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  **U.S. SECURITIES AND EXCHANGE COMMISSION****WASHINGTON, D.C. 20549****FORM 10-KSB**(Mark one)   þ **ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2006**OR   o **TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from ____________ to _______________****Valentec Systems, Inc.**(Name of Small Business Issuer In Its Charter)         **2629 York Avenue****Delaware** **59-2332857** **Minden, LA 71055**(State or other jurisdiction (IRS Employer (Address of principal executive offices) (Zip Code)of incorporation) Identification No.)  Registrant’s telephone number, including area code: **(318) 382-4574**Common Stock, par value $.001 per share(Title of Class)**Securities Registered Under Section 12(b) of the Exchange Act: Common Stock, $0.01 par value****Securities Registered Under Section 12(g) of the Exchange Act: None****Check whether the issuer is not required to file reports pursuant to Section 13 or 15(d) of theExchange Act. o****Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act, as amended (the “Exchange Act”) during the past 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes [X] No [ ]****Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-Bcontained in this form, and no disclosure will be contained, to the best of registrant’s knowledge,in definitive proxy or information statements incorporated by reference in Part III of this Form10-KSB or any amendment to this Form 10-KSB. [X]****Indicate by check mark whether the issuer is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes [ ] No [X]****Issuer’s revenues for its most recent fiscal year ended December 31, 2006 were: $19,624,038****The aggregate market value of the voting and non-voting common equity held by non-affiliatescomputed by reference to the price at which the common equity was sold, or the average bid andasked price of such common equity as of a specified date within the past 60 days, was: $3,107,633****Therewere 15,538,165 shares of the Issuer’s common stock outstandingon April 9, 2007.****Documents incorporated by reference: None**  
 

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**INDEX****PARTI**           **Page No.** **Item 1.** **Description of Business**  **3**        **Item 2.** **Descriptionof Properties**  **18**        **Item 3.** **Legal Proceedings**  **18**        **Item 4.** **Submissionof Matters to a Vote of Security Holders**  **18**          **PART II**           **Item 5.** **Market for theRegistrant’s Common Equity and Related Stockholder Matters andSmall Business Issuer Purchases of Equity Securities**  **19**        **Item 6.** **Management'sDiscussion and Analysis or Plan of Operations**  **20**        **Item 7.** **Financial Statements**  **26**        **Item 8.** **Changes in andDisagreements with Accountants on Accounting and Financial Disclosure**  **26**        **Item 8A.** **Controls and Procedures**  **27**        **Item 8B.** **Other Information**  **27**          **PART III**           **Item 9.** **Directors,Executive Officers, Promoters, Control Persons and CorporateGovernance; Compliance with Section 16(a) Of the Exchange Act**  **27**        **Item 10.** **Executive Compensation**  **31**        **Item 11.** **SecurityOwnership of Certain Beneficial Owners and Management and Related Stockholder Matters**  **34**        **Item 12.** **CertainRelationships and Related Transactions and Director Independence**  **36**        **Item 13.** **Exhibits**  **37**        **Item 14.** **Principal Accountant Fees and Services**  **41**        **SIGNATURES**   **42** **Exhibit 10.29.** **Promissory Note to RobertZummo dated November 19, 2006**    **Exhibit 10.30.** **Promissory Note to Mikal Ltd.dated November 19, 2006**    **Exhibit 31.1** **Certification by the CEO andPrincipal Accounting Officer Pursuant to Rule 13a-14(a)**    **Exhibit 32.2** **Certification of CEO andPrincipal Accounting Officer Pursuant to Section 906**     Promissory Note to Robert Zummo Promissory Note to Mikal Ltd. Certification Pursuant to Rule 13a-14(a) Certification Pursuant to 18 U.S.C. Section 1350
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**PART I****Item 1.****Description of Business**     This annual report contains forward-looking statements as that term is defined in the PrivateSecurities Litigation Reform Act of 1995. These statements relate to future events or our futurefinancial performance. In some cases, you can identify forward-looking statements by terminologysuch as “may”, “will”, “should”, “expects”, “plans”, “anticipates”, “believes”, “estimates”,“predicts”, “potential” or “continue” or the negative of these terms or other comparableterminology. These statements are only predictions and involve known and unknown risks,uncertainties and other factors, including the risks in the section entitled “Risk Factors”, thatmay cause our company’s or our industry’s actual results, levels of activity, performance orachievements to be materially different from any future results, levels of activity, performance orachievements expressed or implied by these forward-looking statements.     Although we believe that the expectations reflected in the forward-looking statements arereasonable, we cannot guarantee future results, levels of activity, performance or achievements.Except as required by applicable law, including the securities laws of the United States, we do notintend to update any of the forward-looking statements to conform these statements to actualresults.     Our financial statements are stated in United States Dollars (US$) and are prepared inaccordance with United States Generally Accepted Accounting Principles. In this annual report,unless otherwise specified, all dollar amounts are expressed in United States dollars and allreferences to “common shares” refer to the common shares in our capital stock.     As used in this annual report, the terms “we”, “us”, “our”, “the Company”, “Acorn” and“Valentec” means Valentec Systems, Inc. (which operated under the name Acorn Holding Corp. untilApril 10, 2006) and our wholly-owned subsidiary, Valentec Operating Corp. The term “Subsidiary”refers to Valentec Operating Corp., which previously operated under the name “Valentec Systems,Inc.” until April 10, 2006.***General***     The Company formerly was incorporated under the laws of the State of Delaware on September 8,1983. In fiscal year 2002, the Company operated as a holding company with one wholly ownedsubsidiary, Recticon Enterprises, Inc. (“Recticon”), and its principal business was the derivationof earnings from the operation of Recticon. Recticon manufactured two, three, four, five andsix-inch monocrystalline silicon wafers, which were used by university research departments andmicroelectronic manufacturers. On June 23, 2003, the Company announced that Recticon had beenadvised by Recticon’s principal customer that the demand for Recticon’s products would not increaseand there would be a sharp erosion in the price for such products going forward. The Board ofDirectors of Recticon and the Company determined that, since the Company did not have the financialresources to sustain the anticipated operating losses of Recticon and to try to limit the furthererosion of Recticon’s assets, the management of Recticon was authorized to liquidate the assets ofRecticon. As of December 31, 2003, all Recticon assets were liquidated and the Company became apublic shell and remained a public shell until its acquisition of Valentec Operating Corp.(formerly Valentec Systems, Inc.) on June 6, 2005. As a result of the acquisition, ValentecOperating Corp. became a wholly owned subsidiary of the Company, and the principal business ofValentec became the derivation of earnings from the operation of the Subsidiary.     Valentec Operating Corp., the Subsidiary, was incorporated in Delaware on May 1, 1998.Valentec Operating Corp. designs, develops, manufactures, and sells ammunition and light weaponsfor military use. From January 1998 through January 2006, the Subsidiary’s business involvedmanufacturing armaments and providing property management services to the United States Army bymaintaining the Army’s Louisiana Army Ammunition Plant and recruiting new tenants. This workinvolved infrastructure maintenance and evaluation of environmental considerations and physicalsecurity. However, beginning in 2003, Valentec began devoting significant time and money torealign its business to focus on more profitable business segments such as SystemsManagement/Systems Integration, Energetic Manufacturing and Metal Parts Manufacturing.
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     In order to build a strong strategic portfolio and to improve profitability, Valentec hasfocused on the following growth strategies and objectives: **•** Enhance marketing and business development in foreign government agencies toincrease sales and backlog.  **•** Acquisitions that complement existing operations.  **•** Capitalize on our systems management and systems integration experience with SoltamSystems and the Israeli Defense Forces to market the same capability to the UnitedStates Army.  **•** Expand energetic manufacturing from current 40mm to 105mm and 155mm.***Recent Developments***     On April 10, 2006, after receipt of shareholder approval pursuant to a written consent, theCompany (1) changed its name to Valentec System, Inc. on April 10, 2006 and (2) the capital stockof the Company was increased to 260,000,000 shares, with 250,000,000 authorized shares of commonstock and 10,000,000 authorized shares of preferred stock.     The Company entered into an employment agreement with Robert A. Zummo effective as of January1, 2006. The terms and conditions of this employment agreement are set forth in “*Item 10.Executive Compensation.*”     Also, on April 10, 2006, the Company changed the name of its operating subsidiary fromValentec Systems, Inc. to Valentec Operating Corp.***Description of Business***     Valentec’s current business pursuits are categorized into 3 major product lines: SystemsManagement/System Integration, Energetic Manufacturing, and Metal Parts Manufacturing. Theseproduct lines are operated by Valentec Operating Corp.**Systems Management / Systems Integration**  ***120MM Mortar Weapon System with Electronic Fire Control — “KESHET”***     Valentec was awarded a system contract from Soltam Systems, Inc., a related party, for theproduction and integration of RMS6 120mm Mortar Weapon System for the Israeli Defense Forces(“IDF”) using U.S. Foreign Military Financing as described herein on page five. The mortar weaponsystem will be fitted with an Electronic Fire Control System and will be integrated into theM1064A3 Mortar carrier as well as the towed platform. Valentec Systems Inc. successfully completedassembly of the first RMS6 Mortar Weapon. Valentec anticipates that the remaining 81 RMS6 MortarWeapons will be assembled and delivered in 2007.     Keshet (Hebrew for bow) 120mm self propelled mortar contains state of the art command, controland communication devices and offers infantry and armor commander unique enhanced operationalcapabilities. Improvements in inertial navigation systems further enhance the accuracy in targetand weapon location and, combined with a more sophisticated laying system, it greatly increases theaccuracy of mortar ammunition delivery. We believe that our 120mm Mortar Weapon System offerssignificant advantages in firepower, area coverage, tactical mobility, flexibility andsurvivability.     The program consists of technology transfer, configuration control, procurement, assembly,integration and testing of the 120MM Mortar Weapon System with Electronic Firing Control. It isanticipated a total of 82 complete integrated systems and 12 equivalent spare parts of the systemwill be delivered under this contract to the IDF for approximately $16,745,000. Valentec SystemsInc. was awarded an additional contract in March 2007 for the integration of the RMS6 Mortar Weaponinto a 106AA3 Mortar Carrier and the modification of an ammunition carrier. The contract is valuedat approximately $3.6 million.
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     Valentec has placed purchase orders with two forging houses and four other prime vendors formajor subcomponents and has also placed numerous purchase orders with a host of smaller vendors forthe parts necessary to assemble the system. Subcomponent deliveries have been timed to ensure anarrival that closely coincides with Valentec’s production schedule, yet leverages quantity and bulkbuys.     Valentec is also responsible for the quality of all components and the reliability of eachsystem. To this end, Valentec has tasked their vendors with a variety of tests and proceduresintended to verify and validate compliance to specifications, functionality, and reliability.These tests include First Article Tests, fire control calibration tests, and function testing.     ***Mortar Ammunition***     Valentec was awarded a 2-year systems integration and management contract in early 2005 fromSoltam Systems to assemble and deliver mortar ammunition for the IDF using U.S. Foreign MilitaryFinancing. The mortar ammunition will be provided in 120mm, 81mm, and 60mm rounds with a contractvalue of approximately $20,000,000 over a two year period. The 120mm and 60mm were ordered withtwo different explosive fillers each and the 81mm was ordered in a single configuration for a totalof five different rounds. Deliveries will begin in 4th quarter 2007.     Mortars are used in the infantry or in a mechanized company against troops, light vehicles orsimilar targets or for incendiary and smoke spotting purposes. When a mortar round is loaded intothe mortar firing system, it slides down the tube until a fixed firing pin at the bottom of thebarrel ignites the ignition cartridge. The energy from the ignition cartridge ignites thepropellant charge. Rapidly expanding gases from the burning propellant accelerates the round andlaunches it in its ballistic trajectory. The mortar is aerodynamically stabilized in flight by itsfins. The fuse is armed after the projectile passes a minimum safe separation distance and, onimpacting the ground, the fuse explodes the high explosive charge that shatters the shell bodyfragments, which are then propelled toward the target. Some mortars are designed to explode at alow height above the ground for maximum lethalness.     Valentec has placed purchase orders with 11 prime vendors for major subcomponents and numerouspurchase orders with a host of smaller vendors for the parts necessary to assemble the ammunition.Subcomponent deliveries have been timed to ensure an arrival that closely coincides with Valentec’sproduction schedule, yet leverages quantity and bulk buys.     In addition to the procurement of necessary sub-components, Valentec is also responsible forthe quality of these components and, of course, the quality and reliability of each mortar. Tothis end, Valentec has tasked their vendors with a variety of tests and procedures intended toverify and validate compliance to specifications, functionality, and reliability. These testsinclude First Article Tests, weight calibration and verification, and function testing. FirstArticle Tests are required performance tests prior to acceptance by the U. S. Army.     In support of this majorproduction effort, additional manufacturing space was leased andequipped with unique fixtures and tooling. As 120mm, 81mm and 60mm mortar ammunition is not uniqueto the IDF, we believe the facilitization accomplished by Valentec for this program has positionedus well to compete successfully on future mortar ammunition contracts in domestic and overseasmarkets.     In the Systems Management / Systems Integration segment, our sources and availability of rawmaterials present no unique challenges with the exception of obtaining M8M propellant from BMJ ofHerzegovina. This requires import licensing for materials and export licenses for delivery of thecomplete product to Israel. Also, part of the State Department process mandates the provision ofEnd User certificates. All of these requirements are known and actions are in process. Ourprimary suppliers for the Systems Management / Systems Integration projects are:     • BMJ Belgrade, Herzegovina M8M Propellant• Accurate Energetics, McCuen, TN Explosive Loading• Medico, Wilkes-Barre, PA Metal Parts• POCAL Metal Parts
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     • Lockheed-Martin, Scranton, PA Metal Parts• Greene Tweed, Kulpsville, PA O-ring & Seals• Pyrotechnics by Grucci Explosive Increments**Energetic Manufacturing**     Our energetic business includes various flares and simulators with multiple end uses.The flares can be used for illumination and/or signaling. The simulators are used for trainingpurposes to simulate a battlefield environment. In the flare work, we are a member of a team thatin May of 2005 was awarded a planned 5-year procurement of 40MM flares. Valentec’s part of thisaward is to produce 40MM, M583, White Star Parachute, flares. We believe this opportunity has apotential value of up to $50 million over 5 years dependent on assigned option quantities. Theoption year quantities are totally dependent on the annualappropriation authorized by the U.S.Congress as supported by the user (Army, Navy, Marines) community.     We believe that there are multiple additional areas/opportunities for pursuit in thepyrotechnic arena. We have successfully manufactured several test devices, which exhibitillumination and burn times that are significantly greater than specification requirements.     Energetic Manufacturing requires appropriate licensing by the Bureau of Alcohol, Tobacco,Firearms, and Explosives (BATFE) before conducting any energetic operations. We believe that wehave completed all known applications and obtained all known licences. Additionally, a safety siteapplication must be presented to the Defense Contract Management Agency (DCMA) for review andapproval, which is complete and in place. Our primary suppliers are:     • GOEX, Inc., Minden, LA Black Powder• ATK, Radford, VA Propellant• Flexible Concepts, Elkhart, IN Metal Component• Woodlawn Manufacturing, Marshall, TX Metal Component• B & T Screw, Bristol, CT Metal Component• Spaulding Composites, Rochester, NH Plastic Component**Metal Parts Manufacturing**     The current U.S. government metal parts work consists of a contract for 83,508 units of105MM, M14B4, Spiral Wrapped Cartridge Case (SWCC). This contract value is approximately $3.25million with completion anticipated in 2007. We believe there will be a significant foreigninterest once the success of our program is realized. Valentec has produced a large volume ofthese products in the past. We believe that the cost of this product is significantly less thanthe more traditional drawn/forged cartridge case and exhibits more insensitive munitions (IM) valuethan the solid cartridge cases. We believe that the use of this design (SWCC) should provideValentec an advantage for the upcoming 105MM Illumination round requirements for the U.S. Army.     In addition, Valentec is evaluating several other metal part manufacturing opportunities,which will be procured in 2007 by U. S. Army.     Metal parts manufacturing and more specifically the spiral wrap cartridge case has only 4primary components, and no specialty materials. Further, there are no exceptional governmentapprovals required. Our primary suppliers are:     • Vy-Comp, Shreveport, LA Metal Components• Northwest Stamping, St. Louis, MO Metal Components• Alta Max, New Orleans, LA Packaging
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***Foreign Work***     Valentec’s foreign business pursuits are associated with two contracting methods, “foreignmilitary sales” and “foreign military financing.” A description of each method follows. **•** ***Foreign Military Sales***     The foreign military sales program is the government-to-government method of sellingU.S.defense equipment, services, and training. The program is managed by the Defense SecurityCooperation Agency within the U.S. Department of Defense. Valentec participates in the program asa known supplier to approved foreign governments through a marketing network established in theforeign countries. Department of Defense Manual 5105.38-M describes the specific detailsconcerning the program requirements.     The U.S. Department of Defense has launched a major effort to reform the current foreignmilitary sales system and to ensure that this valuable program remains viable into the nextmillennium. This reform effort will focus on improving the foreign military sales system’sperformance and adopting better business practices whenever possible. Currently, Valentec does notbelieve these anticipated changes will adversely affect its business. The foreign military salesprogram manages government-to-government purchases of weapons and other defense articles, defenseservices, and military training. The military of a foreign country buying weapons through theforeign military sales program does not deal directly with the business that manufactures theweapons, but rather, the Defense Department serves as an intermediary, usually handlingprocurement, logistics and delivery and often providing product support and training. **•** ***Foreign Military Financing***     The foreign military financing program provides grants and loans to help foreign countriespurchase U. S. produced weapons, defense equipment, defense services and military training throughthe foreign military sales program described above. On a much less frequent basis, foreignmilitary financing also funds purchases made through the direct commercial sales program (describedbelow), which oversees sales between foreign governments to private U.S. companies. Foreignmilitary financing does not provide cash grants to other countries; it generally pays for sales ofspecific U. S.-manufactured goods or services through foreign military or direct commercial sales.     The State Department’s Bureau of Political-Military Affairs sets policy for the foreignmilitary financing program, while the Defense Security Cooperation Agency, within the DefenseDepartment, manages it on a day-to-day basis. Security assistance organizations and militarypersonnel in U.S. embassies overseas play a key role in managing foreign military financing withinrecipient countries. Congress appropriates funds for foreign military sales through the yearlyForeign Operations Appropriations Act.     Foreign military financing exists primarily to fund arms transfers, as military training isnormally granted through the International Military Education and Training Program. However,foreign military financing does support some of the training activities.***The Contracting Process***     Valentec has Marketing / Sales representation at two of its largest customer locations in theUnited States: (1) Picatinny Arsenal in Dover, New Jersey and (2) the Joint Munitions Command inRock Island, Illinois. These representatives keep Valentec informed as to any new businessopportunities that are on the horizon that would fit into the company’s capabilities, andtherefore, allows Valentec to conduct proposal activities prior to the actual receipt of anysolicitation or request for a proposal. Typically, these solicitations or requests are of a “BestValue” evaluation criteria, meaning that the evaluation is based on many factors (not only price)such as past performance, quality assurance plans, manufacturing approach, etc. This kind ofevaluation requires extensive proposal writing skills and we often use outside consultants whospecialize in writing proposals that are responsive to the requirements of U.S. Governmentcustomers.
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     Typically, the U.S. Government allows 60 days for contractors to respond to theirsolicitations or requests for proposals. They, in turn, will take anywhere from 60 days or longerto conduct their evaluations and make the ultimate contract award. Most contracts are of a12-month duration and require a First Article Test prior to the start of production. The U.S. Armyhas the ability to exercise option quantities under each contract.     With regard to international sales, Valentec uses Valentec International Limited of the UnitedKingdom and Soltam Systems, Inc. (“Soltam”) of Israel to market its products and capabilities.Each of these business entities is controlled by shareholders of the Company. All of Valentec’sinternational business has been through either foreign military sales or direct sales to theforeign country. In either case, the customer must submit to Valentec an “End User Certificate”that states who the End User will be. That End User Certificate is submitted to the U.S. StateDepartment along with an entire copy of the contract between Valentec and its foreign customer.For example, if Valentec has a contract with Soltam to supply both weapon systems and ammunitionfor mortars, and Soltam Systems, Inc. in turn, has a contract with the Israeli Defense Forces forthe same product, then the Israeli Defense Forces would be the End User. Because funds for thisprocurement would likely involve U.S. military grant dollars to Israel, the products would have tobe manufactured in the United States. Valentec would ultimately ship these products by sea to therequired location. Or, if Valentec had a contract with Valentec International Limited to supply40mm illuminating rounds of ammunition to a country other than Israel, through a direct sale; i.e.,no foreign military funds, the requirements for End User Certificate would still apply before theU.S. State Department would approve the sale. The end product would be produced by Valentec andshipped directly to the foreign customer.     Any and all foreign sales require End User Certificates and the U. S. State Department’sapproval.***Customers***     ***Soltam Systems, Inc.***     Valentec has received an order from Soltam for the production and integration of theKeshet\RMS6 120mm Mortar Weapon System for the Israeli Defense Forces. The mortar weapon systemwill be fitted with an Electronic Fire Control System and will be integrated in to M1064A3 Mortarcarriers as well as towed platforms. Delivery of the Mortar System will begin in the second quarterof 2007 and is anticipated to be completed in 2007.     The Keshet 120mm self propelled mortar contains state of the art command, control andcommunication devices and offers infantry and armor commanders unique enhanced operationalcapabilities. Improvements in inertial navigation systems further enhance the accuracy in targetand weapon location and, combined with a more sophisticated laying system, it greatly increases theaccuracy of mortar ammunition delivery. We believe that the 120mm mortar system offers significantadvantages in firepower, area coverage, tactical mobility, flexibility and survivability.     The Keshet 120mm mortar is a Soltam design. The mortar weapon system will be produced atValentec’s manufacturing facility in Minden, Louisiana. Valentec expects to complete this order inDecember 2007.     The program consists of technology transfer, configuration control, procurement, assembly,integration and testing of a 120MM Mortar Weapon System with electronic firing control. It isanticipated that, a total of 82 complete integrated systems and 12 equivalent spare parts of thesystem will be delivered under this contract to Soltam Systems, Inc. which in turn will deliverthem to the End User, the IDF.     In addition, Valentec was awarded a 2-year systems integration and management contract inearly 2005 from Soltam to assemble and deliver mortar ammunition to Soltam Systems, Inc. fordelivery to the Israeli Defense Forces. The mortar ammunition will be provided in 120mm, 81mm, and60mm rounds. The 120mm and 60mm were ordered with two different explosive fillers each and the81mm was ordered in a single configuration for a total of five different rounds. Deliveries beganin late 2006 and Valentec anticipates deliveries will be completed in December 2007.
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     ***DSE, Inc.***     DSE, Inc., located in Tampa, Florida is a significant contractor for procurement of 40mmproducts. DSE, Inc. has ordered 266,816 40mm, M583 products from Valentec for deliveries in 2007and 2008. Valentec expects to start the deliveries in May 2007. DSE, Inc. has been awarded U.S.Government Contract #W52P1J-05-O-0036. This contract pertains to the 40MM family of munitions andis projected to cover the next five years. Valentec has been named as the sub-contractor to producethe Illumination Rounds found in this contract. In the solicitation, the US Government estimatedthe annual requirement for Illumination Rounds would be 200,000 to 300,000 rounds per year. Thiswould indicate substantial sales for Valentec dependent upon which option quantity the U.S.Government decides to procure.     ***Kingdom of Saudi Arabia***     Valentec is currently fulfilling a contract received on assignment from Valentec InternationalLimited to provide 250 M583A1 40mm illuminating parachutes and 500 M992 40mm IR and 200 40MM LVSmoke munitions for the Kingdom of Saudi Arabia. We anticipate completion of this purchase order inthe fourth quarter of 2007.     ***U.S. Government***   Valentec is currently fulfilling contracts from the U. S. Army for multiple products. **•** 83,508 — Spiral Wrap Cartridge Cases M14B4  **•** 3,904 — 40MM White Star Cluster M585  **•** 266,816 — 40MM White Star M583     The U. S. Army can exercise option quantities under each contract with Valentec.***Employees***Our current employees consist of the following:      • Management  9• Accounting, Administrative, Contracts, Materials  7• Quality/Technical  10• Manufacturing  15          Total Employees  41     All employees are employed full time. Valentec currently has no collective bargainingagreements with its employees and believes that it has good relations with them. On December 28,2004, prior to the expiration of the facilities management agreement with the Louisiana NationalGuard, certain employees involved in plant security duty were members of the International GuardUnion of America (I.G.U.A.) Local 81. With the expiration of the agreement and the resulting lossof employment, these employees filed a union membership grievance with Valentec, which has beenturned over to the American Arbitration Association. We believe that the claim is without merit andany ruling by the American Arbitration Association would have minimum impact on earnings. Anarbitration hearing was held on March 5, 2007. On April 6, 2007, the Arbitrator ruled in favor ofValentec Systems, Inc. and denied all claims of the Union. Since arbitration decisions are finaland not appealable, the decision concludes the Union Grievance litigation.     Valentec sponsors a 401(k) retirement savings plan, which is categorized as a definedcontribution plan. The plan is available to full time employees who meet the plan’s eligibilityrequirements.     On January 7, 2007, Valentec adopted the 2006 Equity Incentive Plan for the benefit of theemployees, consultants and directors of the Company and of any affiliate thereof and reserved2,000,000 shares of Common Stock designated for allocation under the plan. The reserved shares maybe allocated under the plan either as (i) Incentive Stock Option or Non-Qualified Stock Option, or(ii) Restricted Stock.
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***Competition***     Valentec’s competitors range from local firms to worldwide foreign and domestic firmsdepending on the business segment being considered. In general our competitors are bettercapitalized and more experienced than Valentec. Some competitive considerations for our businesssegments are as follows:   Business Segment Competition   Systems Management / Systems Integration Mostly large businesses such asGeneral Dynamics and Alliant TechSystems.   Energetic Manufacturing All U.S. based small businessfirms with pyrotechniccapability. Primary competitorsare: PSI, Inc., MartinElectronics, and Lance Ordnance.   Metal Parts Manufacturing Valentec is not aware of anycompetition for its current 105MMSpiral Wrap Cartridge Case.***Government Regulations***     In addition to all the federallaws regarding labor, safety and the environment, Valentecbelieves that it complies with all regulatory provisions that are identified in our variouscontracts. These provisions range from the Strom Thurmond National Defense Authorization Act,Public Law 105-261 (also known as the Buy American Act), to contracting with small disadvantagedbusiness, to ozone depleting chemical prohibitions. In addition, Valentec is subject toregulations, which require it to discontinue operations pending root cause analysis andinvestigation associated with the occurrence of a critical defect. After ceasing operations, doingall the analytical work and discussing with multiple customer technical representatives, thecontractor may be allowed to resume operations after implementation of all required correctiveactions. Similar requirements will soon be added to all Department of Defense contract provisions;however, this requirement does not apply to foreign military sales or foreign military financingcontracts.***Research and Development***     Valentec has a continuous programof product — process improvement and of maintainingmanufacturing flexibility to allow the addition of new products andprocesses to existingfacilities. In addition the company is introducing three new systems to improve performance:1. *Enterprise Resource System*Valentec began in 2005 the implementation of an EnterpriseResource Planning (ERP) software systemto manage all phases of the business on an integrated database. Additional computerhardware was added to the system which automatically integrates Purchasing and Supplier ManagementProduction Planning, Scheduling and Inventory Management in real-time. The information providedwill drive corrective actions that will mitigate risks and ensure that the manufacturing processsupports contractual delivery commitments. This process was halted in early 2007 pending resultsof our acquisition of MAST, as detailed below in item 6, with the possible utilization of an ERPSystem in place at MAST.*2. Six Sigma Implementation*The Company has begun in the first quarter of 2006 the introduction of Six-Sigma methodology for planningand manufacturing. Key management personnel are being trained by a staff Six-Sigma Green Beltregarding Six-Sigma principles and methodology and tools for the evaluation of manufacturingprocess improvements.
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Inaddition, the Company’s staff Green Belt attended additional training in 2006 that resulted in hisachieving Black Belt status. Follow-on training will then be provided to key individuals todevelop them into Green Belts who will identify and lead process improvement projects throughoutthe life of a contract.*3. ISO-9000 Certification*The company is actively pursuing ISO-9000-2000 Certification. It is the company’s goal to be ISO9000-2000 certified by year-end 2007. This certification was delayed in 2006 due to a catastrophicfire experienced on the 40MM production line of Valentec Systems Inc and the resources required forexpedited recovery.***Compliance with Environmental Laws***     Environmental issues are no more difficult for munitions manufacturing than other energeticsoperations. However, to help with compliance, Valentec employs an environmental affairscoordinator to perform periodic operations audits and implement corrective actions and/orregulatory reporting, when required. Valentec does not anticipate that compliance with any laws orregulations relating to environmental protection will have a material effect on its capitalexpenditures, earnings or competitive position.     Pursuant to a 1994 environmental class action settlement, Valentec Dayron Corporation(currently Valentec Systems) along with Boise Cascade Corporation, Dictaphone Corporation, HarrisCorporation, Martin Marietta Corporation, Medalist Industries, Inc and Rockwell International, Inc(herein Members) signed the Woodco Site Custody Account Agreement, dated October 5, 1994 as amendedJanuary 28, 2005 which established the “Woodco Site Custody Account” for the purposes of disbursingfunds necessary to satisfy the obligations of the Members. Valentec’s current obligation is $3,474in total for the years 2007, 2008 and 2009.***Intellectual Property / Trade Secrets***     Valentec has not filed for any patents or trademarks. However, Intellectual property, tradesecrets, proprietary rights and licenses are very important to product development and processimprovements. Exclusive and non-exclusive licenses may be acquired from time to time. All salariedemployees are subject to a confidentiality and non-compete agreement.***Investment Policies***     Our current policy is to acquire assets primarily for income purposes, although we may in thefuture determine to make investments for purposes of seeking capital gains. Currently, there areno policy limitations on the nature of investments that we may make or the percentage of ourassets, which may be invested in any one investment or type of investment. We may change ourpolicy regarding investments, from time to time, without approval of our stockholders.**RISK FACTORS****Risks Related to Operations****WE MAY BE UNABLE TO SECURE NECESSARY EXPORT LICENSES, WHICH COULD ADVERSELY IMPACT OUR BUSINESS**     United States law requires that Valentec obtain a government-issued export license to ship itsammunition products to other countries for each order it receives. Valentec could be forced todecline an order from a customer due to refusal of the government to issue the export license.Such refusals would be based on actual or perceived deficiencies of the recipient country’sgovernment or other reasons. Failure to obtain an export licenses for sales to
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Valentec’s traditional customer base could adversely affect our operations and financialresults.**WE MAY EXPERIENCE PRODUCT FAILURES, SCHEDULE DELAYS OR OTHER PROBLEMS WITH EXISTING OR NEW PRODUCTSAND SYSTEMS, ANY OF WHICH COULD ADVERSELY IMPACT OUR BUSINESS.**     We may experience product and service failures, schedule delays and other problems inconnection with the manufacture or delivery of our products. In addition to any costs resultingfrom product warranties, contract performance, or required remedial action, these failures mayresult in increased costs or loss of revenues due to postponement of subsequently scheduled productand service deliveries. Performance penalties could also be imposed should we fail to meetdelivery schedules or other measures of contract performance.**OUR REVENUE CONTINUES TO BE CONCENTRATED AMONG A SMALL NUMBER OF CUSTOMERS.**     A significant percentage of our revenue is concentrated among a relatively small number ofend-user customers. During the last five (5) calendar years, the U.S. Army, the U.S. Department ofDefense, and the Government of Israel have provided the majority of our revenues, and currently weare substantially dependent on our contracts with Soltam. The loss of Soltam as a customer or theloss of any other significant customer or a substantial decrease in sales to such a customer wouldhave a material adverse effect on our revenue and operating results.**OUR SUPPLIERS COULD BE LATE IN DELIVERY OF KEY SUPPLIES, WHICH WOULD DELAY OUR PRODUCTION AND HAVEA NEGATIVE IMPACT ON OUR FINANCIAL RESULTS.**     Valentec’s operations are dependent on the ability of certain suppliers to deliver supplies ona timely basis. From time to time, we have experienced delays in receipt of needed supplies whichhas caused delays in Valentec’s production activities and which in turn has resulted in delays inrecognition of revenue under the percentage of completion method of accounting.**OUR BUSINESS IS SUBJECT TO MANY FACTORS THAT COULD CAUSE OUR QUARTERLY OR ANNUAL OPERATING RESULTSTO FLUCTUATE AND OUR STOCK PRICE TO BE VOLATILE.**     Our quarterly and annual operating results have fluctuated in the past and may fluctuatesignificantly in the future due to a variety of factors, many of which are outside of our control.If our quarterly or annual operating results do not meet the expectations of the investorcommunity, the trading price of our common stock could significantly decline. Some of the factorsthat could affect our quarterly or annual operating results include: **•** the timing and amount of, or cancellation or rescheduling of, orders for our products;  **•** our ability to develop, introduce, ship and support new products and productenhancements and manage product transitions, announcements, and new product introductions;  **•** our ability to achieve cost reductions;  **•** our ability to achieve and maintain production volumes and quality levels for our products;  **•** the volume of products sold and the mix of distribution channels through which they are sold;  **•** the loss of any one of our major customers or a significant reduction in orders fromthose customers; and  **•** increased competition, particularly from larger, better capitalized competitors.     Due to these and other factors, quarterly revenue, expenses and results of operations couldvary significantly in the future, and period-to-period comparisons should not be relied upon asindications of future performance.
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**OUR FUTURE PERFORMANCE WILL DEPEND, IN PART, ON OUR ABILITY TO MANAGE OUR BUSINESS GROWTHEFFECTIVELY, AND THERE IS NO ASSURANCE THAT WE WILL BE ABLE TO SUCCESSFULLY GROW OR MANAGE SUCHGROWTH, WHICH MAY DIMINISH OUR CHANCES OF ACHIEVING PROFITABILITY.**     Our future performance will depend, in part, on our ability to manage our business growtheffectively. Towards that end, we will have to undertake the following tasks, among others:**•** Effectively enhance our operating, administrative, financial, and accountings systemsand controls;**•** Establish and continuously improve coordination among our engineering, accounting,finance, marketing, and operations personnel; and**•** Develop and continuously enhance our management information systems capabilities.**WE MAY EXPERIENCE PRODUCT FAILURES, SCHEDULE DELAYS OR OTHER PROBLEMS WITH EXISTING OR NEW PRODUCTSAND SYSTEMS, ANY OF WHICH COULD ADVERSELY IMPACT OUR BUSINESS.**     We may experience product and service failures, schedule delays and other problems inconnection with the manufacture or delivery of our products. In addition to any costs resultingfrom product warranties, contract performance or required remedial action, these failures mayresult in increased costs or loss of revenues due to postponement of subsequently scheduled productand service deliveries. Performance penalties could also be imposed should we fail to meet deliveryschedules or other measures of contract performance.**WE ARE NOT ABLE TO GUARANTEE THAT CONTRACT ORDERS INCLUDED IN OUR ESTIMATED BACKLOG WILL RESULT INACTUAL REVENUES IN ANY PARTICULAR FISCAL PERIOD OR THAT THE ACTUAL REVENUES FROM SUCH CONTRACTSWILL EQUAL OUR ESTIMATED BACKLOG.**     There can be no assurance that any contracts included in our estimated backlog presented inthis filing will result in actual revenues in any particular period or that the actual revenuesfrom such contracts will equal our estimated backlog. Further, there can be no assurance that anycontract included in our estimated backlog that generates revenue will be profitable.**WE ARE DEPENDENT UPON KEY PERSONNEL WHO WOULD BE DIFFICULT TO REPLACE AND WHOSE LOSS COULD IMPEDEOUR DEVELOPMENT.**     We are highly dependent on Robert A. Zummo and Stephen Shows to manage our businesses, andtheir knowledge of business, management skills and technical expertise would be difficult toreplace. The loss of these key employees could limit or delay our ability to develop new productsand adapt existing products to our customers’ evolving requirements and would also result in lostsales and diversion of management resources. Because of competition for additional qualifiedpersonnel, we may not be able to recruit or retain necessary personnel, which could impededevelopment or sales of our products. Our growth depends on our ability to attract and retainqualified, experienced employees. There is substantial competition for experienced engineering,technical, financial, sales and marketing personnel in our industry. If we are unable to retain ourexisting key personnel, or attract and retain additional qualified personnel, we may from time totime experience inadequate levels of staffing to develop and market our products and performservices for our customers.**OUR EMPLOYEES MAY ENGAGE IN IMPROPER ACTIVITIES WITH ADVERSE CONSEQUENCES TO OUR BUSINESS.**     As with other government and other contractors, we are faced with the possibility that ouremployees may engage in misconduct, fraud or other improper activities that may have adverseconsequences to our prospects and results of operations. Misconduct by employees could include failures to comply with U.S.federal government regulations, violation of requirements concerning the protection of classifiedinformation, improper labor and cost charging to contracts and misappropriation of government orthird party property and information. The occurrence of any such employee activities could resultin our suspension or debarment from contracting with the U.S. federal government, as well as theimposition of fines and penalties, which would cause material harm to our business.
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**DUE TO THE VOLATILE AND FLAMMABLE NATURE OF OUR PRODUCTS, FIRES OR EXPLOSIONS MAY DISRUPT OURBUSINESS.**     Many of our products involve the manufacture and/or handling of a variety of explosive andflammable materials. These activities may result in incidents which may shut down or otherwisedisrupt manufacturing processes, cause production delays and result in liability for workplaceinjuries and fatalities. On August 14, Valentec experienced a small detonation in an unattended (bypersonnel) granulation process at its Louisiana facility. This detonation occurred in a facilitythat had concrete walls and was self-contained, however, the resulting fire completely destroyed75,000 square feet of space at this manufacturing facility, completely eliminating our existing40mm flare capability. We were leasing this facility from the State of Louisiana and had obtainedthe required insurance coverage. Currently, we are engaged in ongoing discussions with the State ofLouisiana concerning the responsibility for rebuilding of this 65-year old facility and for debrisremoval because some of the original construction material contains small amounts of asbestos.Valentec contends that the insurance coverage as required by the lease was in place and that suchinsurance should cover any liability on the part of Valentec. Valentec has safety and lossprevention programs which require detailed pre-construction reviews of process changes and newoperations, along with routine safety audits of operations involving explosive materials, tomitigate such incidents, as well as a variety of insurance policies. However, Valentec cannotensure that it will not experience similar incidents in the future or that any similar incidentswill not result in production delays or otherwise have a material adverse effect on its results ofoperations, financial condition, or cash flows.***Risks Related to our Industry*****OUR BUSINESS COULD BE ADVERSELY IMPACTED BY REDUCTIONS OR CHANGES IN U.S. GOVERNMENT MILITARYSPENDING.**     Our business is substantially dependent on U.S. Government contracts. U.S. Governmentcontracts are dependent on the continuing availability of Congressional appropriations. Congressusually appropriates funds for a given program on a fiscal year basis even though contractperformance may take more than one year. As a result, at the outset of a major program, thecontract is usually incrementally funded, and additional monies are normally committed to thecontract by the procuring agency only as Congress makes appropriations for future fiscal years. Inaddition, most U.S. Government contracts are subject to modification if funding is changed. Anyfailure by Congress to appropriate additional funds to any program in which we participate, or anycontract modification as a result of funding changes, could materially delay or terminate theprogram. These delays or terminations could have a material adverse effect on our operatingresults, financial condition, or cash flows.**WE MAY NOT BE ABLE TO REACT TO INCREASES IN COSTS DUE TO THE NATURE OF U.S. GOVERNMENTCONTRACTS.**     Our U.S. Government contracts can be categorized as either “cost-plus” or “fixed-price.”     *Cost-Plus Contracts*. Cost-plus contracts are cost-plus-fixed-fee, cost-plus-incentive-fee, orcost-plus-award-fee contracts. Cost-plus-fixed-fee contracts allow us to recover our approved costsplus a fixed fee. Cost-plus-incentive-fee contracts and cost-plus-award-fee contracts allow us torecover our approved costs plus a fee that can fluctuate based on actual results as compared tocontractual targets for factors such as cost, quality, schedule, and performance.     *Fixed-Price Contracts*. Fixed-price contracts are firm-fixed-price, fixed-price-incentive, orfixed-price-level-of-effort contracts. Under firm-fixed-price contracts, we agree to performcertain work for a fixed price and absorb any cost underruns or overruns. Fixed-price-incentivecontracts are fixed-price contracts under which the final contract prices may be adjusted based ontotal final costs compared to total target cost, and may be affectedby schedule and performance. Fixed-price-level-of-effort contracts allow for a fixed price perlabor hour, subject to a contract cap. All fixed-price contracts present the inherent risk ofunreimbursed cost overruns, which could have a material adverse effect on operating results,financial condition, or cash flows. The U.S. Government also regulates the accounting methods underwhich costs are allocated to U.S. Government contracts.
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**OUR U.S. GOVERNMENT CONTRACTS ARE SUBJECT TO TERMINATION.**     We are subject to the risk that the U.S. Government may terminate its contracts with itssuppliers, either for its convenience or in the event of a default by the contractor. If acost-plus contract is terminated, the contractor is entitled to reimbursement of its approvedcosts. If the contractor would have incurred a loss had the entire contract been performed, then noprofit is allowed by the U.S. Government. If the termination is for convenience, the contractor isalso entitled to receive payment of a total fee proportionate to the percentage of the workcompleted under the contract. If a fixed-price contract is terminated, the contractor is entitledto receive payment for items delivered to and accepted by the U.S. Government. If the terminationis for convenience, the contractor is also entitled to receive fair compensation for work performedplus the costs of settling and paying claims by terminated subcontractors, other settlementexpenses, and a reasonable profit on the costs incurred or committed. If a contract termination isfor default:**•** the contractor is paid an amount agreed upon for completed and partially completedproducts and services accepted by the U.S. Government,**•** the U.S. Government is not liable for the contractor’s costs for unaccepted items, andis entitled to repayment of any advance payments and progress payments related to theterminated portions of the contract, and**•** the contractor may be liable for excess costs incurred by the U.S. Government inprocuring undelivered items from another source.**WE ARE SUBJECT TO PROCUREMENT AND OTHER RELATED LAWS AND REGULATIONS, NON-COMPLIANCE WHICH MAYEXPOSE US TO ADVERSE CONSEQUENCES.**     We are subject to extensive and complex U.S. Government procurement laws and regulations,along with ongoing U.S. Government audits and reviews of contract procurement, performance, andadministration. We could suffer adverse consequences if we were to fail to comply, eveninadvertently, with these laws and regulations or with laws governing the export of munitions andother controlled products and commodities; or commit a significant violation of any other federallaw. These consequences could include contract termination; civil and criminal penalties; and,under certain circumstances, our suspension and debarment from future U.S. Government contracts fora period of time. In addition, foreign sales are subject to greater variability and risk than ourdomestic sales. Foreign sales subject us to numerous stringent U.S. and foreign laws andregulations, including regulations relating to import-export control, repatriation of earnings,exchange controls, the Foreign Corrupt Practices Act, and the anti-boycott provisions of the U.S.Export Administration Act. Failure to comply with these laws and regulations could result inmaterial adverse consequences to us.***General Risks*****IF WE CANNOT OBTAIN THE NECESSARY SECURITY CLEARANCES, WE MAY NOT BE ABLE TO PERFORM CLASSIFIEDWORK FOR THE U.S. GOVERNMENT, AND OUR REVENUES MAY SUFFER.**     Certain U.S. government contracts require our facilities and some of our employees to maintainsecurity clearances. If we lose or are unable to obtain required security clearances, the clientcan terminate the contract or decide not to renew it upon its expiration. As a result, to theextent we cannot obtain the required security clearances for our employees working on a particularcontract, we may not derive the revenue anticipated from the contract, which, if not replaced withrevenue from other contracts, could seriously harm our operating results.
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**BECAUSE WE SELL SOME OF OUR PRODUCTS IN COUNTRIES OTHER THAN THE UNITED STATES, WE MAY BE SUBJECTTO POLITICAL, ECONOMIC, AND OTHER CONDITIONS THAT COULD RESULT IN REDUCED SALES OF OUR PRODUCTS ANDWHICH COULD ADVERSELY AFFECT OUR BUSINESS.**     Sales to customers outside the U.S. are subject to the political, economic, and otherconditions affecting countries or jurisdictions other than the U.S., including the Middle East,Europe, and Asia. Any interruption or curtailment of trade between the countries in which weoperate and their present trading partners, change in exchange rates, a significant shift in tradepolicies or a significant downturn in the political, economic, or financial condition of thesecountries could cause demand for and sales of our products to decrease, cause disruption of oursupply channels or otherwise disrupt our operations, cause our costs of doing business to increase,or subject us to increased regulation including future import and export restrictions, any of whichcould adversely affect our business.**WE MAY NEED TO RAISE ADDITIONAL CAPITAL ON TERMS UNFAVORABLE TO OUR STOCKHOLDERS.**     Based on our current level of operations, we believe that our cash flow from operations,together with amounts we are able to borrow under our existing lines of credit, will be adequate tomeet our anticipated operating, capital expenditure and debt service requirements for theforeseeable future. However, we do not have complete control over our future performance because itis subject to economic, political, financial, competitive, regulatory and other factors affectingthe defense and security industries. Further, our acquisition strategy will likely requireadditional equity or debt financings. Such financings could also be required to support ourtraditional and recently required operating units. There is no assurance that we will be able toobtain such financings to fuel our growth strategy and support our existing businesses.**WE MAY MAKE ACQUISITIONS WHICH REPRESENT ADDITIONAL RISK AND COULD IMPACT OUR FUTURE FINANCIALRESULTS.**     Our business strategy includes the potential for future acquisitions. Acquisitions involve anumber of risks including integration of the acquired company with our operations and unanticipatedliabilities or contingencies related to the acquired company. We cannot ensure that the expectedbenefits of any future acquisitions will be realized.**VALENTEC HAS A SUBSTANTIAL AMOUNT OF DEBT, AND THE COST OF SERVICING THAT DEBT COULD ADVERSELYAFFECT VALENTEC’S BUSINESS AND HINDER VALENTEC’S ABILITY TO MAKE PAYMENTS ON ITS DEBT.**     Valentec has a substantial amount of indebtedness. As of December 31, 2006, Valentec had totaldebt of $13,546,699. In addition, Valentec had $70.000 of outstanding but undrawn letters of creditand, taking into account these letters of credit, an additional$883,301 of available credit under itsrevolving credit facility. Additional information on Valentec’s debt can be found in Item 7 of thisreport.     Valentec has demands on its cash resources in addition to interest and principal payments onits debt, including, among others, operating expenses. Valentec’s level of indebtedness and thesesignificant demands on Valentec’s cash resources could: **•** make it more difficult for Valentec to satisfy its obligations,  **•** require Valentec to dedicate a substantial portion of its cash flow from operationsto payments on its debt, thereby reducing the amount of cash flow available forworking capital, capital expenditures, share repurchases, acquisitions, and othergeneral corporate purposes,  **•** Valentec’s flexibility in planning for, or reacting to, changes in the defenseindustries,  **•** place Valentec at a competitive disadvantage compared to competitors that havelower debt service obligations and significantly greater operating and financingflexibility, result in an event of default upon a failure to comply with financial covenants contained in Valentec’s senior creditfacilities which, if not cured or waived, could have a material adverse effect onValentec’s business, financial condition, or results of operations.
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 **•** limit, along with the financial and other restrictive covenants applicable toValentec’s indebtedness, among other things, Valentec’s ability to borrow additionalfunds, and  **•** increase Valentec’s vulnerability to general adverse economic and industryconditions.     Valentec’s ability to pay interest on and repay its long-term debt and to satisfy its otherliabilities will depend upon future operating performance and Valentec’s ability to refinance itsdebt as it becomes due. Valentec’s future operating performance and ability to refinance will beaffected by prevailing economic conditions at that time and financial, business and other factors,many of which are beyond Valentec’s control.     If Valentec is unable to service its indebtedness and fund operating costs, Valentec will beforced to adopt alternative strategies that may include: **•** reducing or delaying expenditures for capital equipment and/or share repurchases,  **•** seeking additional debt financing or equity capital,  **•** selling assets, or  **•** restructuring or refinancing debt.There can be no assurance that any such strategies could be implemented on satisfactory terms, ifat all.**OUR STOCK IS A PENNY STOCK. TRADING OF OUR STOCK MAY BE RESTRICTED BY THE SEC’S PENNY STOCKREGULATIONS AND THE NASD’S SALES PRACTICE REQUIREMENTS, WHICH MAY LIMIT A STOCKHOLDER’S ABILITY TOBUY AND SELL OUR STOCK***.*     Our stock is a penny stock. The Securities and Exchange Commission has adopted Rule 15g-9which generally defines “penny stock” to be any equity security that has a market price (asdefined) less than $5.00 per share or an exercise price of less than $5.00 per share, subject tocertain exceptions. Our securities are covered by the penny stock rules, which impose additionalsales practice requirements on broker-dealers who sell to persons other than established customersand “accredited investors”. The term “accredited investor” refers generally to institutions withassets in excess of $5,000,000 or individuals with a net worth in excess of $1,000,000 or annualincome exceeding $200,000 or $300,000 jointly with their spouse. The penny stock rules require abroker-dealer, prior to a transaction in a penny stock not otherwise exempt from the rules, todeliver a standardized risk disclosure document in a form prepared by the SEC which providesinformation about penny stocks and the nature and level of risks in the penny stock market. Thebroker-dealer also must provide the customer with current bid and offer quotations for the pennystock, the compensation of the broker-dealer and its salesperson in the transaction and monthlyaccount statements showing the market value of each penny stock held in the customer’s account. Thebid and offer quotations, and the broker-dealer and salesperson compensation information, must begiven to the customer orally or in writing prior to effecting the transaction and must be given tothe customer in writing before or with the customer’s confirmation. In addition, the penny stockrules require that prior to a transaction in a penny stock not otherwise exempt from these rules,the broker-dealer must make a special written determination that the penny stock is a suitableinvestment for the purchaser and receive the purchaser’s written agreement to the transaction.These disclosure requirements may have the effect of reducing the level of trading activity in thesecondary market for the stock that is subject to these penny stock rules. Consequently, thesepenny stock rules may affect the ability of broker-dealers to trade our securities. We believe thatthe penny stock rules discourage investor interest in and limit the marketability of our commonstock.     In addition to the “penny stock” rules promulgated by the Securities and Exchange Commission,the NASD has adopted rules that require that in recommending an investment to a customer, abroker-dealer must have reasonable grounds for believing that the investment is suitable for thatcustomer. Prior to recommending speculative low priced securities to their non-institutionalcustomers, broker-dealers must make reasonable efforts to obtain information about the customer’sfinancial status, tax status, investment objectives and other information. Under interpretations ofthese rules, the NASD believes that there is a high probability that speculative low priced
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securities will not be suitable for at least some customers. The NASD requirements make it moredifficult for broker-dealers to recommend that their customers buy our common stock, which maylimit your ability to buy and sell our stock.**ITEM 2.** **Description of Property**     Valentec conducts all operations on leased premises at 2629 York Avenue, Minden, Louisiana71055. Valentec’s primary facility is leased from the State of Louisiana with a current termexpiring in 2016 with renewal options available. Valentec negotiated a new lease during 2006 andreduced their monthly lease payment to approximately $17,841 per month in rent for its facilitiesfor the next three years at which time it shall increase to approximately $24,845, which includemanufacturing, storage and warehouse space plus igloos and administrative buildings totalingapproximately 200,000 square feet. These facilities have undergone renovations and modificationsfor Valentec’s specialized operations, and Valentec believes these facilities are adequate for itscurrent and future needs.**ITEM 3.** **Legal Proceedings**     On December 28, 2004, former employees of the Company, who were members of the InternationalGuard Union of America I.G.U.A. Local 81, filed a union membership grievance. The grievancealleges violation of the collective bargaining agreement in that Valentec did not provide severancepay upon the termination of the guards. In total, the grievance asks for approximately $30,000 intermination pay to be distributed among the affected guards. The dispute has been turned over tothe American Arbitration Association. We believe that the claim is without merit and any ruling bythe American Arbitration Association would have minimum impact on earnings. The arbitrationhearing was conducted on March 5, 2007 and on April 6, 2007 ruled in favor of Valentec Systems Inc.     Pursuant to a 1994 environmental class action settlement, Valentec Dayron Corporation(currently Valentec Systems, Inc.) along with Boise Cascade Corporation, Dictaphone Corporation,Harris Corporation, Martin Marietta Corporation, Medalist Industries, Inc and RockwellInternational, Inc (herein Members) signed the Woodco Site Custody Account Agreement, dated October5, 1994 as amended January 28, 2005 which established the “Woodco Site Custody Account” for thepurposes of disbursing funds necessary to satisfy the obligations of the Members. Valentec’scurrent obligation is $1,158 per year for ten years from the date of the Amendment above.     On August 14, 2006, Valentec Systems, Inc. sustained a fire in its 40mm manufacturingfacility. As a result of the fire, the Company experienced a loss of a significant amount ofMachinery and Equipment, Inventory and Leasehold Improvements. The Company believed it hadproperty insurance in the amount of $1,284,850. However in December 2006 the Company was notifiedby its Insurance Broker that the additional $249,850 in coverage requested and believed to be in placeas of August 10, four days before the fire, had not been placed. The Broker claims they did notreceive clear instructions as to when the additional coverage was to be made effective. Thereforeon February 25, 2007, Valentec Systems, Inc filed suit against Moreman, Moore and Company, Inc andits agent Bryan Willis for damages suffered in the amount of $249,850 plus legal costs. TheCompany believes it has sufficient documentation to assert and sustain its claims against thedefendants and is therefore confident in our ability prevail in the litigation.     There is no other litigation or outstanding claims by or against the Company other thandisputes arising in the ordinary course of business**ITEM 4.** **Submission of Matters to a Vote of Security Holders**          None.
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**PART II****ITEM 5.** **Market for the Registrant’s Common Equity and Related Stockholder Matters and SmallBusiness Issuer Purchases of Equity Securities**     The Common Stock is currently quoted on the Pink Sheets under the symbol “VSYN”. Thefollowing table shows the high and low prices of our common stock since January 1, 2004, asreported by the National Daily Quotation Service and the Pink Sheets. We began trading under thename of Acorn Holding Corp. on July 7, 1997.     The following table sets forth, for the fiscal periods indicated, the high and low bid pricesof a share of Common Stock for the last eight quarterly periods. Such quotations reflectinter-dealer prices, without retail mark-up, mark-down or commission and may not necessarilyrepresent actual transactions.         Period High LowFourth Quarter 2006 $0.26  $0.08 Third Quarter 2006 $0.35  $0.26 Second Quarter 2006 $0.70  $0.28 First Quarter 2006 $0.69  $0.44 Fourth Quarter 2005 $0.60  $0.44 Third Quarter 2005 $0.45  $0.20 Second Quarter 2005 $0.25  $0.14 First Quarter 2005 $0.15  $0.10 Fourth Quarter 2004 $0.25  $0.07 Third Quarter 2004 $0.07  $0.06 Second Quarter 2004 $0.14  $0.06 First Quarter 2004 $0.14  $0.05      As of April 9, 2007, we had approximately 377 holders of record of our common stock.***Transfer Agent & Registrar***     Our transfer agent is Continental Stock Transfer & Trust Company of 17 Battery Place, NewYork, NY 10004. Their phone number is (212) 509-4000.***Dividends***     We have not declared any cash dividends with respect to the Common Stock, and we do not intendto declare dividends in the foreseeable future. Our future dividend policy cannot be ascertainedwith any certainty. There are no material restrictions limiting, or that are likely to limit, ourability to pay dividends on either our common stock or preferred stock.     ***Equity Compensation Plan Information***     On January 7, 2007, Valentec adopted the 2006 Equity Incentive Plan for the benefit of theemployees, consultants and directors of the Company and of any affiliate thereof and reserved2,000,000 shares of Common Stock designated for allocation under the plan. The reserved shares maybe allocated under the plan either as (i) Incentive Stock Option or Non-Qualified Stock Option, or(ii) Restricted Stock.     Options granted under the plan to U.S. residents may qualify as incentive stock options withinthe meaning of Section 422 of the Code. The exercise price for incentive stock options must not beless than the fair market value on the date the option is granted, or 110.0% of the fair marketvalue if the option holder holds more than 10.0% of our share capital.
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     On January 2007, the Board of Directors of the Company granted a total of 1,000,000 options topurchase shares of the Company’s common stock under the Company’s 2006 Equity Incentive Plan. Theoptions were granted to several employees of the Company and are vested at a rate of 25% per yearover 4 years.     In connection with their service as directors, Mr. Yarborough and Mr. Cianciolo appointed inMarch 2007 as members of our Board of Directors will receive Valentec’s standard non-employeedirector cash and equity compensation in accordance with the form of engagement letter approved byValentec’s Board of Directors, including an annual grant of option to purchase up to 10,000 sharesof Common Stock of Valentec under its 2006 Stock Incentive Plan as long as the director holds suchoffice in Valentec, subject to approval by the Board. The shares subject to this option will vestin four equal annual installments upon the completion of each year of board service measured fromthe grant date.***Recent Sales of Unregistered Securities***     On June 6, 2005, the transactions contemplated under the Stock Purchase and Share ExchangeAgreement (the “Purchase Agreement”), dated May 27, 2005, by and among the Company, the Subsidiaryand the two stockholders of the Subsidiary (the “Subsidiary Stockholders”) were consummated.Pursuant to the terms of the Purchase Agreement, the Company purchased all of the outstandingshares of common stock of the Subsidiary (i.e., 100 shares) in exchange for the issuance by theCompany to the Subsidiary Stockholders on a pro rata basis of 5,423,130 newly-issued shares of theCompany’s Common Stock. The shares of Common Stock are restricted securities that are exempt fromthe registration requirements of the Securities Act of 1933, as amended (the “Securities Act”), inreliance on the exemption provided by Rule 506 of Regulation D.     On August 19, 2005, Valentec completed a private placement of securities to each of Messrs.Zummo, Gilat, Matheson, and Kreizman pursuant to which each of Mr. Zummo and Mr. Gilat receivedWarrants to purchase up to 200,000 shares of Common Stock at an exercise price of $0.25 per shareand each of Mr. Matheson and Mr. Kreizman received Warrants to purchase up to 100,000 shares ofCommon Stock at an exercise price of $0.25 per share. The Warrants became exercisable immediatelyand expire on August 19, 2008.     In connection with the private placement, Valentec relied on an exemption from registrationprovided by Section 4(2) of the Securities Act and Rule 506 promulgated thereunder. Messrs. Zummo,Gilat, Matheson, and Kreizman represented to Valentec that they were “accredited investors” asdefined in Rule 501(a) promulgated in the Securities Act and that they were receiving the Warrantsfor their own account and not with a present view towards the public sale or distribution thereof.     Warrants issued to Board Members are defined in Item 11.**ITEM 6.** **Management’s Discussion and Analysis and Plan of Operations**     The following discussion should be read in conjunction with our consolidated auditedfinancial statements and the related notes for the years ended December 31, 2006 and December 31,2005 that appear elsewhere in this annual report. The following discussion contains forward-lookingstatements that reflect our plans, estimates and beliefs. Our actual results could differmaterially from those discussed in the forward looking statements. Factors that could cause orcontribute to such differences include, but are not limited to, those discussed below and elsewherein this registration statement, particularly in the section entitled “Risk Factors” beginning onpage 12 of this annual report.***Discussion of Results and Plan of Operation***     As of December 31, 2003, the Company ceased its prior business operations and became a publicshell and remained a public shell until its acquisition of Valentec Systems, Inc. which wascompleted on May 27, 2005 Thus, from December 31, 2003 until May 2005, the Company had norevenues from operations. However, the acquisition of Valentec Systems provided revenue andearnings beginning in 2005.
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     The acquisition of the Subsidiary by the Company has been accounted for as a purchase andtreated as a reverse acquisition since the former owners of Valentec controlled 77.5% of the totalshares of the Common Stock outstanding immediately following the Acquisition. On this basis, thehistorical financial statements prior to June 6, 2005 have been restated to be those of theaccounting acquirer Valentec. The historical stockholders’ equity prior to the Acquisition has beenretroactively restated (a re-capitalization) for the equivalent number of shares received in theAcquisition after giving effect to any difference in par value of the Common Stock and Valentec’scommon stock. The original 100 shares of Valentec common stock outstanding prior to thereorganization have been reflected as an addition in the stockholders’ equity account of theCompany on June 6, 2005.     In 2006 we experienced a 3% increase in gross revenue over fiscal year 2005 from $19,015,978to $19,624,883 despite the fact that we lost our 40MM production facility in August 2006 due to afire in our Louisiana facility, which we were leasing this facility from the State of Louisiana.This line is anticipated to begin full production in April 2007.Gross margin decreased from 34.2%to 22.2%. EBITDA, before one time expenses, decreased 197% from $2,439,199 to ($2,362,436) and pretax earnings decreased from $79,324 to ($6,002,440) after one time expenses.     Energetic Manufacturing accounted for 14.1% of the gross revenue with Systems/ManagementSystems Integration and Metal Parts Manufacturing accounting for 80.5% and 5.4% respectively. Thebacklog at the end of the year was Energetic Manufacturing $1,661,019 (12.7%), Systems/ManagementSystems Integration $11,813,922 (87.3%) and Metal Parts Manufacturing $-0- (0.0%) for a total of$13,474,941     Valentec plans to make investments in bids and proposal activity that, if successful, willsignificantly increase backlog, future sales and future profits. We intend to bid on new U. S.Army systems ammunition requirements as well as new energetic and metal component requirements. Wealso intend to make investments in automation equipment for the energetic production that mayimprove efficiencies and future profits.     The Board intends to seek out other strategic acquisition candidates that could bring valueadded to Valentec in terms of increased revenue, profits, cost savings, management talent anddiversification.     Along with its acquisition strategy, Valentec is actively seeking financing alternatives foracquisitions, working capital, product development, marketing, and business opportunities. In thisregard, on April 28, 2005, the Company entered into a Standby Equity Distribution Agreement(“SEDA”) with Cornell Capital Partners, L.P., (“Cornell”) whereby it can “put” to Cornell, forcash, up to $15 million in our common stock over a two-year period of time. Valentec has noobligation to “put” or draw on this facility and should more attractive financing alternativesbecome available we will thoroughly evaluate the best opportunities for the Company and itsshareholders.     In late 2006, Valentec Systems Inc. employed the services of an Investment Group, CarterSecurities Inc. and Mallon and Associates, to assist in a Private Offering to raise capital foracquisitions, reduction of outstanding debt, working capital, marketing and business opportunities.In conjunction with pursuit of the Private Offering, Valentec entered in January 2007 into abinding term sheet to acquire MAST Technology, Inc. a Missouri based company hereinafter referredto as MAST, in a transaction structure yet to be formally determined, for $15 million in cash,stock and earn-out against future earnings. The term sheet expires on May 20, 2007. MAST is amanufacturer of ammunition and ordnance for the United States Government and other customersspecializes in tight propellant charge tolerances and produces 40mm training practice rounds,igniters for demolitions and training and other specialty ammunition products. The transactioncontemplated is subject to various conditions precedent and there can be no guaranty that thetransaction will be completed..     Valentec has entered into a Master Factoring Agreement with Rockland Credit Finance as anadditional source of financing. A credit line of $10,000,000 has been established to provideadditional working capital for our growth as well as assistance in the rebuilding of our productionfacility destroyed by fire in 2006. We plan to use the additional funding for facilitization andadditional equipment needed to support the increased backlog.     Valentec has retained the New York-based Public Relations firm of GW Communications. Mr. GlennWiener, President of GW Communications (212) 786-6011 will be the Account Manager of record. GWwill work very close with Valentec’s Management and Board of Directors to provide a line ofcommunication to shareholders, investors, the financial community and to the media. They will also provide important market feedback to support the Company’s strategic direction and operational performance.
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     The Company is actively structuring its operation to become ISO 9000 compliant. We have onstaff experienced professionals with ISO experience and Six-Sigma training.***Stock Compensation Expense***     On January 2007, the Board of Directors of the Company granted a total of 1,000,000 options topurchase shares of the Company’s common stock under the Company’s 2006 Equity Incentive Plan. Theoptions were granted to several employees of the Company and are vested at a rate of 25% per yearover 4 years. Because the Stock Options were not granted until 2007 no Stock Compensation Expensewas recognized in 2006.***Liquidity and Capital Resources***     For the twelve months ended December 31, 2006, the Company had negative cash flow fromoperations of $6,499,164. On December 31, 2006, the Company had outstanding borrowings (non-relatedparty) of approximately $13,546,699. On December 31, 2006, the Company had total assets ofapproximately $25,950,749. This is an increase in total assets of $3,274,458 on December 31, 2005.     The Company’s sources and uses of funds were as follows: (1) it used net cash of $6,499,164 inits operating activities in the twelve months ended December 31, 2006; (2) it received cash of$48,476 in investing activities in the twelve months ended December 31, 2006; and (3) it received$6,519,239 from financing activities in the twelve months ended December 31, 2006, consistingprimarily of the release of restricted cash and proceeds from the line of credit. As of December31, 2006, the Company had a working capital deficiency of $10,043,206.     The primary source of financing for the Company since its inception has been through theissuance of common stock and borrowings. The Company had cash andcash equivalents of $150,429 asof December 31, 2006 and $81,879 as of December 31, 2005. The Company is actively seeking financingalternatives for working capital, product development, marketing, and business opportunities. Inthis regard, on April 28, 2005, the Company entered into a Standby Equity Distribution Agreement(“SEDA”) with Cornell Capital Partners, L.P. (“Cornell”), whereby it can “put” to Cornell, forcash, up to $15 million in the Company’s common stock over a two-year period of time. The Companybelieves this equity financing should increase its chances of succeeding in its growth plans. TheCompany anticipates that if it will decide to use the $15 million SEDA, it will enable it tosupport and fund expenditures for bids and proposals, capital equipment automation andacquisitions, as well as working capital growth. In order to make use of the SEDA, the Company hadto first increase its authorized capital, become listed on the Over-the-Counter Electronic BulletinBoard (“OTCBB”), what was already achieved, and register additional shares for public sale. Therecan be no assurance that the Company will be able to successfully comply with these conditions.Therefore, the Company continues to explore additional equity and debt financings, vendor-financingprograms, letters of credit for manufacturing, leasing arrangements for its products, and equityparticipation for media purchases that will advertise its products. In late 2006, Valentec employedthe services of an Investment Group, Carter Securities Inc. and Mallon and Associates, to assist ina Private Offering to raise capital for acquisitions, reduction of outstanding debt, workingcapital, marketing and business opportunities. Also, the Company believes that marketing andconsumer awareness is central to generating monthly revenues. The Company believes that itsproducts may have greater appeal to foreign consumers due to quality, performance and price.     In 2005, the Company entered into a Master Factoring Agreement with Rockland Credit Finance asan additional source of financing. In 2006, the Company increased the credit line from $7,500,000to $10,000,000 for the purpose of providing additional working capital for the Company. The Companyhas used the additional funding for facilitization and additional equipment needed to support theincreased backlog as well as the rebuilding of Valentec’s 40MM production line destroyed by fire in2006. The Company plans to pay off all other credit lines in the future with current revenue andcash on hand.     The Company is indebted under notes payable to two stockholders of the Company. The notesbear interest at various rates based on prime rate per annum which was 8.25% as of December 31,2006. In 2004, the two stockholders waived their right to interest under the notes and the Companyrecorded an in-kind contribution in the
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amount of $33,705 which was included in the December 31, 2006 financial statements. The notesare due on demand and have an outstanding balance of $433,274 as of December 31, 2006.     The Company had a line of credit from Bank One in the amount of $2,000,000 which accruedinterest at a rate of Prime less 0.75%. The line of credit was secured by a letter of credit froma related company and personal property of a stockholder. In September 2006, Bank One called thisline of credit and it was paid off in full by the letter of credit from the related company, MikalLTD, and a loan obtained against the personal property of a stockholder from Rockland CreditFinance. In return, the Company issued a promissory note in the amount of $1,000,000 to each of thelenders payable on or before October 31, 2007.     The Company has a line of credit from Bank Hapoalim in the amount of $4,000,000 accruesinterest at a rate of Libor plus 1.75% (At December 31, 2006 7.10% per annum). The line of creditis secured by a letter of credit from a stockholder. At December 31, 2006 $3,930,000 wasoutstanding under this line.     The Company has a line of credit from Bank Leumi in the amount of $500,000 accrues interest ata rate of 7.13% per annum. The line of credit is secured by a letter of credit from a stockholder.At December 31, 2006 $500,000 was outstanding under this line.     The Company has a line of credit from Rockland Credit Finance with a facility limit of$10,000,000 accruing interest at 1% per month on outstanding balances plus Prime plus 2% per annum(at December 31, 2006 10.25%). The line of credit is secured under a Master Factoring Agreementwhich includes a line on all the assets of the Company. The total amounts available under the linevary based on the total billed and unbilled accounts receivable. The total available as ofDecember 31, 2006 was $10,000,000 based on 70% of in-process receivables and 90% of accountsreceivable. At December 31, 2006, $9,116,699 was outstanding under this line. The line of creditagreement requires the company to submit monthly and annual financial reports and stay incompliance with various state and federal laws.***Off-Balance Sheet Arrangements***     The Company has no off-balance sheet arrangements.***Critical Accounting Policies***     The Company’s discussion and analysis of its financial condition and results of operations arebased upon the Company’s consolidated financial statements, which have been prepared in accordancewith accounting principles generally accepted in the United States. The preparation of thesefinancial statements requires the Company to make estimates and judgments that affect the reportedamounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets andliabilities. The Company re-evaluates its estimates on an on-going basis. The Company’s estimatesare based on historical experience and on various other assumptions that are believed to bereasonable under the circumstances. Actual results may differ from these estimates under differentassumptions or conditions.     The Company believes the following are its critical accounting policies which affect its moresignificant judgments and estimates used in the preparation of its consolidated financialstatements: **•** Revenue recognition via the percentage of completion method     **Revenue Recognition via the Percentage of Completion Method.**We believe our most criticalaccounting policies include revenue recognition and cost estimation on fixed price contracts forwhich we use the percentage of completion method of accounting.     Under the percentage of completion method, revenue is recognized on these contracts as workprogresses during the period, based on the amount of actual cost incurred during the periodcompared to total estimated cost to be incurred for the total contract (cost-to-cost method).Management reviews these estimates as work progresses and the effect of any change in costestimates is reflected in cost of sales in the period in which the change is identified. If thecontract is projected to create a loss, the loss accrued for and is charged to operations beginningin the period it
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first becomes known.     Accounting for the profit on a contract requires (1) the total contract value, (2) theestimated total cost to complete, which is equal to the sum of the actual incurred costs to date onthe contract and the estimated costs to complete the contract’s scope of work, and (3) themeasurement of progress towards completion. The estimated profit or loss on a contact is equal tothe difference between the contract value and the estimated total cost at completion. Adjustmentsto original estimates are often required as work progresses under a contract, as experience isgained and as more information is obtained, even though the scope of work required under thecontract may not change, or if contract modifications occur. A number of internal and externalfactors affect our cost of sales estimates, including labor rates and efficiency variances,material usage variances, delivery schedules and testing requirements. While we believe that thesystems and procedures used by the Company, coupled with the experience of the management team,provide a sound basis for our estimates, actual results will differ from management’s estimates.The complexity of the estimation process and issues related to the assumptions, risks anduncertainties inherent with the application of the percentage of completion method affect theamounts reported in our financial statements.***Recent Accounting Pronouncements***     Statement of Financial Accounting Standards (“SFAS”) No. 151, “Inventory Costs — an amendmentof ARB No. 43, Chapter 4” SFAS No. 152, “Accounting for Real Estate Time-Sharing Transactions — anamendment of FASB Statements No. 66 and 67,” SFAS No. 153, “Exchanges of Non-monetary Assets — anamendment of APB Opinion No. 29,” and SFAS No. 123 (revised 2004), “Share-Based Payment,” wererecently issued. SFAS No. 151, 152, 153 and 123 (revised 2004) have no current applicability to theCompany and have no effect on the financial statements. In January 2003, the Financial AccountingStandards Board (“FASB”) issued FASB Interpretation No. 46, “Consolidation of Variable Entities”,(FIN No. 46) an interpretation of Accounting Research Bulletin No. 51. FIN No. 46 requires thatvariable interest entities be consolidated by a company if that company is subject to a majority ofthe risk and loss from the variable interest entity’s activities or is entitled to receive amajority of the entity’s residual returns or both. FIN No. 46 requires disclosures about variableinterest entities that companies are not required to consolidate but which the company has asignificant variable interest. The consolidation requirements apply for newly formed variableinterest entities created after January 31, 2003 and entities established prior to January 31,2003, in the first fiscal year or interim period beginning after June 30, 2003. The adoption of FINNo. 46 is not expected to have a material impact on our consolidated results of operations andfinancial position.     In May 2005, the FASB issued SFAS 154, Accounting Changes and Error Corrections. ThisStatement replaces APB Opinion No,. 20, Accounting Changes, and FASB Statement No. 3, ReportingAccounting Changes in Interim Financial Statements, and changes the requirements for the accountingfor and reporting of a change in accounting principle. This Statement applies to all voluntarychanges in accounting principle. It also applies to changes required by an accountingpronouncement in the unusual instance that the pronouncement does not include specific transitionprovisions. SFAS 154 also requires that a change in depreciation, amortization or depletion methodfor long-lived, non-financial assets be accounted for as a change in accounting estimate effectedby a change in accounting principle. This Statement is effective in fiscal years beginning afterDecember 15, 2005. The Company has not yet determined the effect of implementing this standard.     In February 2006, the FASB issued SFAS No. 155, “*Accounting for Certain Hybrid FinancialInstruments-an amendment of FASB Statements No. 133 and 140*”, to simplify and make more consistentthe accounting for certain financial instruments. SFAS No. 155 amends SFAS No. 133, “*Accounting forDerivative Instruments and Hedging Activities*”, to permit fair value re-measurement for any hybridfinancial instrument with an embedded derivative that otherwise would require bifurcation, providedthat the whole instrument is accounted for on a fair value basis. SFAS No. 155 amends SFAS No. 140,"*Accounting for the Impairment or Disposal of Long-Lived Assets*”, to allow a qualifyingspecial-purpose entity to hold a derivative financial instrument that pertains to a beneficialinterest other than another derivative financial instrument. SFAS No. 155 applies to all financialinstruments acquired or issued after the beginning of an entity’s first fiscal year that beginsafter September 15, 2006, with earlier application allowed. The adoption of this statement is notexpected to have a material effect on the Company’s future reported financial position or resultsof operations.
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     In March 2006, the FASB issued SFAS No. 156, “*Accounting for Servicing of Financial Assets, anamendment of FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets andExtinguishments of Liabilities*”. This statement requires all separately recognized servicing assetsand servicing liabilities be initially measured at fair value, if practicable, and permits forsubsequent measurement using either fair value measurement with changes in fair value reflected inearnings or the amortization and impairment requirements of Statement No. 140. The subsequentmeasurement of separately recognized servicing assets and servicing liabilities at fair valueeliminates the necessity for entities that manage the risks inherent in servicing assets andservicing liabilities with derivatives to qualify for hedge accounting treatment and eliminates thecharacterization of declines in fair value as impairments or direct write-downs. SFAS No. 156 iseffective for an entity’s first fiscal year beginning after September 15, 2006. The adoption ofthis statement is not expected to have a material effect on the Company’s future reported financialposition or results of operations.     In June 2006, the FASB issued FASB Interpretation No. 48, *“Accounting for Uncertainty inIncome Taxes, an interpretation of FASB Statements No. 109”*. FIN 48 clarifies the accounting foruncertainty in income taxes by prescribing a two-step method of first evaluating whether a taxposition has met a more likely than not recognition threshold and second, measuring that taxposition to determine the amount of benefit to be recognized in the financial statements. FIN 48provides guidance on the presentation of such positions within a classified statement of financialposition as well as on derecognition, interest and penalties, accounting in interim periods,disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006.The adoption of this statement is not expected to have a material effect on the Company’s futurereported financial position or results of operations.     In September 2006, the FASB issued SFAS No. 157, “*Fair Value Measurements*”. The objective ofSFAS 157 is to increase consistency and comparability in fair value measurements and to expanddisclosures about fair value measurements. SFAS 157 defines fair value, establishes a frameworkfor measuring fair value in generally accepted accounting principles, and expands disclosures aboutfair value measurements. SFAS 157 applies under other accounting pronouncements that require orpermit fair value measurements and does not require any new fair value measurements. The provisionsof SFAS No. 157 are effective for fair value measurements made in fiscal years beginning afterNovember 15, 2007. The adoption of this statement is not expected to have a material effect on theCompany’s future reported financial position or results of operations.     In September 2006, the FASB issued SFAS No. 158, “*Employers’ Accounting for Defined BenefitPension and Other Postretirement Plans — an amendment of FASB Statements No. 87, 88, 106, and132(R)*”. This statement requires employers to recognize the over-funded or under-funded status of adefined benefit postretirement plan (other than a multiemployer plan) as an asset or liability inits statement of financial position and to recognize changes in that funded status in the year inwhich the changes occur through comprehensive income of a business entity or changes inunrestricted net assets of a not-for-profit organization. This statement also requires an employerto measure the funded status of a plan as of the date of its year-end statement of financialposition, with limited exceptions. The provisions of SFAS No. 158 are effective for employers withpublicly traded equity securities as of the end of the fiscal year ending after December 15, 2006.The adoption of this statement is not expected to have a material effect on the Company’s futurereported financial position or results of operations.     In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, “*Considering theEffects of Prior Year Misstatements when Quantifying Misstatements in Current Year FinancialStatements*.” SAB No. 108 addresses how the effects of prior year uncorrected misstatements shouldbe considered when quantifying misstatements in current year financial statements. SAB No. 108requires companies to quantify misstatements using a balance sheet and income statement approachand to evaluate whether either approach results in quantifying an error that is material in lightof relevant quantitative an qualitative factors. SAB No. 108 is effective for period ending afterNovember 15, 2006. The Company is currently evaluating the impact of adopting SAB No. 108 but doesnot expect that it will have a material effect on its financial statements.     In February 2007, the Financial Accounting Standards Board (FASB) issued SFAS No. 159, “*TheFair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASBStatement No. 115*”. This statement permits entities to choose to measure many financialinstruments and certain other items at fair value. Most of the provisions of SFAS No. 159 applyonly to entities that elect the fair value option. However, the amendment to SFAS No. 115“*Accounting for Certain Investments in Debt and Equity Securities*” applies to all entities withavailable-for-sale and trading securities. SFAS No. 159 is effective as of the beginning of anentity’s
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first fiscal year that begins after November 15, 2007. Early adoption is permitted as of thebeginning of a fiscal year that begins on or before November 15, 2007, provided the entity alsoelects to apply the provision of SFAS No. 157, “*Fair Value Measurements”.*The adoption of thisstatement is not expected to have a material effect on the Company’s financial statements.**ITEM 7.** **Financial Statements**     The responses to this Item are submitted in a separate section of this Report. SeeIndex to the Financial Statements on page F-1 hereto.**ITEM 8.** **Changes in and Disagreements with Accountants on Accounting and FinancialDisclosure**     On March 29, 2005, Grant Thornton LLP (“Grant Thornton”) advised the Company that ithad resigned as the Company’s independent registered public accounting firm. That determination wasa decision of Grant Thornton and was not recommended by the Company’s Board of Directors.     The audit report issued by Grant Thornton on the consolidated financial statements of theCompany as of and for the year ended December 31, 2003 did not contain an adverse opinion or adisclaimer of opinion, nor was it modified as to uncertainty, audit scope, or accountingprinciples, except that it did contain an explanatory paragraph for the adoption of Statement ofFinancial Accounting Standards No. 142, Goodwill and Other Intangible Assets, on January 1, 2002.     During the Company’s fiscal year ended December 31, 2003 and the subsequent interim periodfrom January 1, 2004 through the date of this report, there were no disagreements with GrantThornton on any matter of accounting principles or practices, financial statement disclosure, orauditing scope or procedure, which disagreements, if not resolved to the satisfaction of GrantThornton, would have caused it to make reference to the subject matter of the disagreement inconnection with its report on the Company’s consolidated financial statements.     On April 14, 2005, the Company engaged Webb & Company as its principal independent accountant.The Company’s Board of Directors approved the appointment of Webb and Company as the Company’sprincipal independent accountant on April 4, 2005.     On January 18, 2006, the Company subsidiary terminated Heard, McElroy & Vestal as theCompany’s independent accountant due to Heard, McElroy & Vestal’s decision to not continue due toValentec Systems, Inc. becoming a publicly traded company. Heard, McElroy & Vestal prepared theCompany’s 2004 audited financial statements.     On January 23, 2006, the Company engaged Webb & Company to continue as its principalindependent accountant. The Board of Directors approved the appointment of Webb and Company as theCompany’s principal independent accountant on January 23, 2006.     During the two most recent fiscal years and through April 14, 2005, the Company did notconsult with Webb & Company regarding either: (i) the application of accounting principles to any specified transaction, eithercompleted or proposed, or the type of audit opinion that might be rendered on theCompany’s financial statements, and neither a written report was provided to theCompany nor oral advice was provided that Webb & Company concluded was an importantfactor considered by the Company in reaching a decision as to any accounting, auditingor financial reporting issue; or  (ii) any matter that was either subject of disagreement, as that term explained inItem 304(a)(1)(iv) of Regulations S-B and the related instruction to Item 304 ofRegulation S-B, or an event, as that term is explained in Item 304(a)(1)(iv) ofRegulation S-B.
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**ITEM 8A.** **Controls and Procedures*****Evaluation of Disclosure Controls and Procedures***     The Company’s chief executive officer, who is also the Company’s chief financial officer, hasreviewed and evaluated the effectiveness of the Company’s disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the periodcovered by this annual report. Based on that review and evaluation, the chief executive officer hasconcluded that the Company’s current disclosure controls and procedures, as designed aresufficiently effective to ensure that such officer is provided with information relating to theCompany required to be disclosed in the reports the Company files or submits under the Exchange Actand that such information is recorded, processed, summarized and reported in a timely manner.However, due to recent changes in responsible financial reporting personnel and insufficienttraining, the implementation of said internal controls have been weakened to cause concerns as totheir effectiveness. The Company’s chief executive officer has committed to ensuring sufficienttraining of responsible financial reporting personnel to correct said issue.***Changes in Internal Controls Over Financial Reporting***     In connection with the evaluation of the Company’s internal controls during the Company’s lastfiscal year, the Company’s Principal Executive Officer and Principal Accounting Officer havedetermined that due to changes in financial reporting personnel and inadequate training, theCompany’s internal controls over financial reporting have weakened and is reasonably likely tomaterially effect the Company’s internal controls over financial reporting. A plan has beenenacted to ensure adequate training of financial reporting personnel to resolve any potentialinternal control weaknesses.***Inherent Limitations on Effectiveness of Controls***     The Company’s management does not expect that its disclosure controls or its internal controlover financial reporting will prevent or detect all error and all fraud. A control system, nomatter how well designed and operated, can provide only reasonable, not absolute, assurance thatthe control system’s objectives will be met. The design of a control system must reflect the factthat there are resource constraints, and the benefits of controls must be considered relative totheir costs. Further, because of the inherent limitations in all control systems, no evaluation ofcontrols can provide absolute assurance that misstatements due to error or fraud will not occur orthat all control issues and instances of fraud, if any, within the Company have been detected.These inherent limitations include the realities that judgments in decision making can be faultyand that breakdowns can occur because of simple error or mistake. Controls can also be circumventedby the individual acts of some persons, by collusion of two or more people, or management overrideof the controls. The design of any system of controls is based in part on certain assumptions aboutthe likelihood of future events, and there can be no assurance that any design will succeed inachieving its stated goals under all potential future conditions. Projections of any evaluation ofcontrols effectiveness to future periods are subject to risks. Over time, controls may becomeinadequate because of changes in conditions or deterioration in the degree of compliance withpolicies or procedures.**ITEM 8B.** **Other Information**     None.**PART III****ITEM 9.** **Directors, Executive Officers, Promoters, Control Persons and Corporate Governance;Compliance with Section 16(a) of The Exchange Act**     The following is a list (along with certain biographical information) of the executiveofficers and directors of Valentec. All of our directors are serving a current term of office,which continues until the next annual meeting of stockholders:
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**Directors, Executive Officers and Control Persons**       **Name** **Age** **Position**       Avraham (Miko) Gilat  57  Director      (June 6, 2005 — Present)       Robert A. Zummo  65  Director, Chief Executive Officer andChairman of the Board      (June 6, 2005 — Present)       Zvi Kreizman  52  Director      (June 6, 2005 — Present)       August Cianciolo     Director      (March 13, 2007 — Present)       W. Glenn Yarborough, Jr     Director      (March 13, 2007 — Present)       Stephen J. Shows  65  Vice President of Operations / General Manager      (June 6, 2005 — Present)**AVRAHAM (MIKO) GILAT**was named director of the Company on June 6, 2005 to serve until the nextannual election of directors. Mr. Gilat has been a member of the Valentec Operating Corp. board ofdirectors since 2000. He currently serves as the chair of Soltam Group and Soltam Systems,positions that he has held since 1999. Soltam Systems is one of Israel’s prominent defensecompanies. In 2000, Mr. Gilat purchased Valentec Operating Corp. with Mr. Zummo. He previouslyserved as a director of Mikal Ltd., a holding company for a wide range of commercial activities,and in various positions with Israel Military Industries, including as vice president of marketingand vice president of business development. Mr. Gilat served in the Israeli Defense Forces as acommand and armor corps officer and retired from reserve duty as a major. He received an M.B.A.from New York University and a B.A. in economics from Tel Aviv University.**ROBERT A. ZUMMO**was named director of the Company on June 6, 2005 to serve until the next annualelection of directors. Mr. Zummo also has been the President and Chief Executive Officer of theCompany since June 6, 2005. Mr. Zummo has been a member of the Valentec Systems board of directorssince October 2000. Mr. Zummo currently serves as the President and Chief Executive Officer ofValentec Systems, positions that he has held since October 2000. Mr. Zummo was also chairman ofthe board of directors of Valentec Systems. Prior to joining Valentec in 2000, Mr. Zummo served asExecutive Vice President of General Defense; a Maryland based artillery-manufacturing company.Prior to that, Mr. Zummo served as Vice President of Program Management of Avco Aerostructures, awing and stabilizer manufacturing company.**ZVI KREIZMAN**was named director of the Company on June 6, 2005 to serve until the next annualelection of directors. Mr. Kreizman currently serves as the Chief Financial Officer of the SoltamGroup and Soltam Systems and has served in this capacity since 1993. Mr. Kreizman has also been adirector of TGC, Ltd., which manufactures rubber products, since January of 2005. Mr. Kreizman isa graduate of the Haifia School of Management in certified accounting. He is certified by thePublic Accountants Association of Israel.**STEPHEN J. SHOWS**has been Vice President of Operations and General Manager of Valentec Systems,Inc. since 1998. Mr. Shows was General Manager for Thiokol Corporation at the Louisiana ArmyAmmunition Plant and Longhorn Army Ammunition Plant from 1985 to 1995. Mr. Shows began his careerin 1962 at the Louisiana Plant as an engineering technician and has over 40 years managerialexperience in the defense industry to include assembly and metal parts manufacturing. Hisexperience also includes positions as Program Director, Operations
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Director, Manufacturing Manager, Planning Manager and Materials Manager functions. Mr. Showsreceived his BS in Business Administration from Southwest University in Metairie, Louisiana.(**RET) LIEUTENANT GENERAL GUS CIANCIOLO**was appointed as a member of the Board of Directors of theCompany on March 17, 2007 to serve until the next annual election of directors. Mr. Cianciolo hasheld a wide variety of important command and staff positions during his 33-year Army career,culminating as the Military Deputy to the Assistant Secretary of the Army for Research,Development, and Acquisition. He also served as the Director of the Army Acquisition Corps.General Cianciolo’s diverse background in research, development, and acquisition included serviceas the Deputy Commanding General for Research, Development, and Acquisition, Army Material Command,and as Commanding General, U.S. Army Missile Command. He was also Project Manager for two majorArmy Weapon systems programs, one involving international participation by four NATO countries.After retiring from the U.S. Armed Forces, Mr. Cianciolo served as Senior Vice President of CypressInternational, a global business development organization that assists clients in the marketing oftheir defense products and relations services worldwide. He later joined the SPECTRUM Group as anassociate and was named President in January 2007. The SPECTRUM Group is a privately heldcorporation that provides consulting services to corporations that primarily conduct business withthe U.S. government and related agencies. Its membership consists of more than 65 distinguishedprofessionals with experience, expertise and relationships at the highest levels of government andbusiness. In addition to his board role with Valentec, Mr. Cianciolo sits on the Board of Directorsof Nammo, Inc., a privately held supplier of electronics and aviation munitions. He also sits onthe Advisory Boards of Fabrique National Manufacturing Inc., CPU Technologies and Combined Systems,Inc. He holds a B.S. degree in Business Administration from Xavier University and a M.S. degreefrom the University of Southern California.**W. GLENN YARBOROUGH, JR.**was appointed as a member of the Board of Directors of the Company onMarch 17, 2007 to serve until the next annual election of directors. He retired from the U.S. Armyas Colonel, after a distinguished 27 years of service. He is currently the Founder of ChiefExecutive Officer of WGY & Associates, LLC, a high technology defense, management and governmentrelations consulting practice. Before founding the firm in 2001, he served as President and ChiefExecutive Officer of Allied Research Corporation, a publicly traded diversified defense andcommercial electronic security firm (now Allied Defense Group). While with Allied, he helped theCompany grow via acquisition and strengthen its global operations and, he successfully led afinancial turnaround, making Allied one of the industry’s fastest growing companies. Before joiningAllied, Mr. Yarborough was Director of Marketing of the Grumman Corporation, overseeing threebusiness programs in the areas of test equipment, vehicular intercom systems and advanced radars.Earlier in his career, he served as the Washington Manager with Ford Aerospace / BDM Corporation,where he was responsible for contract generation with government agencies and as Director ofOperations with Italian Advanced Industries, where he helped launch the Company’s U.S. operationswith a key focus on the U.S. military. Throughout his career, Glenn has worked closely with manydetailed segments of the Department of Defense, Department of the Air Force, Army, Navy, DARPA,FBI, Transportation Security Administration, Department of Homeland Security, NSA, the CIA and theAuthorization and Appropriation Committees of the House and Senate. Before retiring from the U.S.Armed Forces, he served as Military Assistant to the Assistant Secretary of the Army for Research,Development and Acquisition. Mr. Yarborough serves on the Board of Directors of CarletonTechnology, EADA North America Defense Company, Easter Seals, So Others Might Eat (SOME), Friendsof the McLean Community Center, the Patton Museum of Armor and Cavalry, the U.S. CavalryAssociation and the Board of the Moore School of Business at the University of South Carolina. Heholds a B.A. and M.B.A. from the University of South Carolina and is a graduate of the ExecutiveProgram, University of Virginia, the Naval War College and the Army’s Command & General StaffCollege.     There are no family relationships between any executive officers or directors of the Company.     Valentec announced in January 2007 that as part of the term sheet signed with MAST as furtherdetailed above, it was agreed that Gerald Pickens, President and CEO of MAST will join Valentec asChief Operating Officer subject to the consummation of the transaction. Mr. Pickens has enjoyed a35+year career in the defense sector, working in the areas of manufacturing, product development,operations, logistics, quality control and finance. Before his appointment to President of CEO ofMAST, he served as Director of Operations and prior to, was Operations Manager at Day andZimmerman, Inc. Mr. Pickens is a member of the National Management
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Association, American Management Association and National Defense Industrial Association andreceived a Bachelors of Science (B.S.) from Sam Houston State University.     Additionally, Jay Bell, formerly Vice President of Sales and Marketing of MAST Technology whohas been appointed as MAST Technology’s President, a position he will assume upon closing of thetransaction. Bell had previously served as President and CEO of MAST Technology from 1999-2004before taking on sales and marketing responsibilities when Gerald Pickens was appointed to thatrole. Mr. Bell is active in a number of defense, operations and financial institutions and is amember of the NDIA Small Arms Committee. He holds a Bachelors of Arts (B.A.) from the Universityof Southern California.***Director Compensation***     Each Director receives $250 per meeting plus travel expenses. Compensation is subject tochange as new Directors are added to the Board. We have no formal plan for compensating ourdirectors for their service in their capacity as directors, although such directors may in thefuture receive stock options to purchase Common Stock as awarded by our board of directors or (asto future stock options) a compensation committee which may be established. Directors are entitledto reimbursement for reasonable travel and other out-of-pocket expenses incurred in connection withattendance at meetings of our board of directors. Our board of directors may award specialremuneration to any director undertaking any special services on our behalf other than servicesordinarily required of a director. No director received and/or accrued any compensation for theirservices as a director, including committee participation and/or special assignments.***Committees of the Board***     We do not have a separate audit committee at this time. Our board of directors acts as ouraudit committee.***Audit Committee Financial Expert***     Our board of directors has determined that it does not have a member of its audit committeethat qualifies as an “audit committee financial expert” as defined in Item 401(e) of RegulationS-B, and is “independent” as the term is used in Item 7(d)(3)(iv) of Schedule 14A under theSecurities Exchange Act of 1934, as amended. We believe that the members of our board of directorsare collectively capable of analyzing and evaluating our financial statements and understandinginternal controls and procedures for financial reporting. In addition, we believe that retaining anindependent director who would qualify as an “audit committee financial expert” would be overlycostly and burdensome and is not warranted in our circumstances given the early stages of ourdevelopment and the fact that we have not generated any material revenues to date.***Section 16(a) Compliance***     Section 16(a) of the Securities Exchange Act of 1934, as amended, requires that the Company’sdirectors, executive officers and persons who own more than 10% of the outstanding shock of theCompany file initial reports of ownership and reports of changes in ownership in such common stockwith the SEC. Officers, directors and stockholders who own more than 10% of the outstanding commonstock of the Company are required by the SEC to furnish the Company with copies of all Section16(a) reports they file. To the knowledge of the Company, based solely on the review of the copiesof such reports furnished to the Company and written representations that no other reports wererequired during the year ended December 31, 2006, all officers, directors and 10% stockholdersother than Avraham Gilat and Zvi Kreizman complied with all applicable Section 16(a) filingrequirements.***Code of Ethics***     Effective April 3, 2006, our board of directors adopted a preliminary Code ofBusiness Conduct and Ethics that applies to, among other persons, our senior executives (being ourprincipal executive officer, principal accounting officer and senior vice presidents, as well aspersons performing similar functions. As adopted, our Code of Business Conduct and Ethics setsforth written standards that are designed to deter wrongdoing and to promote:
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 1. honest and ethical conduct, including the ethical handling of actual orapparent conflicts of interest between personal and professionalrelationships;  2. full, fair, accurate, timely, and understandable disclosure in reports anddocuments that we file with, or submit to, the Securities and Exchange Commissionand in other public communications made by us;  3. compliance with applicable governmental laws, rules and regulations;  4. the prompt internal reporting of violations of the Code of Business Conductand Ethics to an appropriate person or persons identified in the Code of BusinessConduct and Ethics; and  5. accountability for adherence to the Code of Business Conduct and Ethics.     Our Code of Business Conduct and Ethics requires, among other things, that all of ourSenior Officers commit to timely, accurate and consistent disclosure of information; that theymaintain confidential information; and that they act with honesty and integrity.     In addition, our Code of Business Conduct and Ethics emphasizes that all employees,and particularly Senior Officers, have a responsibility for maintaining financial integrity withinour company, consistent with generally accepted accounting principles, and federal and statesecurities laws. Any Senior Officer who becomes aware of any incidents involving financial oraccounting manipulation or other irregularities, whether by witnessing the incident or being toldof it, must report it to our company. Any failure to report such inappropriate or irregular conductof others is to be treated as a severe disciplinary matter. It is against our policy to retaliateagainst any individual who reports in good faith the violation or potential violation of our Codeof Business Conduct and Ethics by another.     Our Code of Business Conduct and Ethics is filed as an exhibit to this annualreport on Form 10-KSB. We will provide a copy of the Code of Business Conduct and Ethics to anyperson without charge, upon request. Requests can be sent to: Valentec Systems, Inc., 2629 YorkAvenue, Minden, Louisiana 71055.***Corporate Governances***     The Board of Directors is currently reviewing but has not yet adopted a comprehensivecorporate governance policy. As part of our review, we are currently examining our corporategovernance and other policies and procedures. Following such examination, we expect to adoptCorporate Governances applicable to all directors, officers and employees.**ITEM 10.** **Executive Compensation**     The following table sets forth the compensation awarded by the Company for the fiscal yearsended December 31, 2006, 2005 and 2004 to the Company’s named executive officers and directors.**SUMMARY COMPENSATION TABLE**                                 **Nonqualified**                **Non-Equity** **Deferred**    **Name and**       **Stock** **Option** **Incentive Plan** **Compensation** **All Other**  **Principal**   **Salary** **Bonus** **Awards** **Awards** **Compensation** **Earnings** **Compensation** **Total****Position** **Year** **($)** **($)** **($)** **($)** **($)** **($)** **($)** **($)**Robert Zummo Director,