300,429
   
1,731,379
   
1,053,408
 
Selling and marketing expenses
   
4,471,590
   
4,922,217
   
3,532,636
 
General and administrative expenses
   
14,862,435
   
10,656,866
   
5,857,876
 
Amortization of intangible assets
   
3,070,748
   
2,494,556
   
864,910
 
Impairment of goodwill and other intangible assets
   
12,256,756
   
320,279
   
 
                     
Total operating costs and expenses
   
35,961,958
   
20,125,297
   
11,308,830
 
                     
Operating loss
   
(21,301,099
)
 
(4,182,545
)
 
(5,070,029
)
Other income
   
338,900
   
   
 
Financial income (expenses), net
   
(2,705,689
)
 
(4,228,965
)
 
(4,038,709
)
                     
Loss before minorities interests in loss (earnings) of a subsidiaries and tax expenses
   
(23,667,888
)
 
(8,411,510
)
 
(9,108,738
)
Income taxes
   
(237,672
)
 
(586,109
)
 
(396,193
)
Loss from affiliated company
   
(75,000
)
 
   
 
Minorities interests in loss (earnings) of a subsidiaries
   
57,149
   
(44,694
)
 
156,900
 
Loss from continuing operations
   
(23,923,411
)
 
(9,042,313
)
 
(9,348,031
)
                     
Income (loss) from discontinued operations
   
(120,000
)
 
   
110,410
 
Net loss
 
$
(24,043,411
)
$
(9,042,313
)
$
(9,237,621
)
                     
Deemed dividend to certain stockholders
 
$
 
$
(3,328,952
)
$
(350,000
)
                     
Net loss attributable to common stockholders
 
$
(24,043,411
)
$
(12,371,265
)
$
(9,587,621
)
                     
Basic and diluted net loss per share from continuing operations
 
$
(4.07
)
$
(1.81
)
$
(3.37
)
Basic and diluted net loss per share from discontinued operations
 
$
(0.02
)
$
0.00
 
$
(0.04
)
Basic and diluted net loss per share
 
$
(4.09
)
$
(2.48
)
$
(3.45
)
                     
Weighted average number of shares used in computing basic and diluted net loss per share
   
5,872,093
   
4,995,218
   
2,777,870
 

The accompanying notes are an integral part of the consolidated financial statements.
 
F-10

 
AROTECH CORPORATION AND ITS SUBSIDIARIES
STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY 

In U.S. dollars 

   
Common stock
                                 
 
 
Shares
 
Amount
 
Additional
paid-in
capital
 
Accumulated
deficit
 
Deferred
stock
compensation
 
Treasury
stock
 
Notes
receivable
from
stockholders
 
Accumulated other
comprehensive
loss
 
Total
comprehensive
income (loss)
 
Total
stockholders’
equity
 
Balance as of January 1, 2003
   
2,550,115
 
$
357,017
 
$
114,082,584
 
$
(100,673,619
)
$
(12,000
)
$
(3,537,106
)
$
(1,177,589
)
$
(1,786
)
     
$
9,037,501
 
Compensation related to warrants issued to the holders of convertible debentures
               
5,157,500
                                       
5,157,500
 
Compensation related to beneficial conversion feature of convertible debentures
               
5,695,543
                                       
5,695,543
 
Issuance of shares on conversion of convertible debentures
   
497,829
   
69,696
   
6,064,981
                     
(9,677
)
             
6,125,000
 
Issuance of shares on exercise of warrants
   
263,071
   
36,831
   
3,259,422
                                       
3,296,253
 
Issuance of shares to consultants
   
15,971
   
2,236
   
159,711
                                       
161,947
 
Compensation related to grant and reprcing of warrants and options issued to consultants
               
229,259
                                       
229,259
 
Compensation related to non-recourse loan granted to shareholder
               
38,500
                                       
38,500
 
Deferred stock compensation
               
4,750
         
(4,750
)
                         
 
Amortization of deferred stock compensation
                           
8,286
                           
8,286
 
Exercise of options by employees
   
49,260
   
6,896
   
426,668
                                       
433,564
 
Exercise of options by consultants
   
1,071
   
150
   
7,200
                                       
7,350
 
Conversion of convertible promissory note
   
40,284
   
5,640
   
438,720
                                       
444,360
 
Increase in investment in subsidiary against common stock issuance
   
9,000
   
1,260
   
120,960
                                       
122,220
 
Accrued interest on notes receivable from stockholders
               
16,615
                     
(16,615
)
             
 
Other comprehensive income - foreign currency translation adjustment
                                             
106,215
 
$
106,215
   
106,215
 
Net loss
                     
(9,237,621
)
                         
(9,237,621
)
 
(9,237,621
)
 
                                                 
$
(9,131,406
)
     
Balance as of December 31, 2003
   
3,426,601
 
$
479,726
 
$
135,702,413
 
$
(109,911,240
)
$
(8,464
)
$
(3,537,106
)
$
(1,203,881
)
$
104,429
       
$
21,625,877
 

The accompanying notes are an integral part of the consolidated financial statements.

F-11


AROTECH CORPORATION AND ITS SUBSIDIARIES
STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY 

In U.S. dollars

   
Common stock
                                 
   
Shares
 
Amount
 
Additional
paid-in
capital
 
Accumulated
deficit
 
Deferred
stock
compensation
 
Treasury
stock
 
Notes
receivable
from
stockholders
 
Accumulated other
comprehensive
loss
 
Total
comprehensive
income
 
Total
stockholders’
equity
 
Balance as of January 1, 2004
   
3,426,601
 
$
479,726
 
$
135,702,413
 
$
(109,911,240
)
$
(8,464
)
$
(3,537,106
)
$
(1,203,881
)
$
104,429
       
$
21,625,877
 
Issuance of shares, net
   
1,009,892
   
141,384
   
24,252,939
                                       
24,394,323
 
Issuance of shares and warrants due to settlement of litigation
   
32,143
   
4,500
   
1,244,328
                                       
1,248,828
 
Issuance of shares to employees
   
2,857
   
400
   
92,800
                                       
93,200
 
Conversion of convertible debentures
   
274,552
   
38,437
   
3,754,279
                                       
3,792,716
 
Exercise of warrants by investors and others
   
811,667
   
113,633
   
19,119,638
                                       
19,233,271
 
Issuance of shares to consultants
   
6,444
   
902
   
198,489
                                       
199,391
 
Reclassification to liability in connection with warrants granted
               
(10,841,020
)
                                     
(10,841,020
)
Reclassification of liability to equity related to the fair value of warrants
               
10,514,181
                                       
10,514,181
 
Compensation related to non-recourse loan granted to shareholder
               
(10,000
)
                                     
(10,000
)
Deferred stock compensation related to options and restricted stock
   
52,857
   
7,400
   
2,074,057
         
(2,081,457
)
                         
 
Amortization of deferred stock compensation
                           
831,626
                           
831,626
 
Exercise of options by employees
   
64,089
   
8,972
   
1,101,172
                                       
1,110,144
 
Exercise of options by consultants
   
2,687
   
376
   
50,799
                                       
51,175
 
Issuance of shares in respect of FAAC acquisition
   
71,704
   
10,039
   
1,993,639
                                       
2,003,678
 
Accrued interest on notes receivable from stockholders
               
18,990
                     
(18,990
)
             
 
Other comprehensive income - foreign currency translation adjustment
                                             
263,404
 
$
263,404
   
263,404
 
Other comprehensive income - realized gain on available for sale marketable securities
                                             
4,502
   
4,502
   
4,502
 
Net loss
                     
(9,042,313
)
                         
(9,042,313
)
 
(9,042,313
)
                                                   
$
(8,774,407
)
     
Balance as of December 31, 2004
   
5,755,493
 
$
805,769
 
$
189,266,704
 
$
(118,953,553
)
$
(1,258,295
)
$
(3,537,106
)
$
(1,222,871
)
$
372,335
       
$
65,472,983
 
 

The accompanying notes are an integral part of the consolidated financial statements.
 
F-12

 
AROTECH CORPORATION AND ITS SUBSIDIARIES
STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

In U.S. dollars
   
Common stock
                                 
   
Shares
 
Amount
 
Additional
paid-in
capital
 
Accumulated
deficit
 
Deferred
stock
compensation
 
Treasury
stock
 
Notes
receivable
from
stockholders
 
Accumulated
other
comprehensive
income (loss)
 
Total
comprehensive
income (loss)
 
Total
stockholders’
equity
 
Balance as of January 1, 2005
   
5,759,786
 
$
806,370
 
$
189,266,103
 
$
(118,953,553
)
$
(1,258,295
)
$
(3,537,106
)
$
(1,222,871
)
$
372,335
       
$
$65,472,983
 
Issuance of shares, net
   
339,640
   
47,551
   
3,898,185
                                       
3,945,736
 
Shares issued to convertible debenture holders
   
82,976
   
11,617
   
441,434
                                       
453,051
 
Shares issued to consultant
   
36,232
   
5,073
   
516,200
                                       
521,273
 
Compensation related to non-recourse loan granted to shareholder
               
(28,500
)
                                     
(28,500
)
Employee options exercise
   
1,132
   
158
   
17,034
                                       
17,192
 
Shares issued to employees
   
714
   
100
   
(100
)
                                     
 
Deferred stock compensation related to options and restricted stock
   
3,571
   
500
   
50,500
         
(51,000
)
                         
 
Amortization of deferred stock compensation
                           
674,712
                           
674,712
 
Cancellation of deferred stock compensation as a result of forfeitures
   
(2,857
)
 
(400
)
 
(244,880
)
       
245,280
                           
 
Interest accrued on notes receivable from shareholders
               
33,906
                     
(33,906
)
             
 
Other comprehensive loss - foreign currency translation adjustment
                                           
(746,016
)
 
(746,016
)
 
(746,016
)
Other comprehensive loss - unrealized gain on available for sale marketable securities
                                             
(1,764
)
 
(1,764
)
 
(1,764
)
Net loss
                     
(24,043,411
)
                         
(24,043,411
)
 
(24,043,411
)
Total comprehensive loss
                                                 
$
(24,791,191
)
     
Balance as of December 31, 2005
   
6,221,194
 
$
870,969
 
$
193,949,882
 
$
(142,996,964
)
$
(389,303
)
$
(3,537,106
)
$
(1,256,777
)
$
(375,445
)
     
$
46,265,256
 
 

The accompanying notes are an integral part of the consolidated financial statements.
 
F-13


AROTECH CORPORATION AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

In U.S. dollars

   
Year ended December 31, 
 
   
2005
 
2004
 
2003
 
Cash flows from operating activities:
                   
Net loss
 
$
(24,043,411
)
$
(9,042,313
)
$
(9,237,621
)
Less loss (profit) for the period from discontinued operations
   
120,000
   
   
(110,410
)
Adjustments required to reconcile net loss to net cash used in operating activities:
                   
Minorities interests in earnings (loss) of subsidiary
   
(57,149
)
 
44,694
   
(156,900
)
Loss from affiliated company
   
75,000
   
   
 
Depreciation
   
1,373,580
   
1,199,465
   
730,159
 
Amortization of intangible assets, capitalized software costs and impairment of intangible assets
   
15,453,584
   
2,888,226
   
879,311
 
Remeasurement of liability in connection to warrants granted
   
(377,803
)
 
(326,839
)
 
 
Accrued severance pay, net
   
68,839
   
(441,610
)
 
3,693
 
Amortization of deferred stock compensation and compensation related to shares issued to employees
   
674,713
   
884,826
   
8,286
 
Mark up of loans to stockholders
   
   
(32,397
)
 
(12,519
)
Write-off of inventories
   
1,062,336
   
121,322
   
96,350
 
Impairment of property and equipment
   
34,243
   
   
68,945
 
Amortization of compensation related to warrants issued to the holders of convertible debentures and beneficial conversion feature
   
1,702,753
   
4,142,109
   
3,928,237
 
Amortization of deferred charges related to convertible debentures issuance
   
329,152
   
222,732
   
483,713
 
Amortization of prepaid financial expenses
   
   
   
236,250
 
Stock-based compensation related to grant of new warrants and repricing of warrants granted to consultants
   
   
   
229,259
 
Stock-based compensation related to shares issued and to be issued to consultants and shares granted as a donation
   
538,058
   
89,078
   
161,947
 
Stock-based compensation related to non-recourse note granted to stockholder
   
(28,500
)
 
(10,000
)
 
38,500
 
Interest accrued or paid on promissory notes due to acquisition
   
19,704
   
39,311
   
(66,793
)
Interest accrued on restricted collateral deposits
   
   
(267,179
)
 
 
Capital loss (gain) from sale of marketable securities
   
2,695
   
(4,247
)
 
 
Amortization of premium related to restricted held to maturity securities
   
42,234
   
202,467
   
 
Capital loss (gain) from sale of property and equipment
   
3,172
   
(16,479
)
 
(11,504
)
Decrease (increase) in trade receivables
   
(3,608,950
)
 
732,828
   
(820,137
)
Decrease (increase) in other accounts receivable and prepaid expenses
   
(75,982
)
 
(49,513
)
 
40,520
 
Decrease (increase) in deferred tax assets
   
65,376
   
(89,823
)
 
 
Increase in inventories
   
(1,710,528
)
 
(2,040,854
)
 
(193,222
)
Increase in unbilled revenues
   
(2,347,036
)
 
(1,581,080
)
 
 
Decrease in deferred revenues
   
(178,988
)
 
(91,271
)
 
 
Increase (decrease) in trade payables
   
(224,987
)
 
2,913,623
   
(986,022
)
Increase (decrease) in other accounts payable and accrued expenses
   
32,269
   
(125,231
)
 
1,677,668
 
Net cash used in operating activities from continuing operations
   
(11,055,626
)
 
(638,155
)
 
(3,012,290
)
Net cash used in operating activities from discontinued operations
   
   
(214,041
)
 
(313,454
)
Net cash used in operating activities
 
$
(11,055,626
)
$
(852,196
)
$
(3,325,744
)
 
The accompanying notes are an integral part of the consolidated financial statements.
 
F-14


AROTECH CORPORATION AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

In U.S. dollars
 
 
 
Year ended December 31,
 
   
2005
 
2004
 
2003
 
Cash flows from investing activities:
             
Purchase of property and equipment
   
(1,224,752
)
 
(1,659,688
)
 
(580,949
)
Increase in capitalized software costs
   
(651,611
)
 
(365,350
)
 
(209,616
)
Loans granted to stockholders
   
   
(1,036
)
 
(13,737
)
Repayment of loans granted to stockholders
   
   
32,397
   
9,280
 
Proceeds from sale of property and equipment
   
104,175
   
114,275
   
16,753
 
Proceeds from sale of marketable securities
   
91,936
   
90,016
   
 
Investment in marketable securities
   
   
(89,204
)
 
 
Investment in affiliated company
   
(112,500
)
 
   
 
Payment of transaction expenses in relation to previous year investment in subsidiary
   
(12,945
)
 
   
 
Acquisition of Epsilor (1)
   
   
(7,190,777
)
 
 
Acquisition of FAAC (2)
   
   
(12,129,103
)
 
 
Acquisition of AoA (3)
   
   
(17,339,522
)
 
 
Repayment of promissory notes related to acquisition of subsidiaries (1)(2)
   
(14,588,298
)
 
(2,000,000
)
 
(750,000
)
Purchase of certain tangible and intangible assets
   
(150,000
)
 
(150,000
)
 
(196,331
)
Increase in restricted cash and held to maturity securities
   
4,748,178
   
(9,809,091
)
 
(72,840
)
Net cash used in investing activities
   
(11,795,817
)
 
(50,497,083
)
 
(1,797,440
)
Cash flows from financing activities:
                   
Proceeds from issuance of shares, net
   
3,945,736
   
24,361,750
   
(6,900
)
Proceeds from exercise of options to employees and consultants
   
17,192
   
1,148,819
   
440,914
 
Proceeds from exercise of warrants
   
   
19,233,271
   
3,296,254
 
Proceeds from issuance of convertible debentures, net of issuance expenses
   
16,430,767
   
   
13,708,662
 
Long term loan received
   
   
69,638
   
 
Repayment of long term loan
   
(71,238
)
 
(65,674
)
 
 
Increase (decrease) in short term bank credit
   
1,914,892
   
(376,783
)
 
(74,158
)
Payment on capital lease obligation
   
   
(4,145
)
 
(4,427
)
Net cash provided by financing activities
   
22,237,349
   
44,366,876
   
17,360,345
 
Increase (decrease) in cash and cash equivalents
   
(614,094
)
 
(6,982,403
)
 
12,237,161
 
Cash erosion due to exchange rate differences
   
30,234
   
31,790
   
(9,562
)
Cash and cash equivalents at the beginning of the year
   
6,734,512
   
13,685,125
   
1,457,526
 
Cash and cash equivalents at the end of the year
 
$
6,150,652
 
$
6,734,512
 
$
13,685,125
 
Supplementary information on non-cash transactions:
                   
Issuance of shares and warrants against accrued expenses and restricted deposit
 
$
56,577
 
$
1,310,394
 
$
 
Purchase of intangible assets against note receivable
 
$
 
$
 
$
300,000
 
Increase of investment in subsidiary against issuance of shares of common stock
 
$
 
$
 
$
123,480
 
Conversion of promissory note to shares of common stock
 
$
 
$
 
$
450,000
 
Payment of principle installment of convertible debenture in shares
 
$
453,051
 
$
 
$
 
Liability in connection to warrants granted
 
$
44,231
 
$
 
$
 
Conversion of convertible debenture to shares of common stock
 
$
 
$
3,837,500
 
$
6,125,000
 
Benefit due to convertible debentures and warrants
 
$
 
$
 
$
10,853,043
 
Accrual for earn out in regard to subsidiary acquisition
 
$
603,764
 
$
13,435,325
 
$
 
Supplemental disclosure of cash flows activities:
                   
Cash paid during the year for:
                   
Interest
 
$
1,401,681
 
$
532,750
 
$
39,412
 
Taxes on income
 
$
737,080
 
$
969,009
 
$
527,053
 
 
The accompanying notes are an integral part of the consolidated financial statements.
F-15


AROTECH CORPORATION AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Cont.)

In U.S. dollars
 
(1)
In January 2004, the Company acquired substantially all of the outstanding ordinary shares of Epsilor Electronic Industries, Ltd. (“Epsilor”). The net fair value of the assets acquired and the liabilities assumed, at the date of acquisition, was as follows:
 
Working capital, excluding cash and cash equivalents
 
$
(849,992
)
Property and equipment
   
709,847
 
Intangible assets and goodwill
   
10,284,407
 
     
10,144,262
 
Issuance of shares in respect to transaction costs
   
(12,500
)
Issuance of promissory note *)
   
(2,940,985
)
   
$
7,190,777
 

*)
During 2005 and 2004 amounts of $1,000,000 and $2,000,000, respectively, were repaid to the former shareholders of Epsilor.
 
(2)
In January 2004, the Company acquired all of the outstanding common stock of FAAC Incorporated (“FAAC”). The net fair value of the assets acquired and the liabilities assumed at the date of acquisition was as follows:

Working capital, excluding cash and cash equivalents
 
$
1,796,791
 
Property and equipment
   
263,669
 
Intangible assets and goodwill
   
12,072,321
 
     
14,132,781
 
Issuance of shares, net
   
(2,003,678
)
   
$
12,129,103
 
 
*)
During 2005, an additional amount of $13,588,298 was paid to the former shareholders of FAAC in respect of the earnout provisions of the acquisition agreement. The additional amount was charged to goodwill.
 
(3)
In August 2004, the Company acquired all of the outstanding common stock of Armour of America, Incorporated (“AoA”). The net fair value of the assets acquired and the liabilities assumed at the date of acquisition was as follows:

Working capital, excluding cash and cash equivalents
 
$
3,219,728
 
Property and equipment
   
997,148
 
Intangible assets and goodwill
   
13,122,646
 
   
$
17,339,522
 

See note 1.d. regarding additional earnout obligation to the former shareholder of AoA.
 
The accompanying notes are an integral part of the consolidated financial statements.
F-16


AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In U.S. dollars

NOTE 1:  GENERAL
 
a. Arotech Corporation (“Arotech” or the “Company”) and its subsidiaries are engaged in the development, manufacture and marketing of defense and security products, including advanced high-tech multimedia and interactive digital solutions for training of military, law enforcement and security personnel and sophisticated lightweight materials and advanced engineering processes to armor vehicles, and in the design, development and commercialization of its proprietary zinc-air battery technology for electric vehicles and defense applications. The Company is primarily operating through IES Interactive Training, Inc. (“IES”), a wholly-owned subsidiary based in Littleton, Colorado; FAAC Corporation, a wholly-owned subsidiary based in Ann Arbor, Michigan, and FAAC’s 80%-owned United Kingdom subsidiary FAAC Limited; Electric Fuel Battery Corporation, a wholly-owned subsidiary based in Auburn, Alabama; Electric Fuel Ltd. (“EFL”) a wholly-owned subsidiary based in Beit Shemesh, Israel; Epsilor Electronic Industries, Ltd., a wholly-owned subsidiary located in Dimona, Israel; MDT Protective Industries, Ltd. (“MDT”), a majority-owned subsidiary based in Lod, Israel; MDT Armor Corporation, a majority-owned subsidiary based in Auburn, Alabama; and Armour of America, Incorporated, a wholly-owned subsidiary based in Los Angeles, California.
 
Revenues derived from the Company’s largest customers in 2005, 2004 and 2003 are described in Note 16.d.
 
b. Acquisition of Epsilor:
 
In January 2004, the Company entered into a stock purchase agreement between itself and all of the shareholders of Epsilor Electronic Industries, Ltd. (“Epsilor”), pursuant to the terms of which the Company purchased all of the outstanding shares of Epsilor from Epsilor’s existing shareholders. Epsilor develops and sells rechargeable and primary lithium batteries and smart chargers to the military, and to private industry in the Middle East, Europe and Asia.
 
The Acquisition was accounted under the purchase method accounting. Accordingly, all assets and liabilities acquired were recorded at their estimated market values as of the date of acquisition, and results of Epsilor’s operations have been included in the consolidated financial statements commencing the date of acquisition. The total consideration of $10,144,262 (including transaction costs) for the shares purchased consisted of (i) cash in the amount of $7,000,000, and (ii) a series of three $1,000,000 promissory notes, due on the first, second and third anniversaries of the agreement, which were recorded at their fair value of $2,940,985.
 
Based upon a valuation of tangible and intangible assets acquired, Arotech has allocated the total cost of the acquisition to Epsilor’s net assets as follows:
 
Tangible assets acquired
 
$
2,239,848
 
Intangible assets
       
         
Customer list
   
5,092,395
 
Goodwill
   
5,192,012
 
Liabilities assumed
   
(2,379,993
)
Total consideration
 
$
10,144,262
 
 
F-17


AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In U.S. dollars

NOTE 1:– GENERAL (Cont.)
 
Customer list in the amount of $5,092,395 has a useful life of approximately ten years.
 
In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill arising from acquisitions will not be amortized. In lieu of amortization, Arotech is required to perform an annual impairment test. If Arotech determines, through the impairment review process, that goodwill has been impaired, it will record the impairment charge in its statement of operations. Arotech will also assess the impairment of goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable.
 
The value assigned to tangible, intangible assets and liabilities was determined as follows:
 
 
1.
To determine the estimated market value of Epsilor’s net current assets, property and equipment, and net liabilities, the “Cost Approach” was used. According to the valuation made, the book values for the current assets and liabilities were reasonable proxies for their market values.
 
 
2.
The customer list is the asset that generates most of the Company’s sales. Hence, the “Income Approach” was used to estimate its value, resulting in a value of $5,092,395.
 
See Note 1.e. for pro forma financial information.
 
c. Acquisition of FAAC:
 
In January of 2004, the Company entered into a stock purchase agreement with the stockholders of FAAC Incorporated (“FAAC”), pursuant to the terms of which it acquired all of the issued and outstanding common stock of FAAC, a provider of driving simulators, systems engineering and software products to the United States military, government and private industry.
 
The Acquisition was accounted under the purchase method accounting. Accordingly, all assets and liabilities were recorded at their estimated market values as of the date acquired, and results of FAAC’s operations have been included in the consolidated financial statements commencing the date of acquisition. The consideration for the purchase consisted of (i) cash in the amount of $12.0 million, and (ii) the issuance of a total of 71,704 shares of the Company’s common stock, $0.14 par value per share, having a value of approximately $2.0 million. There was also an earn-out based on 2004 net pretax income. Based on FAAC’s 2004 net pretax income, the Company paid the former stockholders of FAAC an earnout of $13.6 million during 2005, in cash and through the issuance of a total of 3,479,465 shares of the Company’s common stock (see Note 13.b.5.). The total consideration of $27.7 million (including the earn-out as well as $137,991 of transaction costs) was determined based upon arm’s-length negotiations between the Company and FAAC’s stockholders.
 
In addition, the Company has a contingent earnout obligation in an amount equal to the net income realized by the Company from certain specific programs that were identified by the Company and the former shareholders of FAAC as appropriate targets for revenue increases in 2005. During 2005, the Company accrued an amount of $603,764 in respect of such earnout obligation against FAAC’s goodwill. Although the former shareholders of FAAC have indicated to the Company their belief that the specific programs identified include more orders than those with respect to which the Company has made accrual in respect of this earnout obligation, the Company believes there is no basis for this claim (see note 11.e.3.).
 
F-18


AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In U.S. dollars

NOTE 1:– GENERAL (Cont.)
 
Based upon a valuation of tangible and intangible assets acquired, Arotech has allocated the total cost of the acquisition (including earnout obligation accrued as of December 31, 2005) to FAAC’s assets and liabilities as follows:
 
Tangible assets acquired
 
$
4,833,553
 
Intangible assets
       
Technology
   
4,610,000
 
Backlog
   
636,000
 
Customer list
   
1,125,000
 
Trademarks
   
374,000
 
Goodwill
   
19,522,343
 
Liabilities assumed
   
(2,770,843
)
Total consideration
 
$
28,330,053
 
 
Intangible assets which are subject to amortization, excluding trademarks, which are not subject to amortization, in the amount of $6,371,000 have a weighted-average useful life of approximately eight years.
 
In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill arising from acquisitions will not be amortized. In lieu of amortization, Arotech is required to perform an annual impairment test. If Arotech determines, through the impairment review process, that goodwill has been impaired, it will record the impairment charge in its statement of operations. Arotech will also assess the impairment of goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable.
 
The value assigned to tangible, intangibles assets and liabilities was determined as follows:
 
 
1.
To determine the estimated fair value of FAAC’s net current assets, property and equipment, and net liabilities, the “Cost Approach” was used. According to the valuation made, the book values for the current assets and liabilities were reasonable proxies for their market values.
 
 
2.
The amount of the cost attributable to technology of the software, documentation and know-how that drives the vehicle simulators and the high-speed missile fly-out simulators is $4,610,000 and was determined using the “Income Approach.”
 
 
3.
FAAC’s sales are all made on a contractual basis, most of which are over a relatively long period of time. At the date of the purchase FAAC had several signed contracts at various stages of completion. The value of the existing contracts was determined using the Income approach and resulting in a value of $636,000.
 
F-19


AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In U.S. dollars

NOTE 1:– GENERAL (Cont.)
 
 
4.
FAAC’s customer list includes various branches of the U.S. military, major defense contractors, various city and country governments and others. Since customer relationship represent one of the most important revenue generating assets for FAAC, its value was estimated using the Income Approach, resulting in a value of $1,125,000.
 
 
5.
FAAC’s trade name value represents the name recognition value of the FAAC brand name as a result of advertising spending by the company. The Cost Approach was used to determine the value of FAAC’s trade name in the amount of $374,000.
 
See Note 1.e. for pro forma financial information.
 
d. Acquisition of AoA:
 
In August 2004, the Company purchased all of the outstanding stock of Armour of America, Incorporated, a California corporation (“AoA”), from AoA’s existing shareholder. The assets acquired through the purchase of all of AoA’s outstanding stock consisted of all of AoA’s assets, including AoA’s current as-sets, property and equipment, and other assets (including intangible assets such as in-tellectual property and contractual rights).
 
The total purchase price consisted of $19,000,000 in cash, with additional possible earn-outs if AoA is awarded certain material contracts. An additional $3,000,000 was to be paid into an escrow account pursuant to the terms of an escrow agreement, to secure a portion of the Earnout Consideration. These funds are currently being held by the seller of AoA. Pursuant to the purchase agreement, the total consideration, sale price plus Earnout Consideration, will not be in excess of $40,000,000. When the contingency on the earn-out provision is resolved, the additional consideration, if any, will be recorded as additional purchase price. The purchase price also included $131,177 of transaction costs. The transaction has been accounted for using the purchase method of accounting, and accordingly, the purchase price has been allocated to the assets acquired and liabilities assumed based upon their fair values at the date the acquisition was completed.
 
F-20


AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In U.S. dollars

NOTE 1:– GENERAL (Cont.)
 
Based upon a valuation of tangible and intangible assets acquired, Arotech has allocated the total cost of the acquisition (including earnout obligation accrued as of December 31, 2005), to AoA’s assets and liabilities as follows :
 
Tangible assets acquired
   
6,346,316
 
Intangible assets
       
Certifications
   
246,969
 
Backlog
   
1,512,000
 
Customer relationships
   
490,000
 
Tradename /Trademark
   
70,000
 
Covenants not to compete
   
260,000
 
Goodwill
   
11,757,812
 
Liabilities assumed
   
(347,770
)
Total consideration
 
$
20,335,327
 
 
Intangible assets, excluding trademarks, which are not subject to amortization, in the amount of $2,508,969 have a weighted-average useful life of approximately two years.
 
In connection with the Company’s acquisition of AoA, the Company has a contingent earnout obligation in an amount equal to the revenues realized by the Company from certain specific programs that were identified by the Company and the former shareholder of AoA as appropriate targets for revenue increases. The earnout provides that if AoA receives certain types of orders from certain specific customers prior to December 31, 2006 (“Additional Orders”), then upon shipment of goods in connection with such Additional Orders, the former shareholder of AoA will be paid an earnout based on revenues, up to a maximum of an additional $6 million. During 2005, the Company accrued an amount of $1,204,150 in respect of such earnout obligation.
 
In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill arising from acquisitions will not be amortized. In lieu of amortization, Arotech is required to perform an annual impairment test. If Arotech determines, through the impairment review process, that goodwill has been impaired, it will record the impairment charge in its statement of operations. Arotech will also assess the impairment of goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable.
 
See Note 1.f. for impairment information.
 
See Note 1.e. for pro forma financial information.
 
e. Pro forma results
 
In January 2004, the Company acquired FAAC and Epsilor, as more fully described in “Note 1.b. - Acquisition of Epsilor” and “Note 1.c. - Acquisition of FAAC,” above, in August 2004, the Company acquired AoA, as more fully described in “Note 1.d. - Acquisition of AoA,” above (the “Acquisitions”). The following summary pro forma information includes the effects of the Acquisitions on the operating results of the Company. The following unaudited pro forma data for 2004 and 2003 are presented as if the Acquisitions had been completed on January 1, 2004 and 2003, respectively.

F-21


AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In U.S. dollars

NOTE 1:– GENERAL (Cont.)
 
This pro forma financial information does not purport to be indicative of the results of operations that would have occurred had the Acquisitions taken place at the beginning of the period, nor do they purport to be indicative of the results of operations that will be obtained in the future.
 
   
Year Ended December 31,
 
     
2004
   
2003
 
     
(Unaudited)
 
Total revenues
 
$
61,086,697
 
$
39,680,394
 
Gross profit
   
22,528,254
   
17,214,249
 
Net loss
   
(5,810,114
)
 
(6,959,174
)
Deemed dividend of common stock attributable to certain stockholders
   
(3,328,952
)
 
(350,000
)
Net loss attributable to stockholders of common stock
 
$
(9,139,066
)
$
(7,309,174
)
               
Basic and diluted net loss per share
 
$
(1.83
)
$
(1.93
)
Weighted average number of shares used in computing basic net loss per share
   
4,995,218