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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                                    FORM 10-K

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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF
1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004 .

                                       OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ______.


Commission File Number:                   0-23336

                            AROTECH CORPORATION
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           (Exact name of registrant as specified in its charter)
<TABLE>
<CAPTION>
<S>                                <C>                                                           <C>

                                Delaware                                                    95-4302784
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     (State or other jurisdiction of incorporation or organization)            (I.R.S. Employer Identification No.)
                           354 Industry Drive, Auburn, Alabama                                 36830

-------------------------------------------------------------------------      --------------------------------------
                (Address of principal executive offices)                                    (Zip Code)

                             (334) 502-9001
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              (Registrant's telephone number, including area code)
          Securities registered pursuant to Section 12(b) of the Act:

 Title of each class                         Name of each exchange on which registered
-----------------------                    ----------------------------------------------
         None                                             Not applicable
</TABLE>

Securities registered pursuant to Section 12(g) of the Act:Common Stock, $0.01
par value

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days: Yes X No __

Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of Regulation  S-K (ss.  229.405 of this chapter) is not contained  herein,  and
will not be  contained,  to the best of  registrant's  knowledge,  in definitive
proxy or information  statements  incorporated  by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. __

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes X No__

The  aggregate   market  value  of  the   registrant's   voting  stock  held  by
non-affiliates  of  the  registrant  as  of  June  30,  2004  was  approximately
$128,605,410  (based  on the  last  sale  price of such  stock  on such  date as
reported by The Nasdaq  National  Market and  assuming,  for the purpose of this
calculation only, that all of the registrant's  directors and executive officers
are affiliates).

(Applicable  only to  corporate  registrants)  Indicate  the  number  of  shares
outstanding  of each of the  registrant's  classes  of common  stock,  as of the
latest practicable date:   80,103,668 as of 3/10/05

Documents incorporated by reference: None

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     Potential  persons  who are to  respond to the  collection  of
     information contained in this form are not required to respond
     unless the form displays a currently valid OMB control number.

<PAGE>
                                PRELIMINARY NOTE

         This annual report contains historical  information and forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995  with  respect  to  our  business,   financial  condition  and  results  of
operations.  The words  "estimate,"  "project,"  "intend,"  "expect" and similar
expressions  are  intended  to  identify   forward-looking   statements.   These
forward-looking  statements  are subject to risks and  uncertainties  that could
cause  actual  results  to differ  materially  from those  contemplated  in such
forward-looking  statements.  Further,  we operate in an industry  sector  where
securities  values may be volatile and may be  influenced  by economic and other
factors beyond our control.  In the context of the  forward-looking  information
provided  in this  annual  report  and in  other  reports,  please  refer to the
discussions  of risk  factors  detailed  in,  as well as the  other  information
contained in, our other filings with the Securities and Exchange Commission.

         Electric  Fuel(R)  is  a  registered  trademark  and  Arotech(TM)  is a
trademark of Arotech  Corporation,  formerly known as Electric Fuel Corporation.
All  company  and  product  names  mentioned  may be  trademarks  or  registered
trademarks of their respective holders. Unless otherwise indicated,  "we," "us,"
"our" and similar terms refer to Arotech and its subsidiaries.

<PAGE>
                                     PART I

ITEM 1. BUSINESS

General

         We are a defense and security products and services company, engaged in
three  business  areas:  high-level  armoring  for  military,  paramilitary  and
commercial air and ground  vehicles;  interactive  simulation for military,  law
enforcement and commercial  markets;  and batteries and charging systems for the
military.  Until September 17, 2003, we were known as Electric Fuel Corporation.
We operate  primarily as a holding  company,  through our various  subsidiaries,
which we have organized  into three  divisions.  Our divisions and  subsidiaries
(all 100% owned by us, unless otherwise noted) are as follows:

      >>    We develop, manufacture and market advanced hi-tech multimedia and
            interactive digital solutions for use-of-force and driving training
            of military, law enforcement, security and other personnel through
            our Simulation and Security Division:

                  o        We  provide   simulators,   systems  engineering  and
                           software  products  to the  United  States  military,
                           government   and   private   industry   through   our
                           subsidiary FAAC  Incorporated,  located in Ann Arbor,
                           Michigan ("FAAC"); and

                  o        We provide  specialized  "use of force"  training for
                           police,  security  personnel and the military through
                           our  subsidiary  IES  Interactive   Training,   Inc.,
                           located in Littleton, Colorado ("IES").

         >>       We  manufacture  aviation  armor and we utilize  sophisticated
                  lightweight  materials and advanced  engineering  processes to
                  armor vehicles through our Armor Division:

                  o        We  manufacturer  ballistic and  fragmentation  armor
                           kits for  rotary  and  fixed  wing  aircraft,  marine
                           armor,   personnel  armor,   military   vehicles  and
                           architectural   applications,   including   both  the
                           LEGUARD   Tactical  Leg  Armor  and  the  Armourfloat
                           Ballistic  Floatation Device,  which is a unique vest
                           that is  certified by the U.S.  Coast Guard,  through
                           our  subsidiary  Armour of  America,  located  in Los
                           Angeles, California, ("AoA"); and

                  o        We   use    state-of-the-art    lightweight   ceramic
                           materials,   special  ballistic  glass  and  advanced
                           engineering  processes  to fully armor vans and SUVs,
                           through our subsidiaries  MDT Protective  Industries,
                           Ltd., located in Lod, Israel ("MDT"), of which we own
                           75.5%, and MDT Armor Corporation,  located in Auburn,
                           Alabama ("MDT Armor"), of which we own 88%.


<PAGE>

         >>       We  manufacture  and sell lithium and Zinc-Air  batteries  for
                  defense and security products and other military  applications
                  and  we  pioneer   advancements  in  Zinc-Air  technology  for
                  electric  vehicles  through  our  Battery  and  Power  Systems
                  Division

                  o        We develop and sell  rechargeable and primary lithium
                           batteries  and smart  chargers to the military and to
                           private industry in the Middle East,  Europe and Asia
                           through our subsidiary Epsilor Electronic Industries,
                           Ltd.,  located in Dimona,  Israel (in Israel's  Negev
                           desert area) ("Epsilor");

                  o        We   manufacture   and  sell   Zinc-Air  fuel  cells,
                           batteries and chargers for the military,  focusing on
                           applications   that  demand  high  energy  and  light
                           weight,  through our subsidiary Electric Fuel Battery
                           Corporation, located in Auburn, Alabama ("EFB"); and

                  o        We  produce  water-activated  lifejacket  lights  for
                           commercial aviation and marine  applications,  and we
                           conduct  our  Electric  Vehicle  effort,  through our
                           subsidiary  Electric Fuel (E.F.L.)  Ltd.,  located in
                           Beit Shemesh, Israel ("EFL").

     Background

         We were  incorporated in Delaware in 1990 under the name "Electric Fuel
Corporation," and we changed our name to "Arotech  Corporation" on September 17,
2003.  Unless  the  context  requires  otherwise,  all  references  to us  refer
collectively  to  Arotech   Corporation  and  Arotech's   wholly-owned   Israeli
subsidiaries,  EFL and Epsilor;  Arotech's  majority-owned Israeli subsidiaries,
MDT and MDT Armor; and Arotech's  wholly-owned United States subsidiaries,  EFB,
IES, FAAC and AoA.

         For financial information  concerning the business segments in which we
operate, see Note 18 of the Notes to the Consolidated Financial Statements.  For
financial information about geographic areas in which we engage in business, see
Note 18.c of the Notes to the Consolidated Financial Statements.

     Facilities

         Our principal  executive offices have recently been re-located to EFB's
premises at 354 Industry Drive, Auburn,  Alabama 36830, and our telephone number
at  our  executive   offices  is  (334)  502-9001.   Our  corporate  website  is
www.arotech.com.  Our periodic reports to the Securities Exchange Commission, as
well as  recent  filings  relating  to  transactions  in our  securities  by our
executive  officers and directors,  that have been filed with the Securities and
Exchange  Commission  in EDGAR  format  are made  available  through  hyperlinks
located   on   the    investor    relations    page   of   our    website,    at
http://www.arotech.com/compro/investor.html,  as soon as reasonably  practicable
after  such  material  is  electronically  filed with or  furnished  to the SEC.
Reference  to our  websites  does  not  constitute  incorporation  of any of the
information thereon or linked thereto into this annual report.



                                       2
<PAGE>

         The offices and facilities of three of our principal subsidiaries, EFL,
MDT and  Epsilor,  are  located  in Israel  (in Beit  Shemesh,  Lod and  Dimona,
respectively,  all of which are within Israel's pre-1967  borders).  Most of the
members of our senior management work extensively out of EFL's facilities. IES's
offices and facilities are located in Littleton,  Colorado,  FAAC's home offices
and facilities are located in Ann Arbor, Michigan,  AoA's offices and facilities
are located in Los Angeles,  California,  and the offices and  facilities of EFB
and MDT Armor are located in Auburn, Alabama.

Simulation and Security Division

         We develop,  manufacture  and market  advanced  hi-tech  multimedia and
interactive digital solutions for use-of-force and driving training of military,
law  enforcement,  security  and other  personnel  through  our  Simulation  and
Security  Division,  the largest of our three  divisions.  During 2004, 2003 and
2002 revenues from our Simulation and Security Division were approximately $21.5
million,  $8.0  million and $2.0  million,  respectively  (on a pro forma basis,
assuming we had owned all  components of our  Simulation  and Security  Division
since  January  1,  2002,  revenues  in  2004,  2003 and 2002  would  have  been
approximately $21.5 million, $17.9 million and $20.3 million, respectively).

     Vehicle Simulators

         We provide simulators, systems engineering and software products to the
United States military, government and private industry through our wholly-owned
subsidiary,   FAAC  Corporation,   based  in  Ann  Arbor,  Michigan.  Our  fully
interactive  driver-training systems feature  state-of-the-art vehicle simulator
technology enabling training in situation awareness,  risk analysis and decision
making, emergency reaction and avoidance procedures, and conscientious equipment
operation.  We  have  an  installed  base  of  over  220  simulators  that  have
successfully  trained  over 100,000  drivers.  Our  customer  base  includes all
branches of the U.S.  Department of Defense,  state and local  governments,  and
commercial entities.

         INTRODUCTION

         We conduct  our  business in two primary  areas:  Vehicle  Simulations,
which focuses on the  development and delivery of complete  driving  simulations
for a wide range of vehicle  types - such as trucks,  automobiles,  buses,  fire
trucks, police cars, ambulances,  airport ground vehicles, and military vehicles
- for commercial,  governmental and foreign customers;  and Military Operations,
which  conducts  tactical air and land combat  analysis and develops  analytical
models,  simulations,  and "turnkey" training systems for the U.S. military.  In
2004,  Vehicle  Simulations  accounted  for  approximately  80% of  our  vehicle
simulation revenues,  and Military Operations accounted for approximately 20% of
our vehicle simulation revenues.

         In the area of  Military  Operations,  we are a  premier  developer  of
validated,  high fidelity  analytical models and simulations of tactical air and
land  warfare  for all  branches  of the  Department  of Defense and its related
industrial  contractors.  Our  simulations  are found in  systems  ranging  from
instrumented  air  combat  and  maneuver  ranges  (such as Top Gun) to full task
training  devices  such as the  F-18  Weapon  Tactics  Trainer.  We are also the
leading  supplier of wheeled  vehicle  simulators  to the U.S.  Armed Forces for
mission-critical vehicle training.

         We supply on-board  software to support weapon launch decisions for the
F-15, F-18, and Joint Strike Fighter (JSF) fighter  aircraft.  Pilots benefit by
having highly accurate presentations of their weapon's  capabilities,  including
susceptibility  to target  defensive  reactions.  We designed  and  developed an
instructor  operator station,  mission operator station and real-time,  database


                                       3
<PAGE>

driven electronic combat environment for the special  operational forces aircrew
training system. The special operational forces aircrew training system provides
a full range of  aircrew  training,  including  initial  qualification,  mission
qualification,  continuation,  and upgrade  training,  as well as combat mission
rehearsal.

         Simulators  are  cost-effective  solutions,  enabling  users to  reduce
overall  aircraft and ground  vehicle usage,  vehicle  maintenance  costs,  fuel
costs,  repairs,  and spares  expenditures.  For  example,  our Medium  Tactical
Vehicle Replacement (MTVR) simulators have reduced total driver training time by
35%. Many  customers have reduced  actual  "behind-the-wheel"  time by up to 50%
while still  maintaining or improving safety.  Additionally,  for customers with
multiple  simulators,  the  corresponding  increase in the student to instructor
ratio has reduced instructor cost per student.

         The  implementation  of our vehicle  simulators  has led to  measurable
benefits.  North  American  Van Lines,  one of our  earliest  vehicle  simulator
customers,  has shown a 22% reduction in  preventable  accidents  since it began
using our  simulators.  The German Army,  one of our earliest  Military  Vehicle
customers,  showed  better  driver  testing  scores  in 14 of 18  driver  skills
compared to classroom and live driver training  results.  Additionally,  the New
York City Transit Authority documented a 43% reduction in preventable  accidents
over its first six months of use and has reduced its driver  hiring and training
"washout" by 50%.

         Simulators  can produce more drastic  situations  than can  traditional
training,  which  inherently  produces  drivers that are more skilled in diverse
driving  conditions.  For example,  while many first-time  drivers will learn to
drive  during  the  summer  months,  they are not  trained  to  drive in  wintry
conditions.  Simulators can produce these and other  situations,  such as a tire
blowout  or having to react to a driver  cutting  off the  trainee,  effectively
preparing the driver for adverse conditions.

         We  believe  that we have  held a 100%  market  share in U.S.  military
wheeled  simulators  since 1999 and hold a market share in excess of 50% in U.S.
commercial wheeled vehicle simulators.

         PRODUCT LINES

         Below is a description  of our vehicle  simulator  products and product
lines.

              Vehicle Simulations

                  Military Vehicles
                  -----------------

         Military  Vehicles  comprise  the  majority of our  vehicle  simulation
business.  Military vehicle  simulators are highly realistic vehicle  simulators
that include  variable  reactive  traffic and road  conditions,  the capacity to
customize driving conditions to be geography-specific, and training in hazardous
and emergency conditions. We have several large contracts and task orders in the
Military Vehicles  business,  including (i) the MTVR contract to develop vehicle
simulators  and related  training  services for the U.S.  Marine  Corps;  (ii) a
series of scheduled General Services Administration purchases of simulators with
the U.S. Army to supply 78 simulators  for 25 training  sites;  (iii) a two-year
contract  with the U.S.  Navy  Seabees  to  supply  eight  simulators  for three
training sites; and (iv) a ten-year,  task order contract to develop a series of
Common Driver  Trainers for the U.S.  Army, the first task order of which is for
nine Stryker  simulators.  We estimate that our software trained 12,000 soldiers
at ten sites in 2004.



                                       4
<PAGE>

         Our military vehicle simulators provide complete training capabilities,
based  on  integrated,  effective  simulation  solutions,  to  military  vehicle
operators in the U.S. Armed Forces.  Our flagship  military  vehicle  simulation
product is our MTVR Operator Driver Simulator,  developed for the USMC. The MTVR
ODS concept is centered on a pod of up to six Student  Training  Stations  (STS)
and  a  single   controlling   Instructor   Operator   Station  (IOS).  The  STS
realistically  simulates  the  form,  fit,  and  feel of the MTVR  vehicle.  The
high-fidelity  version of the STS  consists  of a modified  production  cab unit
mounted on a full  six-degree-of-freedom  motion  platform.  The STS  provides a
field of view of over 180-degrees  into a realistically  depicted virtual world,
simulating  a variety of on-road and  off-road  conditions.  The IOS is the main
simulation control point supporting the instructor's role in simulator training.
The  IOS  initializes  and  configures  the  attached  STS,   conducts  training
scenarios,  assesses student  performance,  and maintains scenarios and approved
curriculum.

         Our software solution provides a complete operator training  curriculum
based upon integrated  simulation  training.  Military vehicle simulators enable
students to learn proper  operational  techniques  under all  terrain,  weather,
road,  and traffic  conditions.  Instructors  can use  simulators as the primary
instructional  device,   quantitatively  evaluating  student  performance  under
controlled,  repeatable scenarios. This monitoring, combined with the ability to
create  hazardous and potentially  dangerous  situations  without risk to man or
material,  results in  well-trained  students  at  significantly  less cost than
through  the use of  traditional  training  techniques.  In addition to standard
on-road driver training, our military vehicle simulators can provide training in
such tasks as:

                  >>       Off-road driving on severe slopes, including muddy or
                           swampy terrain;

                  >>       Night vision goggle and blackout conditions;

                  >>       Convoy training; and

                  >>       The  use of the  Central  Tire  Inflation  System  in
                           response to changing terrain.

         In  addition to  simulation  systems,  we offer  on-site  operator  and
maintenance staff,  train-the-trainer courses, curriculum development,  scenario
development, system maintenance, software upgrades, and warranty packages to our
U.S. Armed Forces customers.

                  Commercial Vehicles

         The Commercial  Vehicles business is comprised of technology similar to
that of the Military Vehicles product line and also is customized to reflect the
specific  vehicle being  simulated.  We serve four primary customer bases in the
Commercial  Vehicles  business:  transit,  municipal,   airport,  and  corporate
customers.

                      Transit

         Transit  customers  represent  an  attractive  customer  base  as  they
generally  have  access to their own funds,  which often  exempts  them from the
lengthy and complex  process of requesting  funds from a governing body. We have
provided bus simulators to fourteen leading transit  authorities,  including the
New York City  Transit  Authority,  Washington,  D.C.  Metro,  Dallas Area Rapid
Transit,  and the  Chicago  Transit  Authority.  We have  also  provided  a rail
simulator  to  Houston  Metro and we were  competitively  awarded  a major  rail
simulator program with New York City Transit.



                                       5
<PAGE>

                      Municipal

         We target municipal  customers in police departments,  hospitals,  fire
departments,  and  departments  of  transportation  for  sales of our  municipal
product.  Our customers include the Mexico  Department of Education,  California
Department  of  Transportation,  and the Fire  Department  of New  York.  We are
developing  an  industry  advisory  group  focusing on the  municipal  market to
identify and address customer needs. Additionally, we have developed a simulator
module to extend the simulation once police,  fire, or emergency medical service
personnel reach the incident  location.  We believe that this represents another
of our bases of differentiation over our competition.

                      Airport

         We were a pioneer in  providing  simulation  software  to  airports  to
facilitate training personnel in adverse  conditions,  including the Detroit and
Toronto airports.

                      Corporate

         We target corporate  fleets and "for-hire"  haulers as customers of the
corporate  simulator product.  These customers use simulators to train personnel
effectively  as well as to avoid the brand damage that could be associated  with
poor driver performance.  To date, we have provided simulators to customers such
as  Schlumberger  Oil Services,  Kramer  Entertainment,  and North  American Van
Lines.

              Military Operations

         We provide air combat range software,  missile launch envelope decision
support software,  the SimBuilder(TM)  simulation  software product,  and Weapon
System Trainer software through the Military Operations business line.

                  Air Combat Range Software

         We serve the U.S. Air Force Air Combat  Training  System and U.S.  Navy
Tactical  Aircrew  Training  System with our air combat training range software.
Air combat  training  ranges allow pilots to train and evaluate new tactics in a
controlled airborne environment. Air "battles" are extremely realistic, with our
software   determining  the  outcome  of  weapon  engagements  based  on  launch
conditions and the target aircraft defensive reactions.

                  Missile Launch Envelope Software

         Onboard weapon  decision-making  software  enables pilots to assimilate
the complex information presented to them in F-15, F-18 and Joint Strike Fighter
(JSF) fighter  aircraft.  We provide our missile launch envelope software to the
U.S. Navy and Air Force through our subcontracting relationships with Boeing and
Raytheon.



                                       6
<PAGE>

                  Weapon System Trainer Software

         We have  successfully  transitioned  software  from U.S.  Navy Tactical
Aircrew  Training  Systems  to over 15 Weapon  Systems  Trainers  built by prime
contractors such as L-3, Boeing, Northrop Grumman, and Lockheed Martin.

                  SimBuilder(TM)

         The SimBuilder(TM)  simulation  software product is designed to provide
weapons simulation models for use in training environments for launched weapons.
This software enables foreign end-users to use weapons simulation models similar
to the U.S.  military  without  classified  U.S.  weapons  data.  Militaries  of
Australia, the United Arab Emirates, Canada, Taiwan, and Singapore currently use
SimBuilders(TM).

         MARKETING

         Our sales and  marketing  effort  focuses on  developing  new  business
opportunities as well as generating  follow-on sales of simulators and upgrades.
Through FAAC, we currently employ four dedicated sales representatives who focus
on   Commercial   Vehicles,   Military   Operations,   and   Military   Vehicles
opportunities. Furthermore, two additional employees spend a significant portion
of their time in sales.  Various  members of FAAC's senior  management  serve as
effective sales  representatives in the generation of municipal,  military,  and
corporate business. We also retain the services of four independent  consultants
who act as marketing  agents on our behalf.  These  representatives  are largely
commission-based agents who focus on particular products and/or regions (such as
airport customers,  Texas,  California,  and Eglin Air Force Base).  Finally, we
have four  customers  that have  agreements  wherein the  companies  support our
marketing efforts and market our products themselves in exchange for commissions
and/or free upgrade services.

         Our  sales   representatives   are  salaried   employees  with  minimal
commission-based  revenue.  Independent  consultants  generally do not receive a
base salary and  receive 5% to 10%  commissions  on the amount of business  that
they  generate  each  year.  The  majority  of our  sales  representatives  have
engineering  backgrounds that they leverage to anticipate the technical needs of
our  dynamic  customer  base and  targeted  markets.  Additionally,  the program
manager and service department assist us in gaining repeat business.

         Developing  a pipeline  of  follow-on  work is one of the tasks for all
program  managers.  We have a long  history  of repeat and  follow-on  work with
programs  such as F-15 and F-18 ZAP (over 20 contracts  with  Boeing),  the U.S.
Navy Tactical Aircrew  Training System (a series of 6 sequential  contracts over
the last 25 years), and F-18 Weapon Tactics Trainer (series of 20 contracts with
the simulator manufacturer).

         We also aggressively pursue several marketing initiatives to complement
our experienced sales force. Our most successful marketing strategy includes the
formation of industry  advisory groups.  Such advisory groups,  which consist of
simulation users within select  industries,  conduct regular seminars to educate
transit and similar agencies on the benefits and challenges of  simulation-based
training, as well as to share training concepts,  curriculums,  and experiences.
These sessions not only serve as excellent sales and marketing tools to generate
orders but also have created  significant  goodwill with  customers.  We believe
that these industry advisory groups have proven to be particularly successful in
cooperative industries,  such as transit, where users are self-funded and do not
compete with one another.



                                       7
<PAGE>

         CUSTOMERS

         We have long-term relationships, many of over ten years' duration, with
the U.S. Air Force,  U.S. Navy, U.S. Army, and most major  Department of Defense
training  and  simulation  prime  contractors  and related  subcontractors.  The
quality of our customer  relationships  is illustrated  by the multiple  program
contract awards we have earned with many of our customers.  For example, under a
series  of 20  subcontracts  over  15  years,  we  have  provided  the  tactical
environment  and F-18 weapons and avionics models for the F/A-18 Weapons Tactics
Trainer.  We have served as a  subcontractor  for the F/A-18 WTT  through  three
distinct prime contractor tenures.

         COMPETITION

         Our  technical  excellence,  superior  product  reliability,  and  high
customer  satisfaction  have  enabled us to  develop  market  leadership  and an
attractive  competitive position.  Several potential competitors in the military
segment are large,  diversified  defense and aerospace  conglomerates who do not
focus on our  specific  niches.  As such,  we are  able to serve  certain  large
military contracts through strategic  agreements with these organizations or can
compete  directly with these  organizations  based on our strength in developing
higher quality software solutions. In commercial market applications, we compete
against smaller, less sophisticated software companies.

         We differentiate ourselves from our competition on several bases:

                  >>       Leading   Technology  -  We  believe  that  we  offer
                           better-developed,  more  dynamic  software  than  our
                           competitors.  Additionally,  we  incorporate  leading
                           graphics  and   motion-cueing   technologies  in  our
                           systems to provide  customers with the most realistic
                           simulation experience on the market.

                  >>       Long History in the Simulation Software Business - As
                           a market leader in the simulation  software  business
                           for more  than  thirty  years,  FAAC's  professionals
                           understand   customer   requirements   and  operating
                           environments. Thus, we build our software to meet and
                           exceed demanding customers' expectations.

                  >>       Low-Cost  Research and Development  Capabilities  for
                           New Products - Our customers  benefit from government
                           and  commercial  funding of research and  development
                           and the low cost of subsequent  adaptation.  As such,
                           internally funded new product  development costs have
                           been less than $100,000 per year since 1999.

                  >>       Service  Reputation  - We  are  known  for  providing
                           better service than the competition, a characteristic
                           that drives new business within our chosen markets.

                  >>       Standardized  Development  Processes  - We  generally
                           deliver our  products to market more quickly than our
                           competition   and  at  higher   quality  due  to  our
                           standardized development processes.



                                       8
<PAGE>

         Below is a description of our competition organized by product lines.

              Vehicle Simulations

                  Military Vehicles

         FAAC has been the sole provider of wheeled vehicle simulation solutions
to  the  U.S.  military  since  1999.  Our  devotion  to  developing  realistic,
comprehensive  products  for a wide range of vehicle  types  positions us as the
preferred  simulation  provider  within  this  market  niche.  Our  strategy  of
identifying a training need,  isolating  government funds, and then developing a
customized training solution has led to considerable  successes.  This approach,
which  differs from the "build first and market  later"  strategy  employed by a
number of our  competitors,  effectively  identifies  market  opportunities  and
provides  a  better  product  to  the  military  customer.  Diversified  defense
companies  and  commercial  simulation  providers  have  attempted  to enter the
military wheeled vehicle market but have been unsuccessful thus far. Although we
believe that market penetration by these companies is ultimately inevitable, the
established FAAC brand, understanding of customer requirements,  and engineering
expertise  provide us with a competitive  advantage in this market segment.  Our
primary  competitors for military vehicle simulation  solutions include Lockheed
Martin Corporation's Information & Technology Services Group, L-3 Communications
Holdings,  Raydon Corporation,  and the Cubic Defense  Applications  division of
Cubic Corporation.

                  Commercial Vehicles

         A handful of simulation product and service companies currently compete
with our targeted commercial driving simulator markets.  However,  our marketing
and  development of selected  commercial  market segments has positioned us as a
leading provider of commercial  simulation  solutions.  Competition  within each
market segment  varies,  but the following  companies  generally  participate in
selected driving simulator market  opportunities:  L-3 Communications  Holdings,
Doron Precision Systems,  Lockheed-Martin  Corporation's  LMIS Division,  Global
SIM, and USADriveSafe, Inc.

              Military Operations

         Currently no significant  competitors participate in the market for our
tactical  environment  software,   and  there  are  essentially  no  independent
competitors  that  exist  in the  market  for  our  decision  support  software.
Competition  for  software  to  support  tactical  environment  requirements  in
aircraft weapon systems trainers comes from the  manufacturers of the simulators
themselves  and from a handful of  companies  who produce  tactical  environment
software. Our primary competitors for training range software,  decision support
software,  and weapons system trainer software solutions include Lockheed Martin
Corporation, L-3 Communications Holdings, Raytheon Company, Science Applications
International Corporation, Dynetics, Inc., and Georgia Tech Research Institute.

     Use-of-Force Training

         We are a leading  provider of  interactive,  multimedia,  fully digital
training  simulators  for  law  enforcement,   security,  military  and  similar
applications.  With a  customer  base  of over  700  customers  in  over  twenty
countries around the world, we are a leader in the supply of simulation training
products to military,  law  enforcement  and corporate  client  communities.  We
believe,  based  on our  general  knowledge  of  the  size  of  the  interactive
use-of-force  market,  our specific  knowledge  of the extent of our sales,  and


                                       9
<PAGE>

discussions  we have held with customers at trade shows,  etc.,  that we provide
more than 35% of the  worldwide  market for  government  and  military  judgment
training simulators.  We conduct our interactive training activities through our
subsidiary IES Interactive Training,  Inc. ("IES"), a Delaware corporation based
in Littleton, Colorado.

         INTRODUCTION

         We offer  consumers the  following  interactive  training  products and
services:

                  >>       Range 3000 - providing  use-of-force  simulation  for
                           military  and law  enforcement.  We believe  that the
                           Range  3000  is  the  most  technologically  advanced
                           judgment training simulator in the world.

                  >>       A2Z Classroom Trainer - a  state-of-the-art  computer
                           based training  (CBT) system that allows  students to
                           interact   with   realistic   interactive   scenarios
                           projected life-size in the classroom.

                  >>       Range  FDU  (Firearms  Diagnostic  Unit)  - a  unique
                           combination of training and interactive  technologies
                           that give  instructors a first-person  perspective of
                           what  trainees  are seeing  and doing  when  firing a
                           weapon.

                  >>       Milo    (Multiple    Interactive    Learning/training
                           Objectives)  - a  simulator  designed  with "plug in"
                           modules to customize the training  system to meet end
                           user needs.

                  >>       Summit Training  International - providing  relevant,
                           cost-effective  professional  training  services  and
                           interactive    courseware   for   law    enforcement,
                           corrections and corporate clients.

                  >>       IES  Studio  Productions  -  providing  cutting  edge
                           multimedia   video  services  for  law   enforcement,
                           military and security agencies,  utilizing the newest
                           equipment to create the training services required by
                           the most demanding authorities.

         Our  products  feature  state  of the art all  digital  video  formats,
ultra-advanced  laser-based lane detection for optimal accuracy and performance,
customer-based  authoring  of  training  scenarios,  and  95%  COTS  (commercial
off-the-shelf)-based system.

         PRODUCTS

         Below is a description of each of the core products and services in the
IES line.

              Range 3000 "Use of Force" Simulator

         We  believe  that the Range  3000,  which was  launched  in late  2002,
combines the most  powerful  operational  hardware and software  available,  and
delivers  performance  unobtainable  by any competing  product  presently on the
market.

         The Range 3000 simulator  allows training with respect to the full "Use
of Force" continuum.  Training can be done on an individual basis, or as many as
four members of a team can participate simultaneously and be scored and recorded
individually. Topics of training include (but are not limited to):



                                       10
<PAGE>

                  >>       Officer's Presence and Demeanor -  Picture-on-picture
                           digital  recordings of the trainee's  actions  allows
                           visual  review  of  the  trainee's   reaction,   body
                           language  and weapons  handling  during the course of
                           the  scenario,  which  then  can be  played  back for
                           debriefing of the trainee's actions.

                  >>       Verbalization - Correct phrases,  timing,  manner and
                           sequence  of  an  officer's  dialogue  is  integrated
                           within  the  platform  of the  system,  allowing  the
                           situation  to  escalate  or  de-escalate  through the
                           officer's  own words in the  context of the  scenario
                           and in conjunction with the trainer.

                  >>       Less-Than-Lethal  Training -  Training  in the use of
                           non-lethal  devices such as Taser, OC (pepper spray),
                           batons and other  devices  can be used with the video
                           training  scenarios  with  appropriate  reactions  of
                           each.

                  >>       Soft  Hand  Tactics  -  Low  level  physical  control
                           tactics with the use of additional  equipment such as
                           take-down dummies can be used.

                  >>       Firearms  Training  and Basic  Marksmanship  - Either
                           utilizing   laser  based   training   weapons  or  in
                           conjunction with a live-fire screen, the use of "Live
                           Ammunition" training can be employed on the system.

         The interactive  training scenarios are projected either through single
or  multiple  screens  and  projectors,  allowing  us to  immerse a  trainee  in
true-to-life  training scenarios and incorporating one or all the above training
issues in the "Use of Force" continuum.

              A2Z Classroom Trainer

         The A2Z is a state-of-the-art Computer Based Training (CBT) system that
allows  students to interact  with  realistic  interactive  scenarios  projected
life-size in the classroom.

         Using individual  hand-held keypads, the students can answer true/false
or multiple choice questions.  Based on the student's performance,  the scenario
will branch and unfold to a virtually  unlimited  variety of different  possible
outcomes of the student's actions. The system logs and automatically scores each
and every trainee's response and answer. At the end of the scenario,  the system
displays a session results summary from which the trainer can debrief the class.

         The advanced A2Z Courseware Authoring Tools allow the trainer easily to
create complete customized interactive courses and scenarios.

         The Authoring  Tools harness  advances in digital video and multimedia,
allowing  the trainer to capture  video and  graphics  from any source.  The A2Z
allows the  trainer  to combine  his or her  insight,  experience  and skills to
recreate a realistic learning  environment.  The A2Z Training System is based on
the well-known  PC-Pentium  technology  and Windows XPTM operated.  The menu and
mouse operation make the A2Z user-friendly.

         The  individual  keypads  are  connected  "wirelessly."  The  system is
completely portable and may be setup within a matter of minutes.



                                       11
<PAGE>

     Key advantages:

                  >>       Provides  repeatable  training to a standard based on
                           established policy

                  >>       Quick  dissemination  and  reinforcement  of  correct
                           behavior and policies

                  >>       Helps reduce liability

                  >>       More  efficient  than   "traditional  and  redundant"
                           role-playing methods

                  >>       Realistic scenarios instead of outdated "play-acting"

                  >>       Interactive   training   of   up  to   250   students
                           simultaneously with wireless keypads

                  >>       Easy Self-Authoring of interactive training content

                  >>       PC-Pentium platform facilitates low cost of ownership

                  >>       Easy to use Windows XP-based software

                  >>       Easy to deploy in any classroom

              Range FDU

         The Range FDU (firearm  diagnostics  unit) is a unique  combination  of
training and  interactive  technologies  that gives  instructors a  first-person
perspective  of what  trainees  are seeing and doing when  firing a weapon.  The
Range FDU is the only firearms training technology of its kind.

         With the Range FDU,  firearms  instructors can see the trainees' actual
sight alignment to the target as well as measure trigger pressure against proper
trigger pressure graphs, making corrective instruction simple and effective.  In
addition,  the Range FDU records a trainee's  recoil control,  grip and stance -
allowing the instructor to playback the  information in slow motion or real time
to better  analyze  the  trainee's  actions  and more  accurately  diagnose  any
deficiencies.

         The Range FDU also has the  ability to record the  firearm  instruction
session to either DVD or VHS,  allowing  both the trainee and the  instructor to
review it at a later time.  Trainees  now have a  diagnostic  tool that they can
learn  from,  even  after  their  training  has  been  completed.  In  addition,
instructors can build a library for each trainee to record progress.

         The Range FDU provides the following benefits:

                  >>       Fall of shot feedback

                  >>       Trigger pressure analysis

                  >>       Recoil control, grip and stance assessment

                  >>       Sight alignment

                  >>       Sight picture analysis and target reacquisition



                                       12
<PAGE>

              Milo

         Milo (Multiple Interactive Learning/training Objectives) is a simulator
designed with "plug in" modules to customize  the  trainings  system to meet end
user needs,  and is designed to expand the market for sales of our IES  products
to include organizations  involved in all aspects of public safety, and not just
law enforcement.

              Professional Conferences and Courseware

         We provide relevant,  cost-effective  professional  training  seminars,
consulting   services,   and   interactive   courseware  for  law   enforcement,
corrections,  and corporate clients through Summit Training International (STI),
a wholly-owned  subsidiary of IES. The emphasis and goal of our  conferences and
courseware is to create a "total training"  environment  designed to address the
cutting edge issues faced today.  We provide  conferences  throughout the United
States,  and  develop  courseware  dealing  with  these  important  topics.  The
incorporation of IES Interactive  Systems in our conferences  creates an intense
learning environment and adds to the realism of the trainee's experience.

                  Conferences

         We have provided  conferences  throughout  the United  States,  on such
topics as:

                  >>       Recruiting  and  Retention  of  Law  Enforcement  and
                           Corrections Personnel

                  >>       Ethics and Integrity

                  >>       Issues of Hate Crimes

                  >>       Traffic Stops and Use of Force

                  >>       Community  and  Corporate   Partnerships  for  Public
                           Safety

                  >>       Creating a Safe School Environment

         In addition to these national and regional  conferences,  we design and
produce training to address specific  department issues. We have a distinguished
cadre  of  instructors   that  allows   adaptation  of  programs  to  make  them
specifically focused for a more intense learning  experience.  The A2Z Classroom
Trainer is  incorporated  into the "live"  presentation  creating a  stimulating
interactive training experience.

                  Courseware

         We  develop  courseware  for use  exclusively  with  IES's  interactive
systems.  Courses are designed to addresses specific  department issues, and can
be customized to fit each agency's  needs.  These courses are available in boxed
sets that  provide  the  customer  with a  turn-key  training  session.  The A2Z
Classroom Trainer and the Range 3000 XP-4 are used to deliver the curriculum and
create a virtual  world  that the  trainees  respond  and  react  to.  Strategic
relationships  with  high  profile  companies  such as H&K  Firearms,  and Taser
International,  provide  customers  with  training  that deals with cutting edge
issues facing law enforcement today. The incorporation of our courseware library
along  with  simulation   systems  allows  training  to  remain  consistent  and
effective, giving customers more value for their training dollar.



                                       13
<PAGE>

              IES Studio Productions

         Through  IES  Studio  Productions,   a  division  of  IES,  we  provide
multimedia video services for law enforcement,  military and security  agencies,
and others and create interactive  courseware and interactive  scenarios for the
Range 3000, Video Training Scenarios and all types of video production services.
With the latest in media equipment,  we provide all media and marketing services
to IES Interactive Training in-house.

         MARKETING
         We market our IES products  and services to domestic and  international
law enforcement,  military and other federal  agencies and to various  companies
that serve them, through  attendance and presentations at conferences,  exhibits
at trade shows,  seminars at law enforcement  academies and government agencies,
through its web pages on the Internet,  and to its compiled database of prospect
and customer names.  Our IES salespeople are also its marketing team. We believe
that this is effective for several  reasons:  (1) customers  appreciate  talking
directly  with  salespeople  who can answer a wide range of technical  questions
about methods and features,  (2) our  salespeople  benefit from direct  customer
contact through gaining an appreciation  for the environment and problems of the
customer,  and (3) the relationships we build through  peer-to-peer  contact are
useful in the military, police and federal agency market.

         We also uses our IES web pages on our Internet site for such activities
as providing product information and software updates.

         We market augmentative and alternative law enforcement products through
a network of employee representatives and independent resellers.  These products
include but are not limited to products manufactured by:

                  >>       Bristlecone Products

                  >>       Fox Valley Technical College

                  >>       Taser Inc.

                  >>       Force Science Research Center

                  >>       H&K Training Centers

         At the present time we have six sales  representatives based in Denver,
eight domestic independent distributors, and twenty-five independent resellers /
representatives  overseas.  We also have three inside sales/support  persons who
answer  telephone  inquiries  on IES's 800 line and  Internet,  and who can also
provide  technical  support.  Additional  outside  salespersons  and independent
dealers and resellers are being actively recruited at this time.

         We typically  participate in over thirty industry conferences annually,
held throughout the United States and in other  countries,  that are attended by
our potential  customers and their respective  purchasing and budgeting decision
makers. A significant percentage of our sales of IES products, both software and
hardware, are sold through leads developed at these shows.



                                       14
<PAGE>

         We and others in the industry demonstrate products at these conferences
and present technical papers that describe the application of their technologies
and  the  effectiveness  of  their  products.  We  also  advertise  in  selected
publications of interest to potential customers.

         CUSTOMERS

         Most  of the  customers  for  our  IES  products  are  law  enforcement
agencies,  both in the United States  (federal,  state and local) and worldwide.
Purchasers  of IES products  have  included (in the United  States) the FBI, the
Secret  Service,  the Bureau of  Alcohol,  Tobacco  and  Firearms,  the  Customs
Service,  the  Federal  Protective  Service,  the Border  Patrol,  the Bureau of
Engraving and Printing,  the Coast Guard,  the Federal Law Enforcement  Training
Centers, the Department of Health and Human Services,  the California Department
of Corrections, NASA, police departments in Texas (Houston), Michigan (Detroit),
D.C.,  California  (Fresno and the  California  Highway  Patrol),  Massachusetts
(Brookline),  Virginia  (Newport  News and the State  Police  Academy),  Arizona
(Maricopa   County),   universities  and  nuclear  power  plants,   as  well  as
international  users such as the Israeli  Defense  Forces,  the German  National
Police,  the Royal  Thailand Army,  the Hong Kong Police,  the Russian  Security
Police,  users in Mexico and the  United  Kingdom,  and over 700 other  training
departments worldwide.

         The mix of customers has historically  been  approximately 40% city and
state agencies, 30% federal agencies, and 30% international.

         COMPETITION

         We  compete  against a number of  established  companies  that  provide
similar  products  and  services,  many  of  which  have  financial,  technical,
marketing, sales, manufacturing,  distribution and other resources significantly
greater  than ours.  There are also  companies  whose  products  do not  compete
directly,  but are sometimes closely related.  Firearms Training Systems,  Inc.,
Advanced  Interactive   Systems,   Inc.,  and  LaserShot  Inc.  are  IES's  main
competitors.

         We believe the key factors in our competing  successfully in this field
will be our ability to develop  simulation  software  and related  products  and
services to effectively train law enforcement and military to today's standards,
our  ability to develop  and  maintain a  proprietary  technologically  advanced
hardware, and our ability to develop and maintain relationships with departments
and government agencies.

Armor Division

         We manufacture  aviation and other armor and we armor vehicles  through
our Armor Division.  During 2004, 2003 and 2002 revenues from our Armor Division
were approximately  $18.0 million,  $3.4 million and $2.7 million,  respectively
(on a pro  forma  basis,  assuming  we had  owned  all  components  of our Armor
Division since January 1, 2002,  revenues in 2004, 2003 and 2002 would have been
approximately $29.2 million, $10.9 million and $13.3 million, respectively).

     Aircraft Armoring

         INTRODUCTION

         We are an innovative  manufacturer  of lightweight  personal,  vehicle,
aviation,  architectural and marine ballistic  armoring.  Our Armor Division has
years of battlefield and commercial  protection experience and has provided life
saving  protection  under the most extreme  conditions.  Through our  subsidiary


                                       15
<PAGE>

Armour of America, located in Los Angeles, California, we manufacturer ballistic
and fragmentation  armor kits for rotary and fixed wing aircraft,  marine armor,
personnel armor, military vehicles,  architectural applications,  including both
the LEGUARD Tactical Leg Armor and the Armourfloat  Ballistic Floatation Device,
which is a unique  armored  floatation  vest that is certified by the U.S. Coast
Guard.

         For over thirty years,  AoA has delivered  ballistic armor equipment to
users worldwide. Initially, AoA designed and manufactured "soft" ballistic armor
only, such as covert and overt ballistic vests, military assault vests, tactical
vests and specially  designed vests for military and law enforcement  users both
in the U.S.  and  abroad.  By 1982,  AoA had  started to design and  manufacture
"hard"  ballistic  armor to stop  military  rifle fire up to and  including  .50
caliber Armor Piercing  Incendiary  (API) and European 12.7 mm API rounds.  This
"hard" ballistic armor is used as chest protection for the full line of personal
vests,  as well as on fixed wing aircraft  (airplanes)  and rotary wing aircraft
(helicopters), military ships, military vehicles and architectural applications.

         Our  proprietary  designs have been developed to meet a wide variety of
customer and industry needs.

         THE ARMORING PROCESS

         Each hard armor kit starts out with detailed templates generated at the
aircraft  or vehicle,  with close  fitting  around  pedals,  consoles  and other
obstructions.  These  templates are converted  into wood patterns that are exact
three-dimensional reproductions of the armor to be manufactured, including as to
the  thickness.  These  patterns  are fitted  back into the user's  aircraft  or
vehicle and approved.  At this point,  fiberglass over wood production molds are
produced for each part,  which will guarantee that each production panel will be
exactly the same and fit perfectly  within the kit. In addition,  each kit has a
complete set of  installation  hardware  that  includes  everything  required to
install the armor kit to the aircraft or vehicle.  This total kit package allows
the armor to be installed at any location with a minimum of tools required.

         Soft armor is manufactured  in the same manner as hard armor.  Detailed
cut and sew patterns are developed from the requirements driven by the customer.
These requirements are normally dealing with collar height, placement of pockets
and location of plate pockets. Once these patterns are completed,  two processes
start  simultaneously.  The first involves spreading multiple plies of ballistic
material on a special  cutting  table.  The material is then dusted with pattern
powder to mark the  packs for  cutting.  After  each pack is cut to size,  it is
routed to the sew shop for stitching.  At the same time,  nylon covers are being
cut and sewn using sew patterns made from the cut patterns.  Upon  completion of
both the ballistic  pack and the cover,  the pack is inserted into the cover and
sewn closed.

         PRODUCTS LINES

         We produce two kinds of armor,  soft armor and hard  armor,  to support
customer armor requirements.  Soft armor, which is capable of protecting against
all handguns and 9mm sub guns, is used in our ballistic and fragmentation  vest,
military vehicle,  marine,  architectural  and special  application armor lines.
Hard armor, which is capable of protecting against rifle fire up to 50cal/12.7mm
API, is used in our ballistic chest plate,  aircraft,  military vehicle,  marine
and architectural  armor lines.  Within these two basic kinds of armor, we offer
the product lines listed below.



                                       16
<PAGE>

              Fixed and Rotary Wing Aircraft Armor Systems

         We design and manufacture ballistic armor systems for a wide variety of
fixed and rotary wing  aircraft.  These  systems  are in the form of kits,  with
individual  contoured  panels which cover the entire  aircraft's  floor,  walls,
seats,  bulkheads,  walls,  oxygen  containers,  avionics and doors.  All of our
ballistic armor kits include a complete installation hardware kit containing all
items  required for  installation.  The  supplied  hardware is designed for each
individual   application   in   accordance   with  the   installation   hardware
certification,  which has been provided by  Lockheed-Martin.  Additionally,  the
fixed and rotary wing aircraft kits have been certified,  by an independent test
facility  that is  approved  by the FAA, to meet  flammability  requirements  of
FAA/FAR 25.853, 12 Second Vertical Test and MIL-STD-810 Environmental Testing.

         These kits have been sold to both the original  airframe  manufacturers
and end users  worldwide.  Armor kits for rotary wing  aircraft  including  Bell
Helicopter's B206, B212, B407, B412, B427, and UH-1H;  Boeing's CH-46 and CH-47;
MD  Helicopter's  MD  500,  MD  600,  and  MD  900;  Agusta  Helicopter's  A109;
Eurocopter's EC-120,  EC-135, BK117, and BO-105;  Aerospatiale's AS 330, AS 332,
and AS 355;  Sikorsky's UH-60 and S-61; MIL MI-8 and MI-17;  Robinson's R-22 and
R-44; and Kaman's K-MAX.

         Fixed wing aircraft kits include Lockheed's  C-130H,  C-130J , and P-3;
Boeing's C-17; Alenia's G-222 and C-27J; Ayers' T-65;  Rockwell's OV-10; CASA CN
235 and CN 295;  and special  configurations  of the  Citation,  Beechcraft  and
Cessna models.

              Military Vehicles Armor Kits

         For the military  vehicle  market,  we provide  ballistic armor kits to
protect  against  fragmentation  and rifle fire, up to 50cal API for Humvees,  2
1/2- and 5-ton trucks, HEMTT wreckers and various construction  vehicles.  These
kits offer  varying  levels of protection  for doors,  floors,  fuel tanks,  air
bottles,  cargo beds, troop seat backs,  critical components and glass. To date,
we have protected vehicles deployed in Iraq, Afghanistan, and Kuwait. All of the
provided  kits are  designed  for easy  field  level  installation  and  include
required hardware and instructions.

              Marine Armor Kits

         For the marine market,  we manufacture armor kits for the gun mounts on
naval ships and  riverine  patrol  boats.  During  Operation  Desert  Storm,  we
designed and  manufactured  .50 cal AP ballistic  panels and deck mount brackets
for the U.S. Navy.  Since then, we have designed and  manufactured  armor to fit
both the .50 cal and 25mm gun  mounts  on  frigates,  destroyers,  cruisers  and
aircraft  carriers.  The result of this effort is that we have  delivered  armor
systems to individual  ships in the class and  currently  are pursuing  armoring
additional classes of ships throughout the Navy Command.

         Additionally,  we have designed program-specific armor for riverine and
small boats throughout the world.  While the majority of these armoring programs
were limited to a small number of boats, the areas of coverage included complete


                                       17
<PAGE>

coverage  of the  exterior  walls  of the  wheel  house,  forward  and  aft  gun
placements,  fire boxes, fuel tanks and engines. Unlike designing armor kits for
aircraft,  this type of armoring requires unique  installation  methods to allow
for  interference  caused by surface  mounted  hardware and the impact of "green
water" impacting the armor during rough weather.

              Ballistic Vests and Plates and Body Armor

         We  manufacture  a complete  line of  personal  body  armor,  including
concealable,  external and special application armor. The concealable armor vest
offers complete front,  side and back protection using soft,  lightweight,  high
strength proprietary woven ballistic fabrics.

         Our external  vest line  includes  assault,  tactical,  riot,  stab and
T-panel  designs.  Each of these designs can be modified to meet the  individual
wearer  of  customer's  requirements.  Special  application  vests  include  the
Armourfloat,  which to our knowledge is currently the only  ballistic/floatation
vest approved by the U.S.  Coast Guard;  the Zip Out armor jacket,  which offers
covert  protection  in  both a  lightweight  jacket  or  vest  design;  and  our
helicopter vest, which incorporates a unique protection/comfort design.

         We offer a complete line of personal body armor  including  concealable
ballistic vests, military vests and external tactical vests as well as a line of
products specially designed for U.S. Navy Seal Teams and various law enforcement
agencies in the United States and overseas.  Our hard ballistic armor,  designed
to stop military rifle fire up to and including .50 caliber and European 12.7 mm
Armor Piercing  Incendiary  (API) rounds,  is used primarily on fixed and rotary
wing aircraft, military ships and military vehicles, as well as in architectural
applications.

         We have designed and  manufactured  special  operations  personal armor
including  ballistic  hand held shields and the  LEGUARD(R)  Tactical Leg Armor,
which offers  complete  front  protection  for the lower thigh,  knee,  shin and
instep.

              Other Armor for Specialty Applications

         In  addition to  aircraft,  marine,  vehicle  and vest  armor,  we also
manufacture  ballistic  and  fragmentation  blankets  and  curtains for numerous
specialty  applications.  These applications  include operator protection around
test equipment;  rupture  protection of pressure vessels,  mechanical failure of
production  machinery and high pressure piping.  Additionally,  we have supplied
armor for office use in protection of occupants  from blast and glass  fragments
of windows and isolation of security rooms from surrounding environments.

         SALES, MARKETING AND CUSTOMERS

         We maintain  broad  relationships  throughout the aerospace and defense
communities,  including  U.S.  federal,  state  and  local  government  and  law
enforcement  agencies,   along  with  many  foreign  government  end  users  and
procurement agencies.

         We have  developed  what we  believe  to be an  effective  approach  in
marketing  our  ballistic  armor  products  worldwide.  We market  our  products
directly to both the original  airframe  manufacturer,  such as Alenia,  Agusta,
Bell-Textron,  Boeing, EADS (Eurocopter),  Lockheed-Martin and MD Helicopter, as
well as, aircraft completion  operations and end users worldwide.  We maintain a


                                       18
<PAGE>

strong  presence in Europe,  Southeast  Asia,  Asia,  Central  America and South
America, utilizing key representatives located in each country.

         Because of our constant  contact with both engineering and marketing at
the various  airframe  manufacturers,  we have access to their new and  existing
model  aircraft so that we can always update  and/or design new ballistic  armor
kits to protect the flight deck, cabin, bulkhead and engine areas as required.

         At the  request  of an  airframe  manufacturer  or end user,  we send a
technical  representative  to meet the  customer  at the  aircraft to review the
layout of areas to be armored,  develop  templates  if required and to determine
any unique  characteristics  that the customer or end user desires  incorporated
into the armor.  After the  templates  are  converted to full size armor mock-up
panels,  they are taken back to the  aircraft  for review and approval by either
the OEM or the user prior to production. This approach has proven to be the most
effective  in  obtaining  both OEM  certification  of each of our systems and in
ensuring  that  our  ballistic  armor  systems  meet or  exceed  the end  users'
operational and ballistic demands.

         Our  commercial  customers  include  Bell  Helicopter,  MD  Helicopter,
Robinson Helicopter,  Sikorsky Helicopter,  Schweitzer  Helicopter,  Agusta, and
Lockheed-Martin  in the United States, as well as Eurocopter  (Germany),  Alenia
Aerospazio (Italy), EADS (Spain), and Bell (Canada).

         Our U.S. military customers include NAVSEA,  NAVAIR, Army, Coast Guard,
Marines, State Department, Border Patrol, and various SEAL and Small Boat Units.

         Our foreign military  customers  include the air forces of New Zealand,
Australia, Thailand, Malaysia, Spain, Belgium, Sweden, Norway, Italy, Sri Lanka,
Indonesia,  Brazil,  Argentina,  and Turkey; the navies of Singapore,  Thailand,
Malaysia,  Ecuador, Mexico, Colombia, Spain, Australia, and Japan; the armies of
Thailand, Malaysia, Sri Lanka, Colombia, Mexico, Ecuador, Venezuela and Peru.

         MANUFACTURING

         Our  manufacturing  facilities are located in Los Angeles,  California,
and are divided into hard and soft armor production  areas.  Dedicated cells are
established for machining,  pressing,  cutting,  molding,  lay-up,  assembly and
creation of the hard armor panels.  The soft armor  production are has cells for
cutting,  sewing  and  packaging.  All of our hard armor is  manufactured  using
AoA-designed  production  molds,  which ensure proper fit of each panel into the
total ballistic armor kit.

         AoA's entire  administrative and manufacturing  operations are directed
and controlled by procedures conforming to ISO 9001-2000. AoA has been certified
as ISO 9001-2000 in December 2003 and was  successfully  recertified in December
2004.

         COMPETITION

         Aircraft  armor   competition   includes  LAST  Armor  (a  division  of
Foster-Miller,  Inc.),  Simula Inc. (a subsidiary of Armor Holdings,  Inc.), and
Protective  Materials  Company  (a  division  of The  Protective  Group,  Inc.).
Military  vehicle  armor  competition  includes:  O'Gara-Hess  &  Eisenhardt  (a
subsidiary  of Armor  Holdings,  Inc.),  ArmorWorks  Harl  Facility,  Protective


                                       19
<PAGE>

Materials  Company,  and Ceradyne,  Inc.  Ballistic vests competition  includes:
Point Blank Body Armor,  Inc. (a subsidiary  of DHB  Industries,  Inc.),  Second
Chance Body Armor, Inc.,  Protective  Materials Company,  American Body Armor (a
subsidiary  of Armor  Holdings,  Inc.),  Protech  Armor Systems (a subsidiary of
Armor  Holdings,  Inc.) and  Safariland,  Ltd. (a subsidiary of Armor  Holdings,
Inc.). Marine armor competition includes Protective Materials Company.

     Vehicle Armoring

         INTRODUCTION

         We specialize in using state-of-the-art  lightweight ceramic materials,
special ballistic glass and advanced  engineering  processes to fully armor vans
and SUVs through our  majority-owned  subsidiaries,  MDT  Protective  Industries
Ltd.,  located in Lod,  Israel,  and MDT Armor  Corporation,  located in Auburn,
Alabama.  We are a leading  supplier to the Israeli  military,  Israeli  special
forces  and  special  services.  Our  products  have been  proven  in  intensive
battlefield  situations and under actual  terrorist attack  conditions,  and are
designed to meet the demanding  requirements of governmental  and private sector
customers worldwide.

         We have acquired many years of  battlefield  experience in Israel.  Our
vehicles have provided  proven  life-saving  protection for their  passengers in
incidents of rock  throwing,  handgun and assault  rifle  attack at  point-blank
range,  roadside  bombings and suicide  bombings.  In fact,  to our knowledge an
MDT-armored  vehicle has never  experienced  bullet  penetration  into a vehicle
cabin under  attack.  We also use our  technology  to protect  vehicles  against
vandalism.

         In 2003,  we  established  MDT Armor's  operations in a new facility in
Auburn,   Alabama.   Soon   thereafter,   the  United  States  General  Services
Administration  (GSA)  awarded us a five-year  contract  for  vehicle  armoring,
establishing  a pricing  schedule  for  armoring of GM Suburban  and Toyota Land
Cruiser SUVs and of GM Savana/Express  passenger vans. With this contract, these
armored vehicles became available for purchase  directly by all federal agencies
beginning  December 1, 2003,  and we received our first U.S.  orders for vehicle
armoring products during 2004.

         THE ARMORING PROCESS

         Armoring a vehicle  involves much more than just adding "armor plates."
It  includes  professional  and  secure  installation  of  a  variety  of  armor
components - inside doors,  behind dashboards,  and all other areas of passenger
and engine  compartments.  We use overlapping sections to ensure protection from
all angles,  and install  armored glass in the windshield  and windows.  We have
developed certain unique features,  such as new window operation mechanisms that
can raise windows rapidly despite their increased  weight,  gun ports,  run-flat
tires, and more. We developed the majority of the materials that we use in-house
or in conjunction with Israeli companies specializing in protective materials.

         In order to armor a  vehicle,  we first  disassemble  the  vehicle  and
remove the interior  paneling,  passenger seats,  doors,  windows,  etc. We then
fortify the entire body of the vehicle,  including the walls,  pillars,  floors,
roof and other critical  components,  and reinforce the door hinges.  We achieve
firewall  protection  from frontal assault with carefully  designed  overlapping
armor.  Options,  such as air-conditioning,  seating  modifications and run-flat
tires,  are also  available.  We fix the armoring into the shell of the vehicle,


                                       20
<PAGE>

ensuring that the  installation  and finishing is according to the standards set
for that  particular  model.  We then  reassemble  the  vehicle  as close to its
original appearance as possible.

         Once we have  ensured full  vehicle  protection,  we place a premium on
retaining the original vehicle's look and feel to the extent possible, including
enabling  full  serviceability  of the vehicle,  thereby  rendering the armoring
process   "invisible."   We  work  with  our  customers  to   understand   their
requirements,  and  together  with the customer  develop an  optimized  armoring
solution.  A flexible  design-to-cost  process helps evaluate  tradeoffs between
heavy and light materials and various levels of protection.

         By  working  within  the  vehicle  manufacturer's  specifications,   we
maintain  stability,  handling,  center-of-gravity  and overall  integrity.  Our
methods  minimize  impact  on  payload,  and do not  obstruct  the  driver's  or
passengers'  views.  In many cases all the original  warranties  provided by the
manufacturer are still in effect.

         ARMORING MATERIALS

         We offer a variety of armoring  materials,  optimized to the customer's
requirements.  We use ballistic steel, composite materials (including Kevlar(R),
Dyneema(R) and composite armor steel) as well as special ceramics, together with
special  armored  glass.  We use  advanced  engineering  techniques  and "light"
composite  materials,  and avoid,  to the  extent  possible,  using  traditional
"heavy"  materials  such as armored  steel  because of the added  weight,  which
impairs the  driving  performance  and  handling  of the  vehicle.  We also sell
certain kinds of vehicles pre-armored.

         All  materials  that  we use  meet  not  only  international  ballistic
standards,  but also the far more stringent requirements set down by the Israeli
military,  the  Israeli  Ministries  of Defense  and  Transport,  and the Israel
Standards  Institute.  Our  facilities  have also been  granted the ISO 9001:200
quality standards award.

         PRODUCTS AND SERVICES

         We armor a  variety  of  vehicles  for  both  commercial  and  military
markets.

         In the military market, we armor:

                  >>       The David,  an Ultra Light Armored Vehicle based on a
                           Land Rover or Mercedes platform;

                  >>       Command  vehicles  (such as the Land  Rover  Defender
                           110); and

                  >>       Pickup trucks such as the Defender 130.

         In the commercial market, we armor:

                  >>       Sports utility vehicles (such as the GM Suburban, the
                           Toyota Land Cruiser and the Land Rover Defender);

                  >>       Trucks, such as the Ford F550;

                  >>       Passenger  vans (such as the Chevrolet  Express,  the
                           General Motors Savana and the Ford Econoline); and



                                       21
<PAGE>

                  >>       Small buses  (based on vehicles in the  Mercedes-Benz
                           Vario and Sprinter lines).

         In 2004,  we began to purchase some types of vehicles and armor them in
order to be able to sell pre-armored vehicles.

         SALES, MARKETING AND CUSTOMERS

         Most of our  vehicle  armoring  business  has  historically  come  from
Israel,  although we have armored  vehicles  under  contracts  from companies in
Yugoslavia, Mexico, Colombia, South Africa, Nigeria and Singapore. Our principal
customer at present is the Israeli Ministry of Defense.  Other customers include
Israeli and American  government  ministries  and agencies,  private  companies,
medical  services and private clients.  In the United States,  we armor vehicles
for U.S. operations in Iraq.

         In Israel,  we market our vehicle armoring  through vehicle  importers,
both pursuant to marketing  agreements  and  otherwise,  and directly to private
customers  in the public and private  sectors.  Most sales are  through  vehicle
importers. In the U.S., vehicles are sold to the Army or to businesses operating
in Iraq.

         We hold exclusive  armoring contracts with Israel's sole General Motors
and Chevrolet distributors.  This means that these distributors will continue to
honor the original vehicle warranty on armored versions of vehicles sold by them
only if the armoring was done by us.

         COMPETITION

         The global armored car industry is highly  fragmented.  Major suppliers
include both vehicle  manufacturers  and  aftermarket  specialists.  As a highly
labor-intensive process, vehicle armoring is numerically dominated by relatively
small businesses. Industry estimates place the number of companies doing vehicle
armoring in the range of around 500  suppliers  globally.  While  certain  large
companies may armor several  hundred cars annually,  most of these companies are
smaller operations that may armor in the range of five to fifty cars per year.

         Among   vehicle   manufacturers,    Mercedes-Benz   has   the   largest
vehicle-armoring  market  share,  estimated  in 2003 at around 7% of the  global
market. Among aftermarket specialists, the largest share of the vehicle-armoring
market is held by O'Gara-Hess & Eisenhardt, a subsidiary of Armor Holdings, Inc.
Other aftermarket specialists include International Armoring Corp., Lasco, Texas
Armoring and Chicago Armor  (Moloney).  Many of these  companies have financial,
technical,  marketing,  sales,  manufacturing,  distribution and other resources
significantly greater than ours.

         We believe the key factor in our competing  successfully  in this field
will be our ability to penetrate new military and  paramilitary  markets outside
of Israel, particularly those operating in Iraq and Afghanistan.

Battery and Power Systems Division

         We manufacture and sell lithium and Zinc-Air  batteries for defense and
security products and other military applications and we pioneer advancements in
Zinc-Air  technology for electric vehicles through our Battery and Power Systems
Division. During 2004, 2003 and 2002 revenues from our Battery and Power Systems


                                       22
<PAGE>

Division  were  approximately  $10.5  million,  $5.9  million and $1.7  million,
respectively (on a pro forma basis,  assuming we had owned all components of our
Battery and Power Systems Division since January 1, 2002, revenues in 2004, 2003
and 2002 would have been  approximately  $10.5  million,  $10.8 million and $6.5
million, respectively).

     Lithium Batteries and Charging Systems for the Military

         INTRODUCTION

         We sell lithium  batteries and charging systems to the military through
our  subsidiary  Epsilor  Electronic  Industries,  Ltd., an Israeli  corporation
established in 1985 that we purchased early in 2004.

         We specialize in the design and manufacture of primary and rechargeable
batteries,  related  electronic  circuits and  associated  chargers for military
applications.  We have  experience  in working  with  government  agencies,  the
military and large corporations. Our technical team has significant expertise in
the  fields of  electrochemistry,  electronics,  software  and  battery  design,
production, packaging and testing.

         We intend to work to open a lithium  battery  production,  research and
development,  and marketing facility at our current Auburn premises. The goal is
to penetrate the military lithium battery market in the United States,  and also
enable U.S.-produced lithium batteries to be sold using funding from the Foreign
Military  Sales  (FMS)  program  to  countries  such as Israel  and  Turkey.  To
facilitate this technology transfer, we have hired Graydon C. Hansen, a seasoned
battery industry executive, to preside over the complete Auburn facility.

         PRODUCTS

         We  currently  produce  over 50  different  products  in the  following
categories:

                  >>       Primary batteries;

                  >>       Rechargeable batteries;

                  >>       Smart chargers;

                  >>       State of charge indicators; and

                  >>       Control and monitoring battery circuits

         Our lithium batteries are based on commercially-available battery cells
that we  purchase  from  several  leading  suppliers,  with  proprietary  energy
management  circuitry and software.  Our battery packs are designed to withstand
harsh  environments,  and have a track  record  of years of  service  in  armies
worldwide.

         We  produce a wide range of primary  batteries  based on the  following
chemistries: lithium sulfur dioxide, lithium manganese dioxide and alkaline. The
rechargeable  battery  chemistries  that we employ are: nickel  cadmium,  nickel
metal hydride and lithium-ion.  We manufacture  single and  multi-channel  smart
chargers for nickel cadmium, nickel metal hydride and lithium-ion batteries.



                                       23
<PAGE>

         We have designed a number of sophisticated  state of charge indicators.
These are employed in our Epsilor  products and are also sold as  components  to
other  battery  pack  manufacturers.  We also  develop and  manufacture  control
systems  for  high  rate  primary   battery-packs  and  monitoring  systems  for
rechargeable battery-packs.

         MARKETS/APPLICATIONS

         Our target markets for our lithium  batteries are military and security
entities  seeking  high-end  solutions  for their power source  needs.  By their
nature,  the sell-in cycles are long and the resultant  entry barriers are high.
This is due to the high cost of  developing  custom  designs and the long period
needed to qualify any product for military use.

         Our present customers include:

                  >>       Armed forces in the Middle East and Asia;

                  >>       Military original equipment manufacturers (OEMs); and

                  >>       Various battery manufacturers.

         COMPETITION

         The main  competitors for our lithium battery products are Bren-tronics
Inc. in the United States, which controls much of the U.S.  rechargeable market,
AEA Battery  Systems (a wholly owned  subsidiary of AEA  Technology  plc) in the
United  Kingdom,  which has the  majority of the English  military  market,  and
Ultralife  Batteries,  Inc. On the primary end of the market there are a host of
players who include the cell manufacturers  themselves,  including Saft S.A. and
Ultralife Batteries, Inc.

         It  should  be noted  that a number  of OEMs,  such as  Motorola,  have
internal  engineering  groups that can develop  competitive  products  in-house.
However,  on many occasions they outsource such activities in order to stabilize
their staffing level.

         MARKETING

         We market to our existing  customers  through direct sales. To generate
new  customers  and  applications,  we rely on our working  relationship  with a
selection of OEMs, with the intent of having these OEMs design our products into
their equipment,  thereby  creating a market with a high entry barrier.  Another
avenue  for  market  entry  is  via  strategic  relationships  with  major  cell
manufacturers.

         MANUFACTURING

         Our battery  production lines for military  batteries and chargers have
been ISO-9001 certified since 1994. We believe that Epsilor's 19,000 square foot
facility in Dimona,  Israel has the  necessary  capabilities  and  operations to
support our production cycle.

     Zinc-Air Fuel Cells, Batteries and Chargers for the Military

         INTRODUCTION

         We base our strategy in the field of Zinc-Air military batteries on the
development  and  commercialization  of our Zinc-Air  fuel cell  technology,  as
applied in the  batteries  we produce  for the U.S.  Army's  Communications  and
Electronics  Command  (CECOM)  through  our  subsidiary  Electric  Fuel  Battery


                                       24
<PAGE>

Corporation.  We will continue to seek new  applications  for our  technology in
defense  projects,  wherever  synergistic  technology and business  benefits may
exist.  We intend to  continue  to develop  our  battery  products  for  defense
agencies,  and plan to sell our  products  either  directly to such  agencies or
through  prime  contractors.  We will also look to extend our reach to  military
markets outside the United States.

         Since 1998 we have  received and  performed a series of contracts  from
CECOM to  develop  and  evaluate  advanced  primary  Zinc-Air  fuel cell  packs.
Pursuant to these  contracts,  we  developed  and began  selling in 2002 a 12/24
volt, 800 watt-hour  battery pack for battlefield  power,  which is based on our
Zinc-Air  fuel cell  technology,  weighs  only six pounds and has  approximately
twice the energy capacity per pound of the U.S.  Army's standard  lithium-sulfur
dioxide battery packs - the BA-8180/U battery.

         In the second half of 2002, our five-year program with CECOM to develop
a Zinc-Air  battery for  battlefield  power  culminated  in the  assignment of a
National Stock Number and a $2.5 million delivery order for the newly designated
BA-8180/U  battery.  Subsequent to this initial $2.5 million  delivery order, we
received additional follow-on orders from the Army.

         Our batteries have been used in both  Afghanistan  (Operation  Enduring
Freedom) and in Iraq  (Operation  Iraqi  Freedom).  In June of 2004, our BA-8180
Zinc-Air  battery  was  recognized  by the U.S Army  Research,  Development  and
Engineering Command as one of the top ten inventions of 2003.

         Our Zinc-Air  fuel cells,  batteries  and chargers for the military are
manufactured through our Electric Fuel Battery Corporation subsidiary.  In 2003,
our EFB facilities were granted ISO 9001 "Top Quality Standard" certification.

         PRODUCTS

              Zinc-Air Power Packs

                  BA-8180/U

         Electric Fuel Zinc-Air power packs are  lightweight,  low-cost  primary
Zinc-Air  batteries  with up to twice the energy  capacity  per pound of primary
lithium (LiSO2) battery packs,  which are the most popular batteries used in the
US  military  today.   Zinc-Air   batteries  are  inherently  safe  in  storage,
transportation, use, and disposal.

         The BA-8180/U is a 12/24 volt, 800 watt-hour battery pack approximately
the size and  weight  of a  notebook  computer.  The  battery  is based on a new
generation of  lightweight,  30 ampere-hour  cells developed by us over the last
five years with partial funding by CECOM.  Each BA-8180/U  battery pack contains
24 cells.

         The  battery  has  specific  energy  of  up  to  350  Wh/kg,  which  is
substantially  higher than that of any competing disposable battery available to
the defense and  security  industries.  By way of  comparison,  the  BA-5590,  a
popular LiSO2  battery  pack,  has only 175 Wh/kg.  Specific  energy,  or energy
capacity  per  unit of  weight,  translates  into  longer  operating  times  for
battery-powered  electronic equipment,  and greater portability as well. Because
of lower cost per watt-hour,  the BA-8180/U can provide substantial cost savings


                                       25
<PAGE>

to the Army when deployed for longer missions,  even for  applications  that are
not man-portable.

         CECOM has  assigned  a  National  Stock  Number  (NSN) to our  Zinc-Air
battery,  making it possible to order and stock the battery for use by the Armed
Forces.  CECOM also assigned the designation  BA-8180/U to our Zinc-Air battery,
the first time an official US Army battery  designation  was ever  assigned to a
Zinc-Air battery.

         Based on extensive  contacts with the US and foreign military agencies,
we believe that a significant  market  exists for the  BA-8180/U  both in the US
Armed Forces and abroad.

                  8140/U

         The  BA-8140/U is a new product that is presently  being  qualified and
that has begun to generate  initial sales. The BA-8140/U is a smaller version of
our 8180/U, which we developed at the request of CECOM. It is approximately half
the size,  weight and  capacity of our 8180/U,  and is  appropriate  for smaller
hand-held communications devices.

                  Adapters

         The BA-8180/U is a battery, but in order to connect it or the 8140/U to
a specific  piece of  equipment,  an adapter  must be used.  In order to provide
compatibility  between the battery and various items of military  equipment,  we
supply various types of electrical  interface adapters for the BA-8180/U and the
8140/U,  including  equipment-specific  adapters for the AN/PRC-119 SINCGARS and
SINCGARS  ASIP  tactical  radio  sets,  and a  generic  interface  for  items of
equipment that were designed to interface with a BA-5590 or equivalent  battery.
Each of the three  interfaces was also assigned a national stock number (NSN) by
CECOM.  In  addition,  we are in the  process  of adding  four  more  electrical
interfaces.  These will address  various  applications,  including other radios,
night vision, missile launchers and chemical detectors.

                  Hybrids

         We have also developed  interface adapters for other items of equipment
which  require  higher  power than the  BA-8180/U  can  provide  by itself.  For
example,  we have  developed  a hybrid  battery  system  comprising  a BA-8180/U
battery pack and two small rechargeable lead-acid packs. Even with the weight of
the lead-acid  batteries,  this hybrid system powers a satellite  communications
terminal for  significantly  longer than an  equivalent  weight of BA-5590 LiSO2
battery  packs.  We have  also  developed  a  hybrid  system  that  incorporates
ultracapacitors.

                  Forward Field Chargers

         One of the  initial  goals to develop  high  energy  density  and power
density Zinc-Air batteries was to deploy them as forward field chargers.  It was
envisioned  that a man portable  power pack would be required by the  dismounted
soldier to charge the range of rechargeable  batteries now  proliferating in the
military.  A high  efficiency  forward  field charger has been  developed  which
enables  either a BB-390/U  (NiMH) or a BB-2590/U  (Li-ion) to receive  multiple
charges  from a single  BA-8180/U.  We are also in the process of  developing  a
forward field charger for the CSEL survival radio.



                                       26
<PAGE>

              Other Zinc-Air Products

         A  fourth  generation  of  Zinc-Air  products  is being  developed  for
applications  where volume is  critical,  and/or where the power to energy ratio
needs to be  significantly  higher  than  that of the  BA-8180/U.  These  "Gen4"
Zinc-Air products consist of an air cathode folded around a zinc electrode. Gen4
was originally  developed for the Marine Corps Dragon Eye UAV, which requires up
to 200 W from a battery that fits into its sleek  fuselage and which weighs less
than one kilogram.  Along the way, it was recognized  that the Gen4 design could
be  applied to other  battery  missions  requiring  high power as well as energy
density, such as Land Warrior and Objective Force Warrior soldier systems, where
up to 300 Wh of  energy  are  required  of a 24 hour  battery  that must be worn
conformably,  at minimal weight.  For these systems the battery currently limits
functionality, and Gen4 zinc-air may be the enabling technology. During 2004, we
were awarded $1 million of  congressional  funds and CECOM funding for the first
phase of a  three-phase  BAA (Broad Agency  Announcement,  which is a simplified
form of government  solicitation  for basic research and development) to develop
this technology.

         We are currently  under  contract,  the second of its kind, with a U.S.
agency, and a multi-year program with an Israeli security agency, to demonstrate
the  feasibility of Zinc-Air  batteries for both unmanned  aerial vehicles (UAV)
and  micro-air  vehicles  (MAV)  platforms,   respectively.  Flights  have  been
demonstrated with a 50W, 200Wh/kg battery for a 500g MAV.

         MARKETS/APPLICATIONS

         Being an external  alternative to the popular lithium based  BA-5590/U,
the BA-8180 can be used in many applications operated by the 5590. The BA-8180/U
can be used for a variety of military applications, including:

                >>       Tactical radios
                >>       SIGINT systems
                >>       Training systems
                >>       SATCOM radios
                >>       Nightscope power
                >>       Guidance systems
                >>       Surveillance systems
                >>       Sensors

         CUSTOMERS

         The principal  customer for our Zinc-Air  batteries during 2004 was the
U.S. Army's Communications-Electronics Command (CECOM).

         COMPETITION

         The  BA-8180/U is the only  Zinc-Air  battery to hold a US Army battery
designation.   It  does,  however,   compete  with  other  primary  (disposable)
batteries,  and primarily lithium based batteries.  In some cases,  primarily in
training missions, it will also compete with rechargeable batteries.



                                       27
<PAGE>

         Zinc-Air  batteries are inherently  safer than primary  lithium battery
packs  in  storage,  transportation,  use,  and  disposal,  and  are  more  cost
effective. They are lightweight,  with up to twice the energy capacity per pound
of primary lithium battery packs.  Zinc-Air  batteries for the military are also
under development by Rayovac Corporation.  Rayovac's military Zinc-Air batteries
utilize  cylindrical  cells,  rather than the prismatic cells that we developed.
While  cylindrical  cells may provide  higher  specific power than our prismatic
cells,  we believe they will generally  have lower energy  densities and be more
difficult to manufacture.

         The  most  popular  competing  primary  battery  in use by the US Armed
Forces is the BA-5590,  which uses  lithium-sulfur  dioxide  (LiSO2) cells.  The
largest  suppliers of LiSO2 batteries to the US military are believed to be Saft
America Inc. and Eagle Picher  Technologies LLC. The battery compartment of most
military  communications  equipment,  as well as other  military  equipment,  is
designed for the x90 family of  batteries,  of which the BA-5590  battery is the
most commonly  deployed.  Another primary battery in this family is the BA-5390,
which  uses  lithium-manganese  dioxide  (LiMnO2)  cells.  Suppliers  of  LiMnO2
batteries include Ultralife Batteries Inc., Saft and Eagle Picher.

         Rechargeable  batteries  in the  x90  family  include  lithium-ion  and
nickel-metal  hydride  batteries which may be used in training missions in order
to save the higher costs associated with primary batteries. Because of the short
usage time per charge cycle,  rechargeable batteries are not considered suitable
for use in combat.

         Our BA-8180 does not fit inside the battery compartment of any military
equipment, and therefore is connected externally using an interface adapter that
we also sell to the Army.  Our battery  offers  greatly  extended  mission time,
along with lower total  mission cost,  and these  significant  advantages  often
greatly outweigh the slight inconvenience of fielding an external battery.

         MANUFACTURING

         We have  established  a battery  factory for EFB at our new location in
Auburn,  Alabama,  where we have leased 15,000  square feet of light  industrial
space from the city of Auburn.  We also have  production  capabilities  for some
battery  components  at the facility of EFL in Beit  Shemesh,  Israel.  Both the
facilities  in Auburn  and those in Beit  Shemesh  have  received  ISO 9001 "Top
Quality Standard" certification.

     Electric Vehicles

         INTRODUCTION

         We believe  that  electric  buses  represent a  particularly  important
market for electric  vehicles in the United States.  An all-electric,  full-size
bus powered by the  Electric  Fuel system can provide to transit  authorities  a
full day's  operating  range for both heavy duty city and suburban routes in all
weather  conditions.  We conduct our  electric  vehicle  activities  through our
subsidiary Electric Fuel Ltd.

         THE ELECTRIC FUEL ZINC-AIR ENERGY SYSTEM FOR ELECTRIC VEHICLES

         The Electric Fuel Zinc-Air Energy System consists of:



                                       28
<PAGE>

                  >>       an in-vehicle,  Zinc-Air fuel cell unit consisting of
                           a series of Zinc-Air cells and  refuelable  zinc-fuel
                           anode cassettes using commercially-available zinc;

                  >>       a battery exchange unit for fast vehicle  turn-around
                           that is  equivalent  to the time  needed  to refuel a
                           diesel bus;

                  >>       an   automated    battery    refueling   system   for
                           mechanically  replacing depleted zinc-fuel  cassettes
                           with charged cassettes; and

                  >>       a regeneration system for  electrochemical  recycling
                           and  mechanical  repacking  of  the  discharged  fuel
                           cassettes.

         With  its   proprietary   high-power   air   cathode   and  zinc  anode
technologies,   our  Zinc-Air  fuel  cell  delivers  a  unique   combination  of
high-energy  density and  high-power  density,  which  together  power  electric
vehicles with speed, acceleration,  driving range and driver convenience similar
to that of conventionally powered vehicles.

         THE  DEPARTMENT  OF   TRANSPORTATION-FEDERAL   TRANSIT   ADMINISTRATION
ZINC-AIR ALL ELECTRIC TRANSIT BUS PROGRAM

         In the  United  States,  our  Zinc-Air  technology  is the  focus  of a
Zinc-Air All Electric Bus  demonstration  program the costs and  expenditures of
which are 50%  offset by  subcontracting  fees  paid by the U.S.  Department  of
Transportation's  Federal  Transit  Administration  (FTA).  The test  program is
designed  to prove  that an  all-electric  bus can meet  these and all other Los
Angeles and New York  Municipal  Transit  Authority  mass  transit  requirements
including  requirements  relating to performance,  speed,  acceleration and hill
climbing.

         Phase IV of the  program,  which we began in  October  2003,  is a $1.5
million  cost-shared  program  (half  of  which  is  funded  by the  FTA and the
remainder  by the  program  partners,  including  us) that  will  explore  steps
necessary for  commercializing the all-electric  zinc-air/ultracapacitor  hybrid
bus. It will focus on continued  optimization of the propulsion system developed
in previous phases, on additional vehicle and system testing,  including testing
alternative   advanced  auxiliary  battery   technologies,   and  on  evaluating
alternative zinc anodes, which are more commercially available in North America.

         COMPETITION

         We  believe  that our  products  must be  available  at a price that is
competitive with alternative  technologies,  particularly those intended for use
in zero or  low-emission  vehicles.  Besides other battery  technologies,  these
include  hydrogen  fuel  cells,   "hybrid  systems"  that  combine  an  internal
combustion engine and battery technologies,  and use of regular or low-pollution
fuels such as gasoline,  diesel,  compressed natural gas, liquefied natural gas,
ethanol  and  methanol.  Other  alternative  technologies  presently  use costly
components,  including  use of flywheels and  catalytic  removal of  pollutants.
These various technologies are at differing stages of development and any one of
them, or a new  technology,  may prove to be more cost  effective,  or otherwise
more readily  acceptable  by consumers,  than the Electric Fuel Zinc-Air  Energy
System for electric vehicles. In addition, the California Air Resource Board has
expressed  to  us  concerns  about  the  costs   associated  with  the  Zinc-Air
regeneration  infrastructure  as  compared  to  battery  technologies  that  use
electrical recharging.



                                       29
<PAGE>

     Lifejacket Lights

         PRODUCTS

         In 1996,  we began to produce and market  lifejacket  lights built with
our  patented  magnesium-cuprous  chloride  batteries,  which are  activated  by
immersion  in water  (water-activated  batteries),  for the  aviation and marine
safety and emergency markets.  Additionally,  in 2004 we added two new models to
our line of lifejacket light, based on lithium  batteries.  At present we have a
product line  consisting of seven  lifejacket  light  models,  five for use with
marine life jackets and two for use with aviation life vests,  all of which work
in both freshwater and seawater.  Each of our lifejacket lights is certified for
use by relevant  governmental  agencies  under  various U.S.  and  international
regulations.  We  manufacture,  assemble and package all our  lifejacket  lights
through EFL in our factory in Beit Shemesh, Israel.

         MARKETING

         We market  our  marine  safety  products  through  our own  network  of
distributors  in Europe,  the United  States,  Asia and  Oceania.  We market our
lights to the  commercial  aviation  industry  through  The  Burkett  Company of
Houston, Texas, which receives a commission on sales.

         COMPETITION

         Two  of  the  largest  manufacturers  of  aviation  and  marine  safety
products,   including  TSO  and   SOLAS-approved   lifejacket  lights,  are  ACR
Electronics  Inc.  of  Hollywood,  Florida,  and Pains  Wessex  McMurdo  Ltd. of
England.  Other  significant  competitors in the marine market include Daniamant
Aps of Denmark, and SIC of Italy.

Backlog

We  generally  sell  our  products  under  standard   purchase  orders.   Orders
constituting  our backlog are subject to changes in delivery  schedules  and are
typically  cancelable  by our  customers  until a  specified  time  prior to the
scheduled delivery date. Accordingly, our backlog is not necessarily an accurate
indication  of future sales.  As of December 31, 2004 and 2003,  our backlog for
the  following  years  was  approximately   $25.0  million  and  $17.2  million,
respectively,  divided among our divisions as follows  (backlog  attributable to
subsidiaries  acquired after December 31, 2003 is given as it stood at such date
in the books of the seller, prior to the acquisition):

<TABLE>
<CAPTION>
                   Division                            2004                2003
-------------------------------------------------------------------  ------------------
<S>                                              <C>                  <C>
Simulation and Security Division...............  $     12,691,000     $     6,600,000
Battery and Power Systems Division.............         8,325,000           9,630,000
Armor Division.................................         4,002,000             931,000
                                                -------------------  ------------------
     TOTAL: ...................................  $     25,018,000     $    17,161,000
                                                ===================  ==================
</TABLE>

Major Customers

         During  2004,  including  all of  our  divisions,  Bechtel  Corporation
accounted  for  approximately  24% of our revenues  and various  branches of the
United States military accounted for approximately 13% of our revenues.


                                       30
<PAGE>

Patents and Trade Secrets

         We rely on  certain  proprietary  technology  and seek to  protect  our
interests through a combination of patents,  trademarks,  copyrights,  know-how,
trade secrets and security measures,  including confidentiality  agreements. Our
policy  generally is to secure  protection  for  significant  innovations to the
fullest  extent  practicable.  Further,  we  seek  to  expand  and  improve  the
technological  base and  individual  features of our  products  through  ongoing
research and development programs.

         We rely on the laws of unfair  competition and trade secrets to protect
our  proprietary  rights.  We  attempt to protect  our trade  secrets  and other
proprietary  information through  confidentiality and non-disclosure  agreements
with customers, suppliers, employees and consultants, and through other security
measures.  However,  we may be unable to detect the unauthorized use of, or take
appropriate steps to enforce our intellectual  property rights.  Effective trade
secret  protection  may not be available  in every  country in which we offer or
intend to offer our  products  and  services to the same extent as in the United
States.  Failure to adequately  protect our intellectual  property could harm or
even destroy our brands and impair our ability to compete effectively.  Further,
enforcing our  intellectual  property  rights could result in the expenditure of
significant  financial and  managerial  resources and may not prove  successful.
Although we intend to protect our rights  vigorously,  there can be no assurance
that these measures will be successful.

Research and Development

         Research and  development is conducted by IES in Denver,  Colorado;  by
FAAC in Ann Arbor,  Michigan;  by EFB in Auburn,  Alabama; by Epsilor in Dimona,
Israel;  and by EFB and EFL in Beit  Shemesh,  Israel.  During  the years  ended
December 31, 2004,  2003 and 2002,  our gross  research and product  development
expenditures  were  approximately  $1.7 million,  $1.1 million and $2.2 million,
respectively,  including  research and development in  discontinued  operations.
During these periods,  the Office of the Chief  Scientist of the Israel Ministry
of Industry and Trade (the "Chief  Scientist")  participated in our research and
development efforts relating to our consumer battery business,  thereby reducing
our gross  research  and  product  development  expenditures  in the  amounts of
approximately  $0,  $26,000  and  $49,000  for the  years  2004,  2003 and 2002,
respectively.

         EFL has certain contingent  royalty  obligations to Chief Scientist and
the Israel-U.S. Binational Industrial Research and Development Foundation (BIRD,
which apply (in respect of continuing  operations)  only to our Electric Vehicle
program. As of December 31, 2004, our total outstanding  contingent liability in
this connection was approximately $10.9 million.

Employees

         As of February 28, 2005, we had 291 full-time employees  worldwide.  Of
these employees,  4 hold doctoral degrees and 21 hold other advanced degrees. Of
the total, 33 employees were engaged in product  research and  development,  199
were engaged in  production  and  operations,  16 were engaged in marketing  and
sales, and 43 were engaged in general and administrative  functions. Our success
will  depend in large  part on our  ability to attract  and retain  skilled  and
experienced employees.



                                       31
<PAGE>

         We and our  employees  are not  parties  to any  collective  bargaining
agreements.  However,  as certain  of our  employees  are  located in Israel and
employed by EFL, MDT or Epsilor, certain provisions of the collective bargaining
agreements between the Histadrut (General Federation of Labor in Israel) and the
Coordination  Bureau of Economic  Organizations  (including  the  Manufacturers'
Association of Israel) are applicable to EFL's, MDT's and Epsilor's employees by
order (the  "Extension  Order") of the Israeli  Ministry  of Labor and  Welfare.
These  provisions  principally  concern  the length of the work day and the work
week, minimum wages for workers,  contributions to a pension fund, insurance for
work-related  accidents,  procedures for dismissing employees,  determination of
severance pay and other conditions of employment,  including  certain  automatic
salary adjustments based on changes in the Israeli CPI.

         Israeli law generally  requires  severance  pay upon the  retirement or
death  of  an  employee  or  termination   of  employment   without  due  cause;
additionally,  some of our senior employees have special severance arrangements,
certain  of which  are  described  under  "Item  11.  Executive  Compensation  -
Employment   Contracts,"   below.  We  currently  fund  our  ongoing   severance
obligations by making monthly payments to approved  severance funds or insurance
policies.  In addition,  Israeli  employees  and  employers  are required to pay
specified  sums to the  National  Insurance  Institute,  which is similar to the
United  States  Social  Security  Administration.  Since  January 1, 1995,  such
amounts also include payments for national health insurance. The payments to the
National  Insurance  Institute are  approximately  15.6% of wages,  of which the
employee   contributes   approximately   62%   and  the   employer   contributes
approximately  38%. The  majority of the  permanent  employees  of EFL,  about a
quarter of the permanent employees of MDT, and one of the permanent employees of
Epsilor,  are covered by "managers'  insurance," which provides life and pension
insurance  coverage with customary benefits to employees,  including  retirement
and  severance  benefits.  We  contribute  14.33%  to 15.83%  (depending  on the
employee) of base wages to such plans and the permanent employees  contribute 5%
of their base wages.

         In 1993, an Israeli court held that  companies  that are subject to the
Extension Order are required to make pension  contributions  exclusively through
contributions  to Mivtachim  Social  Institute of Employees Ltd., a pension fund
managed by the Histadrut.  We  subsequently  reached an agreement with Mivtachim
with respect to providing coverage to certain production  employees and bringing
ourselves  into  conformity  with the court  decision.  The  agreement  does not
materially increase our pension costs or otherwise  materially  adversely affect
its  operations.  Mivtachim  has agreed not to assert any claim  against us with
respect to any of our past  practices  relating  to this  matter.  Although  the
arrangement does not bind employees with respect to instituting  claims relating
to any  nonconformity  by us, we believe that the likelihood of the assertion of
claims by employees is low and that any  potential  claims by employees  against
us, if successful, would not result in any material liability to us.

ITEM 2. PROPERTIES

         Our world  headquarters  has been  re-located  to our  Auburn,  Alabama
facility,  constituting  approximately  30,000 square feet, which is leased from
the City of Auburn through December 2005, and for another three years thereafter
at a 10% rent increase.

         Our management and administrative facilities and research,  development
and  production  facilities  for the  manufacture  and  assembly of our Survivor
Locator Lights,  constituting  approximately  18,300 square feet, are located in
Beit Shemesh,  Israel,  located between  Jerusalem and Tel-Aviv (within Israel's
pre-1967 borders).  The lease for these facilities in Israel expires on December


                                       32
<PAGE>

31, 2007;  we have the ability to terminate the lease every two years upon three
months'  written notice.  Moreover,  we may terminate the lease at any time upon
twelve  months  written  notice.  Most of the members of our senior  management,
including our Chief  Executive  Officer,  our Chief Operating  Officer,  and our
Chief Financial Officer, work extensively out of our Beit Shemesh facility.

         Our  Epsilor  subsidiary  rents  approximately  19,000  square  feet of
factory,  office and warehouse space in Dimona, Israel, in Israel's Negev desert
(within Israel's pre-1967 borders), on a month-to-month basis.

         Our IES subsidiary rents  approximately 8,900 square feet of office and
warehouse  space in  Littleton,  Colorado,  approximately  ten miles  outside of
Denver, pursuant to a lease expiring in September 2005, with an option to extend
the lease for an additional  five years, or until September 2010. IES also holds
an option under certain circumstances to rent an additional 3,200 square feet of
contiguous space.

         Our FAAC subsidiary  rents  approximately  17,800 square feet of office
and  warehouse  space in Ann Arbor,  Michigan,  pursuant to a lease  expiring in
February 2010.

         Our MDT  subsidiary  rents  approximately  20,000 square feet of office
space in Lod,  Israel,  near Ben-Gurion  International  airport (within Israel's
pre-1967 borders) pursuant to a lease renewable on an annual basis.

         We also have approximately 1,100 square feet at our former headquarters
at 250 West 57th  Street in New York City,  pursuant  to an  agreement  of lease
expiring in June 2009.  We are  attempting  to sublease  this space,  which will
require our  landlord's  consent.  No  assurance  can be given that we will find
someone to sublease this space or that our landlord's consent to a sublease will
be forthcoming.

         We  believe  that our  existing  facilities  are  adequate  to meet our
current and foreseeable future needs.

ITEM 3. LEGAL PROCEEDINGS

         As of the date of this  filing,  there were no material  pending  legal
proceedings against us, except as follows:

         In December  2004,  AoA filed an action in the United  States  Court of
Federal  Claims  against the United States Naval Air Systems  Command  (NAVAIR),
seeking  approximately  $2.2  million in damages for NAVAIR's  alleged  improper
termination of a contract for the design,  test and manufacture of a lightweight
armor  replacement  system for the  United  States  Marine  Corps  CH-46E  rotor
helicopter. NAVAIR, in its answer, counterclaimed for approximately $2.1 million
in alleged reprocurement and administrative costs.



                                       33
<PAGE>

ITEM 4.           SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         We held a Special Meeting of Stockholders on December 14, 2004. At that
meeting,  the  stockholders  voted on the  following  matters with the following
results:

1.   Ratifying,  for purposes of NASD  Marketplace Rule  4350(i)(1)(C)(ii),  the
     issuance in July 2004 of  five-year  warrants  to purchase up to  8,717,265
     shares of Arotech Corporation common stock at a price of $1.38 per share:

           Votes For      Votes Against      Abstentions    Shares Not Voting
           ---------      -------------      -----------    -----------------
          12,922,150        3,486,253          203,444         56,597,504


                                       34
<PAGE>

                                     PART II

ITEM 5.  MARKET FOR REGISTRANT'S  COMMON EQUITY,  RELATED STOCKHOLDER MATTERS
         AND ISSUER PURCHASES OF EQUITY SECURITIES

         Our common stock is traded on the Nasdaq  National  Market.  Our Nasdaq
ticker symbol is currently  "ARTX";  prior to February  2003,  our Nasdaq ticker
symbol was "EFCX." The following  table sets forth,  for the periods  indicated,
the  range  of high and low  sales  prices  of our  common  stock on the  Nasdaq
National Market System:

Year Ended December 31, 2004                    High        Low
                                                ----        ---
    Fourth Quarter..........................  $   2.16    $   1.50
    Third Quarter...........................  $   2.14    $   1.18
    Second Quarter..........................  $   4.34    $   1.90
    First Quarter...........................  $   2.53    $   1.65

Year Ended December 31, 2003                    High        Low
                                                ----        ---
    Fourth Quarter..........................  $   2.86    $   1.28
    Third Quarter...........................  $   1.62    $   0.81
    Second Quarter..........................  $   1.19    $   0.49
    First Quarter...........................  $   0.66    $   0.43

         As of February 28, 2005 we had  approximately  322 holders of record of
our common stock.

Dividends

         We have never paid any cash dividends on our common stock. The Board of
Directors presently intends to retain all earnings for use in our business.  Any
future  determination  as to payment of dividends will depend upon our financial
condition  and  results of  operations  and such  other  factors as the Board of
Directors deems relevant.

Recent Sales of Unregistered Securities

     Issuance of Restricted Stock to Certain Employees

         In October  2004,  we  granted a total of 430,000  shares of our common
stock as stock bonuses to two employees. Under the terms of this grant, the sale
or other  transfer of these shares is restricted  for a period of two years from
the date of grant,  and such shares  automatically  return to us if the employee
leaves our employ during such two-year period under circumstances that would not
entitle the  employee  to  statutory  severance  under  Israeli law  (generally,
resignation without good cause or dismissal with good cause).

         In December  2004,  we granted a total of 310,000  shares of our common
stock as stock  bonuses to five  employees.  Under the terms of this grant,  the
sale or other  transfer of these shares is restricted  for a period of two years
from the  date of  grant,  and such  shares  automatically  return  to us if the
employee leaves our employ during such two-year period under  circumstances that
would not  entitle  the  employee  to  statutory  severance  under  Israeli  law
(generally, resignation without good cause or dismissal with good cause).



                                       35
<PAGE>

         We issued  the above  securities  in  reliance  on the  exemption  from
registration  provided by Section 4(2) of the Securities Act as  transactions by
an issuer not involving a public offering.  The issuance of these securities was
without the use of an  underwriter,  and the shares of common  stock were issued
with restrictive  legends permitting  transfer thereof only upon registration or
an exemption under the Act.

     Issuance of Stock to a Charity

         In December  2004,  we donated  40,000  shares of our common stock to a
charitable organization recognized by the Internal Revenue Service as tax-exempt
under Section 501(c)(3) of the Internal Revenue Code of 1986, as amended.

         We issued  the above  securities  in  reliance  on the  exemption  from
registration  provided by Section 4(2) of the Securities Act as  transactions by
an issuer not involving a public offering.  The issuance of these securities was
without the use of an  underwriter,  and the shares of common  stock were issued
with restrictive  legends permitting  transfer thereof only upon registration or
an exemption under the Act.

ITEM 6.  SELECTED FINANCIAL DATA

         The selected financial  information set forth below with respect to the
consolidated  statement of  operations  for each of the five fiscal years in the
period ended  December 31, 2004,  and with respect to the balance  sheets at the
end of each such fiscal year has been  derived from our  consolidated  financial
statements.

         The results of operations,  including revenue,  operating expenses, and
financial  income,  of the consumer battery segment for the years ended December
31,  2003,  2002,  2001 and 2000  have  been  reclassified  in the  accompanying
statements  of  operations  as   discontinued   operations.   Our   accompanying
consolidated  balance  sheets at December  31,  2003,  2002,  2001 and 2000 give
effect to the assets of the consumer battery business as discontinued operations
within current assets and liabilities. Thus, the financial information presented
herein includes only continuing operations.

         As  discussed  in Note 1.b. to the  Consolidated  Financial  Statements
contained in Item 8 of this Report,  the  Consolidated  Financial  Statements at
December 31, 2003 and for the year then ended have been restated for the matters
set forth therein.

         The financial information set forth below is qualified by and should be
read in conjunction with the Consolidated Financial Statements contained in Item
8 of this Report and the notes thereto and "Item 7. Management's  Discussion and
Analysis of Financial Condition and Results of Operations," below.



                                       36
<PAGE>
<TABLE>
<CAPTION>

                                                                             Year Ended December 31,
                                                  ------------------------------------------------------------------------------
                                                  --------------- --------------- -------------- --------------- ---------------
                                                       2000            2001           2002            2003**           2004
                                                       ----            ----           ----            ----             ----
                                                                  (dollars in thousands, except per share data)
<S>                                                 <C>             <C>             <C>            <C>             <C>
Statement of Operations Data:
Revenues........................................    $    1,490      $    2,094      $    6,407     $   17,326      $   49,954
                                                    ----------      -----------     ----------     ----------      ----------
Research and development expenses and costs of
  revenues......................................         1,985           2,448           5,108         12,141          35,742
Selling, general and administrative expenses
  and their impairment and amortization of
  intangible assets.............................         3,434           3,934           5,982         10,255          18,394
                                                    ----------      ----------      ----------     -----------     ----------
Operating loss..................................        (3,929)         (4,288)         (4,683)        (5,070)         (4,182)
Financial income (expenses), net................           544             263             100          4,039           4,229
                                                    ----------      ----------      ----------     ----------      ----------
Loss before minority interest in (loss)
  earnings of subsidiary and tax expenses.......        (3,385)         (4,026)         (4,583)        (9,109)         (8,411)
Taxes on income.................................             -               -               -           (396)           (586)
Minority interest in (loss) earnings of
  subsidiary....................................             -               -            (355)           157             (45)
                                                    ----------      ----------      -----------    ----------      -----------
Loss from continuing operations.................        (3,385)         (4,026)         (4,938)        (9,348)         (9,042)
Income (loss) from discontinued operations......        (8,596)        (13,261)        (13,566)           110               -
                                                    -----------     -----------     -----------    ----------      ----------
Net loss for the period.........................       (11,981)        (17,287)        (18,504)        (9,238)         (9,042)
Deemed dividend to certain stockholders of
  common stock..................................             -          (1,197)              -           (350)         (3,329)
                                                    ----------      -----------     ----------     -----------     -----------
Net loss attributable to stockholders of common
  stock ........................................    $  (11,981)     $  (18,483)     $  (18,504)    $   (9,588)     $  (12,371)
                                                    ===========     ===========     ===========    ===========     ===========
Basic and diluted net loss per share from
  continuing operations.........................    $    (0.18)     $    (0.21)     $    (0.15)    $    (0.24)     $    (0.13)
                                                    ===========     ===========     ===========    ===========     ===========
Loss per share for combined operations..........    $    (0.62)     $    (0.76)     $    (0.57)    $    (0.25)     $    (0.18)
                                                    ===========     ===========     ===========    ===========     ===========
Weighted average number of common shares used
  in computing basic and diluted net loss per
  share (in thousands)..........................        19,243          24,200          32,382         38,890          69,933

                                                                               As At December 31,
                                                  ------------------------------------------------------------------------------
                                                  --------------- --------------- -------------- --------------- ---------------
                                                       2000            2001           2002            2003**          2004
                                                       ----            ----           ----            ------          ----
                                                  ------------------------------------------------------------------------------
                                                                             (dollars in thousands)
Balance Sheet Data:
Cash, cash equivalents, investments in
  marketable debt securities and restricted
  collateral deposits...........................    $   11,596      $   12,672      $    2,091     $   14,391      $   13,832
Receivables and other assets*...................        13,771          11,515           7,895          8,898          25,746
Property and equipment, net of depreciation.....         2,289           2,221           2,555          2,293           4,601
Goodwill and other intangible assets, net.......             -               -           7,522          7,440          54,113
                                                    ----------      ----------      ----------     ----------      ----------
Total assets....................................    $   27,656      $   26,408      $   20,063     $   33,022      $   98,292
                                                    ==========      ==========      ==========     ==========      ==========
Current liabilities*............................    $    4,787      $    3,874      $    7,272     $    6,710      $   26,381
Long-term liabilities***........................         2,791           3,126           3,753          4,686           6,438
Stockholders' equity............................        20,078          19,408           9,038         21,626          65,473
                                                    ----------      ----------      ----------     -----------     ----------
Total liabilities and stockholders equity*......    $   27,656      $   26,408      $   20,063     $   33,022      $   98,292
                                                    ==========      ==========      ==========     ==========      ==========
</TABLE>
------------------------------------
  *Includes assets and liabilities, as applicable, from discontinued operations.
  **Restated (see Note 1.b. of Notes to Consolidated Financial Statements).
 ***Includes minority interest.


                                       37
<PAGE>

ITEM 7. MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION

         The  following  Management's   Discussion  and  Analysis  of  Financial
Condition and Results of Operations  contains  forward-looking  statements  that
involve  inherent risks and  uncertainties.  When used in this  discussion,  the
words "believes,"  "anticipated," "expects," "estimates" and similar expressions
are intended to identify such  forward-looking  statements.  Such statements are
subject to certain risks and  uncertainties  that could cause actual  results to
differ materially from those projected. Readers are cautioned not to place undue
reliance on these  forward-looking  statements,  which speak only as of the date
hereof.  We  undertake  no  obligation  to  publicly  release  the result of any
revisions to these forward-looking statements that may be made to reflect events
or  circumstances  after  the  date  hereof  or to  reflect  the  occurrence  of
unanticipated  events.  Our actual  results could differ  materially  from those
anticipated in these  forward-looking  statements as a result of certain factors
including,  but not limited to, those set forth elsewhere in this report. Please
see "Risk  Factors,"  below,  and in our other filings with the  Securities  and
Exchange Commission.

         The following  discussion  and analysis  should be read in  conjunction
with the Consolidated  Financial  Statements contained in Item 8 of this report,
and the notes  thereto.  We have rounded  amounts  reported  here to the nearest
thousand,  unless such amounts are more than 1.0 million, in which event we have
rounded such amounts to the nearest hundred thousand.

General

         We are a defense and security products and services company, engaged in
three business areas:  interactive  simulation for military, law enforcement and
commercial  markets;  batteries  and  charging  systems  for the  military;  and
high-level armoring for military,  paramilitary and commercial  vehicles.  Until
September 17, 2003, we were known as Electric  Fuel  Corporation.  We operate in
three business units:

         >>       we develop, manufacture and market advanced hi-tech multimedia
                  and interactive digital solutions for use-of-force and driving
                  training of  military,  law  enforcement,  security  and other
                  personnel,  as well as offering security  consulting and other
                  services (our Simulation, Security and Consulting Division);

         >>       we  manufacture  aviation  armor and we utilize  sophisticated
                  lightweight  materials and advanced  engineering  processes to
                  armor vehicles (our Armoring Division); and

         >>       we  manufacture  and sell  Zinc-Air and lithium  batteries for
                  defense and security products and other military  applications
                  and we pioneer advancements in Zinc-Air battery technology for
                  electric vehicles (our Battery and Power Systems Division).

         During  2004,  we  acquired  three new  businesses:  FAAC  Corporation,
located in Ann Arbor, Michigan,  which provides simulators,  systems engineering
and software  products to the United  States  military,  government  and private
industry (which we have placed in our Simulation and Security Division); Epsilor
Electronic Industries, Ltd., located in Dimona, Israel, which develops and sells
rechargeable  and primary  lithium  batteries and smart chargers to the military


                                       38
<PAGE>

and to private  industry  in the  Middle  East,  Europe and Asia  (which we have
placed in our  Battery  and Power  Systems  Division);  and  Armour of  America,
Incorporated,  located in Los Angeles,  California, which manufacturers aviation
armor both for helicopters and for fixed wing aircraft,  marine armor, personnel
armor, armoring kits for military vehicles,  fragmentation blankets and a unique
ballistic/flotation vest (ArmourFloat) that is U.S. Coast Guard-certified, which
we have  placed  in our Armor  Division.  Prior to the  acquisition  of FAAC and
Epsilor,  we were organized into two  divisions:  Defense and Security  Products
(consisting of IES, MDT and MDT Armor), and Electric Fuel Batteries  (consisting
of EFL and EFB). Our financial results for 2003 do not include the activities of
FAAC, Epsilor or AoA and therefore are not directly  comparable to our financial
results for 2004.

     Restatement of Previously-Issued Financial Statements

         During our management's review of our interim financial  statements for
the period ended  September 30, 2004, we, after  discussion  with and based on a
new and revised  review of  accounting  treatment by our  independent  auditors,
conducted a comprehensive  review of the re-pricing of warrants and grant of new
warrants to certain of our  investors and others during the years 2004 and 2003.
As a result of that review,  we, upon  recommendation of our management and with
the approval of the Audit Committee of our Board of Directors  after  discussion
with our  independent  auditors,  reconsidered  the accounting  related to these
transactions and reclassified  certain expenses as a deemed dividend, a non-cash
item, instead of as general and  administrative  expenses due to the recognition
of these transactions as capital transactions that should not be expensed. These
restatements did not affect our balance sheet, shareholders' equity or cash flow
statements. In addition and as a result of the remeasurement described above, we
have reviewed  assumptions used in the calculation of fair value of all warrants
granted during the year 2003. As a result of this comprehensive  review, we have
decreased general and administrative expenses in the amount of $150,000, related
to  errors  found  in the  valuation  of  warrants  granted  in  the  litigation
settlement  described in Note  14.f.6.  of the Notes to  Consolidated  Financial
Statements for the year ended December 31, 2004.

         In addition,  during our management's  review of our interim  financial
statements  for the period  ended  September  30,  2004,  we also  reviewed  our
calculation  of  amortization  of debt discount  attributable  to the beneficial
conversion  feature associated with our convertible  debentures.  As a result of
this review,  we found  errors which  increased  our  financial  expenses in the
amount of $568,000 for the year ended December 31, 2003. The errors were related
to the  amortization  of debt  discount  attributable  to the  warrants  and the
related   convertible   debentures,   whereby  we  understated   the  amount  of
amortization for the year ended December 31, 2003 attributable to certain of the
convertible debentures.

         Similar errors were also noted in our interim  financial  statements in
the  three-month  period  ended  June 30,  2003,  the  nine-month  period  ended
September 30, 2003, and the three- and six-month periods ended March 31 and June
30, 2004.

         The  impacts  of these  restatements  with  respect  to the year  ended
December 31, 2003 are summarized below:



                                       39
<PAGE>

Statement of Operations Data:
<TABLE>
<CAPTION>

                                                             For the Year ended December 31, 2003
                                                  -----------------------------------------------------------
                                                     Previously
                                                       Reported           Adjustment          As Restated
                                                  -----------------    -----------------    -----------------
<S>                                                <C>                  <C>                  <C>
General and administrative expenses..............  $    6,196,779       $     (338,903)      $    5,857,876
Operating loss...................................       5,408,932             (338,903)           5,070,029
Financial expenses, net..........................       3,470,459              568,250            4,038,709

Loss from continuing operations..................       9,118,684              229,347            9,348,031
                                                  -----------------    -----------------    -----------------
Net loss.........................................       9,008,274              229,347            9,237,621
Deemed dividend to certain stockholders of
   common stock.................................                -              350,000              350,000
                                                  -----------------    -----------------    -----------------
Net loss attributable to common stockholders.....  $    9,008,274       $      579,347       $    9,587,621
                                                  =================    =================    =================

Basic and diluted net loss per share from
  continuing operations..........................  $     0.23           $     0.01           $     0.24
                                                  =================    =================    =================
Basic and diluted net loss per share.............  $     0.23           $     0.02           $     0.25
                                                  =================    =================    =================

Balance Sheet Data:

                                                             As of December 31, 2003
                                      -----------------------------------------------------------------------
                                      Previously Reported           Adjustment              As Restated
                                      ---------------------    ---------------------    ---------------------
Other accounts payable and accrued     $      4,180,411         $      (150,000)         $      4,030,411
   expenses..........................
Total current liabilities............         6,859,752                (150,000)                6,709,752
Convertible debenture................           881,944                 568,250                 1,450,194
Total long term liabilities..........         4,066,579                 568,250                 4,634,829

Additional paid in capital...........       135,891,316                (188,903)              135,702,413
Accumulated deficit..................      (109,681,893)               (229,347)             (109,911,240)
Total shareholders' equity...........        22,044,127                (418,250)               21,625,877

Cash Flow Data:

                                                             For the Year ended December 31, 2003
                                                  -----------------------------------------------------------
                                                      Previously
                                                       Reported           Adjustment          As Restated
                                                  -----------------    -----------------    -----------------
Net loss.........................................  $    9,008,274       $      229,347       $    9,237,621
Stock based compensation related to repricing of
  warrants granted to investors and the grant of
  new warrants...................................         388,403             (188,903)             199,500
Increase in other accounts payable and accrued
  expenses.......................................       1,827,668             (150,000)           1,677,668

Amortization of compensation related to
  beneficial conversion feature and warrants
  issued to holders of convertible debentures....       3,359,987              568,250            3,928,237
</TABLE>



                                       40
<PAGE>

Critical Accounting Policies

         The preparation of financial  statements  requires us to make estimates
and assumptions  that affect the reported  amounts of assets and liabilities and
the disclosure of contingent liabilities at the date of the financial statements
and the reported  amounts of revenues and expenses during the reporting  period.
On an ongoing basis,  we evaluate our estimates and judgments,  including  those
related   to  revenue   recognition,   allowance   for  bad  debts,   inventory,
contingencies  and  warranty  reserves,  impairment  of  intangible  assets  and
goodwill.  We base our estimates and judgments on historical  experience  and on
various other factors that we believe to be reasonable under the  circumstances,
the  results  of which form the basis for making  judgments  about the  carrying
values of assets  and  liabilities  that are not  readily  apparent  from  other
sources.  Under different  assumptions or conditions,  actual results may differ
from these estimates.

         We believe the following critical  accounting  policies affect our more
significant  judgments and estimates used in the preparation of our consolidated
financial statements.

     Revenue Recognition

         Significant management judgments and estimates must be made and used in
connection  with the recognition of revenue in any accounting  period.  Material
differences  in the amount of  revenue  in any given  period may result if these
judgments or estimates prove to be incorrect or if management's estimates change
on the basis of  development  of the business or market  conditions.  Management
judgments and estimates  have been applied  consistently  and have been reliable
historically.

         A portion of our revenue is derived from license agreements that entail
the customization of FAAC's simulators to the customer's specific  requirements.
Revenues  from initial  license fees for such  arrangements  are  recognized  in
accordance  with  Statement of Position  81-1  "Accounting  for  Performance  of
Construction  - Type  and  Certain  Production  - Type  Contracts"  based on the
percentage  of  completion  method over the period  from  signing of the license
through  to  customer   acceptance,   as  such  simulators  require  significant
modification  or  customization  that takes time to complete.  The percentage of
completion  is  measured by  monitoring  progress  using  records of actual time
incurred  to date in the  project  compared  with the  total  estimated  project
requirement,  which  corresponds  to  the  costs  related  to  earned  revenues.
Estimates  of total  project  requirements  are  based on  prior  experience  of
customization, delivery and acceptance of the same or similar technology and are
reviewed and updated regularly by management.

         We  believe  that the use of the  percentage  of  completion  method is
appropriate as we have the ability to make  reasonably  dependable  estimates of
the extent of progress towards completion, contract revenues and contract costs.
In addition,  contracts  executed  include  provisions  that clearly specify the
enforceable rights regarding services to be provided and received by the parties
to the contracts,  the consideration to be exchanged and the manner and terms of
settlement.  In all cases we expect to perform our  contractual  obligations and
our licensees are expected to satisfy their obligations under the contract.  The
complexity of the estimation  process and the issues related to the assumptions,
risks and  uncertainties  inherent  with the  application  of the  percentage of
completion  method of  accounting  affect the  amounts of  revenue  and  related
expenses reported in our consolidated financial statements. A number of internal
and  external   factors  can  affect  our  estimates,   including  labor  rates,
utilization and specification and testing requirement changes.



                                       41
<PAGE>

         We account for our other  revenues  from IES  simulators  in accordance
with the provisions of SOP 97-2,  "Software Revenue  Recognition," issued by the
American  Institute of Certified  Public  Accountants and as amended by SOP 98-4
and SOP 98-9 and related interpretations. We exercise judgment and use estimates
in  connection  with the  determination  of the amount of  software  license and
services revenues to be recognized in each accounting period.

         We assess whether collection is probable at the time of the transaction
based on a number of factors,  including the customer's past transaction history
and credit  worthiness.  If we determine  that the  collection of the fee is not
probable,  we defer the fee and recognize revenue at the time collection becomes
probable, which is generally upon the receipt of cash.

     Allowance for Doubtful Accounts

         We make judgments as to our ability to collect outstanding  receivables
and provide  allowances for the portion of receivables  when collection  becomes
doubtful.  Provisions are made based upon a specific  review of all  significant
outstanding receivables. In determining the provision, we analyze our historical
collection  experience and current economic trends. We reassess these allowances
each accounting  period.  Historically,  our actual losses and credits have been
consistent  with  these  provisions.  If  actual  payment  experience  with  our
customers is different than our estimates,  adjustments to these  allowances may
be necessary resulting in additional charges to our statement of operations.

     Accounting for Income Taxes

         Significant  judgment is required in determining  our worldwide  income
tax expense  provision.  In the ordinary course of a global business,  there are
many transactions and calculations  where the ultimate tax outcome is uncertain.
Some of  these  uncertainties  arise  as a  consequence  of  cost  reimbursement
arrangements among related entities, the process of identifying items of revenue
and expense that qualify for  preferential  tax  treatment  and  segregation  of
foreign and domestic  income and expense to avoid double  taxation.  Although we
believe  that our  estimates  are  reasonable,  the final tax  outcome  of these
matters may be different than that which is reflected in our  historical  income
tax provisions and accruals.  Such  differences  could have a material effect on
our  income  tax  provision  and net  income  (loss) in the period in which such
determination is made.

         We have  provided a  valuation  allowance  on the  majority  of our net
deferred  tax assets,  which  includes  federal and foreign net  operating  loss
carryforwards,  because of the  uncertainty  regarding  their  realization.  Our
accounting for deferred taxes under Statement of Financial  Accounting Standards
No.  109,  "Accounting  for  Income  Taxes"  ("Statement  109"),   involves  the
evaluation of a number of factors  concerning the  realizability of our deferred
tax assets. In concluding that a valuation allowance was required,  we primarily
considered  such factors as our history of operating  losses and expected future
losses in certain  jurisdictions and the nature of our deferred tax assets.  The
Company and its subsidiaries provide valuation allowances in respect of deferred
tax assets resulting principally from the carryforward of tax losses. Management
currently  believes  that it is more  likely  than  not that  the  deferred  tax
regarding the  carryforward of losses and certain  accrued  expenses will not be
realized in the foreseeable  future. The company does not provide for US Federal
Income taxes on the undistributed  earnings of its foreign  subsidiaries because
such earnings are re-invested  and, in the opinion of management,  will continue
to be re-invested indefinitely.



                                       42
<PAGE>

         In addition, we operate within multiple taxing jurisdictions and may be
subject  to audits in these  jurisdictions.  These  audits can  involve  complex
issues  that  may  require  an  extended  period  of  time  for  resolution.  In
management's opinion, adequate provisions for income taxes have been made.

     Inventories

         Our policy for  valuation  of  inventory  and  commitments  to purchase
inventory, including the determination of obsolete or excess inventory, requires
us to perform a detailed  assessment  of inventory  at each balance  sheet date,
which  includes a review of, among other  factors,  an estimate of future demand
for products within specific time horizons,  valuation of existing inventory, as
well as product lifecycle and product development plans. The estimates of future
demand that we use in the  valuation of inventory  are the basis for our revenue
forecast,  which is also used for our short-term  manufacturing plans. Inventory
reserves are also provided to cover risks  arising from  slow-moving  items.  We
write down our inventory for estimated  obsolescence or  unmarketable  inventory
equal to the difference  between the cost of inventory and the estimated  market
value based on assumptions about future demand and market conditions.  We may be
required to record additional  inventory  write-down if actual market conditions
are less favorable than those projected by our  management.  For fiscal 2004, no
significant changes were made to the underlying assumptions related to estimates
of inventory valuation or the methodology applied.

     Goodwill

         Under Financial Accounting Standards Board Statement No. 142, "Goodwill
and Other Intangible  Assets" (SFAS 142),  goodwill and intangible assets deemed
to have  indefinite  lives are no longer  amortized  but are  subject  to annual
impairment tests based on estimated fair value in accordance with SFAS 142.

         In June 2004, we completed our annual  impairment test and assessed the
carrying value of goodwill as required by SFAS 142. The goodwill impairment test
compared the carrying value of the Company's reporting units with the fair value
at that date.  Because the market  capitalization  exceeded the  carrying  value
significantly, no impairment arose.

         We determine fair value using discounted cash flow analysis.  This type
of analysis  requires us to make  assumptions and estimates  regarding  industry
economic factors and the profitability of future business strategies.  It is our
policy to conduct  impairment  testing based on our current business strategy in
light  of  present  industry  and  economic   conditions,   as  well  as  future
expectations.  In  assessing  the  recoverability  of  our  goodwill,  we may be
required to make  assumptions  regarding  estimated  future cash flows and other
factors to determine the fair value of the  respective  assets.  This process is
subjective and requires judgment at many points throughout the analysis.  If our
estimates or their related assumptions change in subsequent periods or if actual
cash flows are below our  estimates,  we may be  required  to record  impairment
charges for these assets not previously recorded.

     Other Intangible Assets

         Other  intangible  assets are  amortized to the Statement of Operations
over the  period  during  which  benefits  are  expected  to  accrue,  currently
estimated at two to ten years.



                                       43
<PAGE>

         We recorded a $320,000  impairment charge in 2004 in respect of certain
technology acquired from Bristlecone in 2003.

         The determination of the value of such intangible assets requires us to
make assumptions  regarding future business  conditions and operating results in
order to estimate  future  cash flows and other  factors to  determine  the fair
value of the respective  assets.  If these estimates or the related  assumptions
change in the  future,  we could be  required  to record  additional  impairment
charges.

     Contingencies

         We are from  time to time  involved  in  legal  proceedings  and  other
claims.  We are required to assess the  likelihood  of any adverse  judgments or
outcomes to these matters,  as well as potential ranges of probable  losses.  We
have  not  made any  material  changes  in the  accounting  methodology  used to
establish our self-insured liabilities during the past three fiscal years.

         A  determination  of the amount of reserves  required,  if any, for any
contingencies  are made after careful  analysis of each  individual  issue.  The
required  reserves  may  change  due to future  developments  in each  matter or
changes in approach, such as a change in the settlement strategy in dealing with
any contingencies, which may result in higher net loss.

         If  actual  results  are  not  consistent   with  our  assumptions  and
judgments, we may be exposed to gains or losses that could be material.

     Warranty Reserves

         Upon  shipment  of  products  to our  customers,  we  provide  for  the
estimated  cost to  repair  or  replace  products  that  may be  returned  under
warranty.  Our  warranty  period is  typically  twelve  months  from the date of
shipment  to the end user  customer.  For  existing  products,  the  reserve  is
estimated based on actual historical experience.  For new products, the warranty
reserve is based on historical experience of similar products until such time as
sufficient  historical data has been collected on the new product.  Factors that
may impact our warranty costs in the future include our reliance on our contract
manufacturer  to provide  quality  products  and the fact that our  products are
complex and may  contain  undetected  defects,  errors or failures in either the
hardware or the software.

Functional Currency

         We consider the United  States dollar to be the currency of the primary
economic  environment  in which we and our Israeli  subsidiary  EFL operate and,
therefore,  both we and EFL have adopted and are using the United  States dollar
as our functional currency.  Transactions and balances originally denominated in
U.S.  dollars are presented at the original  amounts.  Gains and losses  arising
from non-dollar transactions and balances are included in net income.

         The majority of financial  transactions of our Israeli subsidiaries MDT
and Epsilor is in New Israel Shekels ("NIS") and a substantial  portion of MDT's
and Epsilor's costs is incurred in NIS.  Management believes that the NIS is the
functional currency of MDT and Epsilor. Accordingly, the financial statements of
MDT and Epsilor  have been  translated  into U.S.  dollars.  All  balance  sheet
accounts have been translated  using the exchange rates in effect at the balance
sheet date.  Statement  of  operations  amounts have been  translated  using the
average exchange rate for the period. The resulting translation  adjustments are
reported as a component of accumulated other comprehensive loss in shareholders'
equity.



                                       44
<PAGE>

Recent Developments

     CECOM IDIQ Order

         In March 2005 we received a new Firm Fixed Price,  Indefinite Delivery,
Indefinite Quantity (IDIQ) order from the U.S. Army's Communications  Electronic
Command  (CECOM) to supply up to $24 million in zinc-air  batteries and adaptors
to the Department of Defense over the next three years.  Under the new contract,
EFB will be enabled to deliver  the  BA-8180/U  zinc-air  battery  and the three
existing interface adapters. In addition, a new battery, the BA-8140/U, and four
new  adapters  are  included in this  contract  and have been  ordered for First
Article Testing (FAT).

Executive Summary

         The  following   executive  summary  includes  discussion  of  our  new
subsidiaries, FAAC Incorporated,  Epsilor Electronic Industries, Ltd. and Armour
of America Incorporated, that we purchased in 2004.
     Divisions and Subsidiaries

         We  operate  primarily  as  a  holding  company,  through  our  various
subsidiaries,  which we have organized into three  divisions.  Our divisions and
subsidiaries (all 100% owned, unless otherwise noted) are as follows:

         >>       Our Simulation,  Security and Consulting Division,  consisting
                  of:

                  o        FAAC  Incorporated,  located in Ann Arbor,  Michigan,
                           which provides  simulators,  systems  engineering and
                           software  products  to the  United  States  military,
                           government and private industry ("FAAC"); and

                  o        IES Interactive Training, Inc., located in Littleton,
                           Colorado,  which provides  specialized "use of force"
                           training  for  police,  security  personnel  and  the
                           military ("IES").

         >>       Our Armor Division, consisting of:

                  o        Armour   of   America,   located   in  Los   Angeles,
                           California,   which   manufacturers   ballistic   and
                           fragmentation  armor  kits for  rotary and fixed wing
                           aircraft,  marine armor,  personnel  armor,  military
                           vehicles and  architectural  applications,  including
                           both  the   LEGUARD   Tactical   Leg  Armor  and  the
                           Armourfloat  Ballistic  Floatation Device, which is a
                           unique vest that is certified by the U.S. Coast Guard
                           ("AoA");

                  o        MDT  Protective  Industries,  Ltd.,  located  in Lod,
                           Israel,  which specializes in using  state-of-the-art
                           lightweight  ceramic  materials,   special  ballistic
                           glass and  advanced  engineering  processes  to fully
                           armor vans and SUVs, and is a leading supplier to the
                           Israeli military,  Israeli special forces and special
                           services ("MDT") (75.5% owned); and



                                       45
<PAGE>

                  o        MDT Armor  Corporation,  located in Auburn,  Alabama,
                           which conducts MDT's United States  activities  ("MDT
                           Armor") (88% owned).

         >>       Our Battery and Power Systems Division, consisting of:

                  o        Epsilor  Electronic  Industries,   Ltd.,  located  in
                           Dimona, Israel (in Israel's Negev desert area), which
                           develops and sells  rechargeable  and primary lithium
                           batteries  and smart  chargers to the military and to
                           private industry in the Middle East,  Europe and Asia
                           ("Epsilor");

                  o        Electric Fuel Battery Corporation, located in Auburn,
                           Alabama,  which  manufactures and sells Zinc-Air fuel
                           sells,  batteries  and  chargers  for  the  military,
                           focusing on applications  that demand high energy and
                           light weight ("EFB"); and

                  o        Electric Fuel (E.F.L.) Ltd., located in Beit Shemesh,
                           Israel,  which  produces  water-activated  lifejacket
                           lights   for    commercial    aviation   and   marine
                           applications, and which conducts our Electric Vehicle
                           effort,   focusing  on  obtaining  and   implementing
                           demonstration projects in the U.S. and Europe, and on
                           building broad industry partnerships that can lead to
                           eventual  commercialization  of our  Zinc-Air  energy
                           system for electric vehicles ("EFL").

     Overview of Results of Operations

         We incurred  significant  operating losses for the years ended December
31, 2004, 2003 and 2002. While we expect to continue to derive revenues from the
sale of products that we manufacture and the services that we provide, there can
be no assurance that we will be able to achieve or maintain  profitability  on a
consistent basis.

         During 2003 and 2004,  we  substantially  increased  our  revenues  and
reduced our net loss, from $18.5 million in 2002 to $9.2 million in 2003 to $9.0
million  in 2004.  This was  achieved  through  a  combination  of  cost-cutting
measures  and  increased  revenues,  particularly  from  the  sale  of  Zinc-Air
batteries  to the  military  and from  sales  of  products  manufactured  by the
subsidiaries we acquired in 2002 and 2004.

         We  succeeded  during  2004 in  moving  Arotech  to a  positive  EBITDA
situation,  for the first time in our history. We are focused on continuing this
success in 2005 and beyond, and ultimately on achieving  profitability.  In this
connection, we note that most of our business lines historically have had weaker
first halves than second halves, and weaker first quarters than second quarters.
We expect this to be the case for 2005 as well.

         A portion of our operating  loss during 2004 and 2003 arose as a result
of non-cash  charges.  These charges were primarily related to our acquisitions,
financings and issuances of restricted shares and options to employees.  Because
we anticipate  continuing  certain of these activities during 2005, we expect to
continue to incur such non-cash charges in the future.



                                       46
<PAGE>

         ACQUISITIONS

         In acquisition of subsidiaries, part of the purchase price is allocated
to intangible assets and goodwill,  Amortization of intangible assets related to
acquisition of subsidiaries is recorded based on the estimated  expected life of
the assets. Accordingly, for a period of time following an acquisition, we incur
a non-cash charge related to amortization of intangible  assets in the amount of
a fraction  (based on the useful  life of the  intangible  assets) of the amount
recorded as intangible  assets.  Such amortization  charges will continue during
2005. We are required to review intangible assets for impairment whenever events
or changes in circumstances  indicate that carrying amount of the assets may not
be recoverable.  If we determine,  through the impairment  review process,  that
intangible asset has been impaired,  we must record the impairment charge in our
statement of operations.

         In the case of  goodwill,  the  assets  recorded  as  goodwill  are not
amortized;  instead,  we are required to perform an annual impairment review. If
we determine,  through the  impairment  review  process,  that goodwill has been
impaired, we must record the impairment charge in our statement of operations.

         As a  result  of the  application  of the  above  accounting  rule,  we
incurred  non-cash charges for amortization of intangible  assets and impairment
in the amount of $2.8 million during 2004. See "Critical  Accounting  Policies -
Other Intangible Assets," above.

         FINANCINGS

         The  non-cash  charges  that  relate  to  our  financings  occurred  in
connection  with our issuance of convertible  debentures  with warrants,  and in
connection  with our  repricing of certain  warrants and grants of new warrants.
When we issue  convertible  debentures,  we record a discount  for a  beneficial
conversion  feature  that is amortized  ratably over the life of the  debenture.
When a  debenture  is  converted,  however,  the  entire  remaining  unamortized
beneficial  conversion feature expense is immediately  recognized in the quarter
in which the  debenture  is  converted.  Similarly,  when we issue  warrants  in
connection with  convertible  debentures,  we record debt discount for financial
expenses that is amortized ratably over the term of the convertible  debentures;
when the convertible debentures are converted,  the entire remaining unamortized
debt discount is immediately  recognized in the quarter in which the convertible
debentures  are converted.  As and to the extent that our remaining  convertible
debentures are converted, we would incur similar non-cash charges going forward.

         As a  result  of the  application  of the  above  accounting  rule,  we
incurred non-cash charges related to amortization of debt discount  attributable
to beneficial conversion feature in the amount of $4.1 million during 2004.

         Additionally,  in an  effort  to  improve  our cash  situation  and our
shareholders'  equity,  and in order to reduce  the  number  of our  outstanding
warrants,  during 2003 and 2004 we induced holders of certain of our warrants to
exercise  their  warrants  by lowering  the  exercise  price of the  warrants to
approximately  market value in exchange for immediate exercise of such warrants,
and by issuing to such  investors  a lower  number of new  warrants  at a higher
exercise  price.  Under such  circumstances,  we record a deemed  dividend in an
amount  determined based upon the fair value of the new warrants.  As and to the
extent that we engage in similar warrant repricings and issuances in the future,
we would incur similar non-cash charges.



                                       47
<PAGE>

         As a  result  of the  application  of the  above  accounting  rule,  we
recorded  a deemed  dividend  related  to  warrants  repricing  and grant of new
warrants in the amount of $3.3 million during 2004.

         RESTRICTED SHARE AND OPTION ISSUANCES

         During 2004, we issued  restricted  shares to certain of our employees.
These shares were issued as stock  bonuses,  and are  restricted for a period of
two years from the date of issuance.  Relevant accounting rules provide that the
aggregate amount of the difference  between the purchase price of the restricted
shares (in this case,  generally zero) and the market price of the shares on the
date of grant is taken as a general and administrative  expense,  amortized over
the life of the period of the restriction.

         Additionally,  during 2003 and 2004 we issued options to employees that
were  subject to  shareholder  approval of a new stock  option  plan.  While the
options were issued at the market price of our stock on the respective  dates of
issuance,  they were not considered by applicable  accounting rules to have been
finally issued until the date shareholder approval for the new stock option plan
was obtained.  In the interim, the market price of our stock had risen, and thus
the options  were deemed to have been issued at a  below-market  price.  We were
therefore required to take as a general and administrative expense the aggregate
difference  between  the option  exercise  prices of the  options and the market
price of the shares on the date  shareholder  approval was  obtained,  amortized
over the vesting periods of the options.

         As a result  of the  application  of the  above  accounting  rules,  we
incurred  non-cash charges related to stock-based  compensation in the amount of
$884,000 during 2004.

     Overview of Financial Condition and Operating Performance

         We shut down our  money-losing  consumer  battery  operations and began
acquiring new businesses in the defense and security field in 2002.  Thereafter,
we  concentrated  on  eliminating  our operating  deficit and moving  Arotech to
cash-flow  positive  operations,  a goal we  achieved  for the first time in our
history in the second half of 2004. In order to do this, we focused on acquiring
businesses with strong revenues and profitable operations.

         In  our   Simulation   and  Security   Division,   revenues  grew  from
approximately  $8.0  million  in 2003 to $21.5  million  in 2004 (on a pro forma
basis,  assuming we had owned all  components  of our  Simulation  and  Security
Division  since January 1, 2003,  revenues  would have grown from  approximately
$17.9 million in 2003 to $21.5 million in 2004).  We attribute  this to a number
of substantial orders, such as orders from the U.S. Army and the Chicago Transit
Authority.  As of December 31, 2004, our backlog for our Simulation and Security
Division totaled $12.7 million.

         Our Armor  Division  had record  revenues  during 2004,  with  revenues
growing from  approximately  $3.4 million in 2003 to $18.0 million in 2004 (on a
pro forma  basis,  assuming we had owned all  components  of our Armor  Division
since  January 1, 2003,  revenues  would  have  grown from  approximately  $10.9
million in 2003 to $29.2 million in 2004).  Much of this growth was attributable
to armoring orders  connected with the war in Iraq. As of December 31, 2004, our
backlog for our Armor Division totaled $4.0 million.



                                       48
<PAGE>

         In  our  Battery  and  Power  Systems  Division,   revenues  grew  from
approximately  $5.9  million  in 2003 to $10.5  million  in 2004 (on a pro forma
basis,  assuming we had owned all  components  of our Battery and Power  Systems
Division since January 1, 2003,  revenues  would have fallen from  approximately
$10.8  million in 2003 to $10.5 million in 2004).  As of December 31, 2004,  our
backlog for our Battery and Power Systems Division totaled $8.3 million.

Results of Operations

     Preliminary Note

         SUMMARY

         Results of operations  for the year ended December 31, 2004 include the
results of FAAC,  Epsilor and AoA for the periods  following our  acquisition of
each such company during 2004.  However,  the results of these subsidiaries were
not  included in our  operating  results for the year ended  December  31, 2003.
Accordingly,  the following  year-to-year  comparisons should not necessarily be
relied upon as indications of future performance.

         Following  is a table  summarizing  our results of  operations  for the
years  ended  December  31,  2004 and 2003,  after  which we present a narrative
discussion and analysis:

<TABLE>
<CAPTION>
                                                                         Year Ended December 31,
                                                                 -----------------------------------------
                                                                         2004                 2003*
                                                                 --------------------  -------------------
Revenues:
<S>                                                              <C>                 <C>
     Simulation and Security Division........................... $      21,464,406   1.$       8,022,026
     Armor Division.............................................        17,988,687             3,435,716
     Battery and Power Systems Division.........................        10,500,753             5,868,899
                                                                 --------------------  -------------------
                                                                  $     49,953,846      $     17,326,641
Cost of revenues:
     Simulation and Security Division...........................  $     11,739,690      $      3,944,701
     Armor Division.............................................        15,449,084             2,621,550
     Battery and Power Systems Division.........................         6,822,320             4,521,589
                                                                 --------------------  -------------------
                                                                  $     34,011,094      $     11,087,840
Research and development expenses:
     Simulation and Security Division...........................  $        395,636      $        132,615
     Armor Division.............................................            17,065                84,186
     Battery and Power Systems Division.........................         1,318,678               836,607
                                                                 --------------------  -------------------
                                                                  $      1,731,379      $      1,053,408
Sales and marketing expenses:
     Simulation and Security Division...........................  $      3,185,001      $      2,237,386
     Armor Division.............................................           565,981               180,631
     Battery and Power Systems Division.........................         1,171,235               926,872
     All Other..................................................                 -               187,747
                                                                 --------------------  -------------------
                                                                  $      4,922,217      $      3,532,636
General and administrative expenses:
     Simulation and Security Division...........................  $      2,852,969      $      1,001,404
     Armor Division.............................................         1,323,982               518,053
     Battery and Power Systems Division.........................           965,058               188,655
     All Other..................................................         5,514,857             4,149,764
                                                                 --------------------  -------------------
                                                                  $     10,656,866      $      5,857,876
</TABLE>


                                       49
<PAGE>
<TABLE>
<CAPTION>
                                                                         Year Ended December 31,
                                                                 -----------------------------------------
                                                                         2004                 2003*
                                                                 --------------------  -------------------
Financial expense (income):
<S>                                                               <C>                   <C>
     Simulation and Security Division...........................  $         27,842      $       (119,750)
     Armor Division.............................................            13,503               (19,918)
     Battery and Power Systems Division.........................            54,511                 7,936
     All Other..................................................         4,133,109             4,170,441
                                                                 --------------------  -------------------
                                                                  $      4,228,965      $      4,038,709
Tax expenses:
     Simulation and Security Division...........................  $         77,811      $         30,130
     Armor Division.............................................           134,949               363,173
     Battery and Power Systems Division.........................           320,878                     -
     All Other..................................................            52,471                 2,890
                                                                 --------------------  -------------------
                                                                  $        586,109      $        396,193
Amortization of intangible assets and impairment losses:
     Simulation and Security Division...........................  $      1,643,682      $        720,410
     Armor Division.............................................           661,914               144,500
     Battery and Power Systems Division.........................           509,239                     -
                                                                 --------------------  -------------------
                                                                  $      2,814,835      $        864,910
Minority interest in loss (profit) of subsidiaries:
     Simulation and Security Division...........................  $              -      $              -
     Armor Division.............................................           (44,694)              156,900
     Battery and Power Systems Division.........................                 -                     -
                                                                 --------------------  -------------------
                                                                  $        (44,694)     $        156,900
Loss from continuing operations:
     Simulation and Security Division...........................  $      1,541,775      $         75,130
     Armor Division.............................................          (222,485)             (299,559)
     Battery and Power Systems Division.........................          (661,166)             (612,760)
     All Other..................................................        (9,700,437)           (8,510,842)
                                                                 --------------------  -------------------
                                                                  $     (9,042,313)     $     (9,348,031)
Income from discontinued operations:
     Simulation and Security Division...........................  $              -      $              -
     Armor Division.............................................                 -                     -
     Battery and Power Systems Division.........................                 -               110,410
                                                                 --------------------  -------------------
                                                                  $              -      $        110,410
Net loss:
     Simulation and Security Division...........................  $      1,541,775      $         75,130
     Armor Division.............................................          (222,485)             (299,559)
     Battery and Power Systems Division.........................          (661,166)             (502,350)
     All Other..................................................        (9,700,437)           (8,510,842)
                                                                 --------------------  -------------------
                                                                  $     (9,042,313)     $     (9,237,621)
                                                                 ====================  ===================
</TABLE>

-----------------------------
     * Restated (see Note 1.b. of Notes to Consolidated Financial Statements).

         ADJUSTED EBITDA

         In this Item,  we use the term  "Adjusted  EBITDA."  Each  reference to
Adjusted  EBITDA  herein is  qualified  by  reference  to, and should be read in
conjunction with, this section and the reconciliation contained herein.

         Adjusted EBITDA,  as used herein,  is defined as earnings before income
taxes,  interest  expenses,   depreciation  and  amortization,  as  adjusted  to
eliminate  certain  non-cash  charges.  Adjusted  EBITDA is provided solely as a
supplemental   disclosure   because  we  believe   that  it   enhances   overall
understanding  of our current  financial  performance  and our  progress  toward
cash-flow break even and toward GAAP profitability.



                                       50
<PAGE>

         Adjusted  EBITDA is a  non-GAAP  financial  measure  as  defined in SEC
Regulation  G.  Adjusted  EBITDA is  presented  because it is a widely  accepted
financial  indicator  used by  investors  and  analysts  to analyze  and compare
companies on the basis of cash-flow break even and debt service  capability.  We
use Adjusted EBITDA to set targets and monitor and assess financial performance.
Adjusted  EBITDA should not be  considered  in isolation.  It is not intended to
represent cash flows for the periods presented,  nor has it been presented as an
alternative to net loss as an indicator of operating performance or to cash flow
as a measure of liquidity.

         The most  nearly  comparable  GAAP  measure to  Adjusted  EBITDA is net
income  or loss.  Following  is a  reconciliation  between  our net loss and our
Adjusted EBITDA for the years ended December 31, 2004, 2003 and 2002:

<TABLE>
<CAPTION>
                                 ADJUSTED EBITDA
-------------------------------------------------------------------------------------------------------------------
                                                                   2004              2003*              2002
                                                             ------------------ -----------------  ----------------
<S>                                                           <C>                <C>                <C>
Net loss from continuing operations before deemed dividend    $  (9,042,313)     $  (9,348,031)     $  (4,938,152)
  to certain shareholders (GAAP measure)....................
Add back:
Interest expense (income), net (after deduction of minority
  interest).................................................      4,226,312          4,039,950            (99,150)
Taxes (after deduction of minority interest)................        555,507            240,039                  -
Depreciation of fixed assets................................      1,199,465            730,159            473,739
Amortization of inventory adjustment to market values with
  the acquisition of one of our subsidiaries...............         920,544                  -                  -
Amortization of intangible assets, capitalized software
  costs and technology impairment...........................      2,888,226            879,312            649,543
                                                             ------------------ -----------------  ----------------
EBITDA (non-GAAP measure)...................................  $     747,741      $  (3,458,571)     $  (3,914,020)
                                                             ================== =================  ================
Add back certain non-cash charges:
Write-down of promissory notes..............................              -                  -            394,452
Expenses attributed on issuance of shares to consultants
  and as a donation.........................................         89,078            333,627                  -
Expenses attributed on issuance of warrants and options to
  employees, directors and consultants......................        662,392            276,045             19,000
Expenses attributed on issuance of shares to employees......        212,424                  -                  -
Markdown of loans to shareholders...........................         45,253                  -                  -
Non-cash portion of settlement agreement....................              -            688,642                  -
                                                             ------------------ -----------------  ----------------
ADJUSTED EBITDA (non-GAAP measure)..........................  $   1,756,888      $  (2,160,257)     $  (3,500,568)
                                                             ================== =================  ================
</TABLE>

---------------------
*Restated (see Note 1.b. of Notes to Consolidated Financial Statements).

         The Adjusted EBITDA information  presented herein may not be comparable
to similarly titled measures employed by other companies

     Fiscal Year 2004 compared to Fiscal Year 2003

         Revenues. During 2004, we recognized revenues as follows:

                  >>       From the sale of  interactive  training  systems  and
                           from the provision of warranty services in connection
                           with such systems (FAAC and IES);

                  >>       From payments  under armor  contracts and for service
                           and repair of armored vehicles (AoA and MDT);

                  >>       From the sale of batteries,  chargers and adapters to
                           the military, and under certain development contracts
                           with the U.S. Army (EFB and Epsilor);



                                       51
<PAGE>

                  >>       From the sale of lifejacket lights (EFL); and

                  >>       From  subcontracting fees received in connection with
                           Phase  III  of  the  United   States   Department  of
                           Transportation  (DOT)  electric  bus  program,  which
                           began  in  October  2003 and was  completed  in March
                           2004.  Phase IV of the DOT  program,  which  began in
                           October 2004,  did not result in any revenues  during
                           2004 (EFL).

         Revenues from  continuing  operations  for the year ended  December 31,
2004 totaled $50.0  million,  compared to $17.3 million for 2003, an increase of
$32.6  million,  or  188%.  This  increase  was  primarily  attributable  to the
following factors:

                  >>       Increased revenues from vehicle armoring; and

                  >>       Revenues  generated by FAAC,  Epsilor and AoA in 2004
                           that were not present in 2003.

         These  increases were offset to some extent by decreased  revenues from
sales of interactive  use-of-force  training systems and decreased revenues from
sales of our Zinc-Air military batteries.

         In 2004,  revenues were $21.5 million for the  Simulation  and Security
Division  (compared to $8.0 million in 2003,  an increase of $13.4  million,  or
168%, due primarily to the added revenues from sales of driver training  systems
since we acquired FAAC (approximately  $16.5 million),  offset to some extent by
decreased revenues from use-of-force  training  systems);  $18.0 million for the
Armor Division  (compared to $3.4 million in 2003, an increase of $14.6 million,
or 424%,  due primarily to increased  revenues from vehicle  armoring and to the
added revenues from aircraft  armoring since we acquired AoA); and $10.5 million
for the Battery and Power Systems Division (compared to $5.9 million in 2003, an
increase of $4.6 million, or 79%, due primarily to the added revenues from sales
of lithium batteries and chargers since we acquired Epsilor  (approximately $5.3
million), offset to some extent by decreased revenues from our Zinc-Air military
batteries).

         Cost of  revenues  and gross  profit.  Cost of revenues  totaled  $34.0
million  during 2004,  compared to $11.1  million in 2003,  an increase of $22.9
million, or 207%, due to increased cost of goods sold, particularly in the Armor
Division  (partly as a result of our beginning to sell  pre-armored  vehicles in
2004,  which  requires  us to purchase  vehicles  for  pre-armoring)  and in the
Simulation and Security Division,  as well as the inclusion of the cost of goods
of FAAC, Epsilor and AoA in our results for 2004 but not 2003.

         Direct expenses for our three divisions  during 2004 were $17.9 million
for the Simulation and Security  Division  (compared to $7.3 million in 2003, an
increase of $10.6  million,  or 145%,  due primarily to the addition of expenses
associated  with sales of driver training  systems  through FAAC  (approximately
$12.0 million),  offset to some extent by decreased expenses associated with the
sales of use-of-force  training  systems);  $16.4 million for the Armor Division
(compared to $3.6 million in 2003, an increase of $12.9  million,  or 359%,  due
primarily to increased  expenses  associated  with sales of vehicle  armoring (a
$12.1 million  increase in 2004,  including the expenses of purchasing  vehicles
for  pre-armoring in 2004,  which was not present in 2003),  and to the addition
beginning in August 2004 of expenses  associated with sales of aircraft armoring
through our new  subsidiary  AoA);  and $10.0  million for the Battery and Power


                                       52
<PAGE>

Systems Division (compared to $5.9 million in 2003, an increase of $4.0 million,
or 68%,  due  primarily  to the  addition of expenses  associated  with sales of
lithium  batteries  and  chargers  through  our  new  Epsilor  subsidiary  ($4.2
million),  offset to some extent by decreased expenses associated with the sales
of Zinc-Air military batteries).

         Gross profit was $15.9  million  during 2004,  compared to $6.2 million
during 2003, an increase of $9.7 million,  or 155%. This increase was the direct
result of all factors  presented  above,  most  notably the  inclusion  of FAAC,
Epsilor  and  AoA in our  results  for  2004  ($10.2  million),  as  well as the
increased  revenues from vehicle armoring ($1.6 million),  offset to some extent
by a decrease of $2.0 million in gross profit from IES.

         Research and development  expenses.  Research and development  expenses
for 2004 were $1.7  million,  compared to $1.1  million in 2003,  an increase of
$678,000, or 64%. This increase was primarily the result of the inclusion of the
research  and  development  expenses of FAAC,  Epsilor and AoA in our results in
2004 ($533,000) and increased research and development expenses of EFL and EFB.

         Sales and marketing  expenses.  Sales and  marketing  expenses for 2004
were $4.9  million,  compared  to $3.5  million  in 2003,  an  increase  of $1.4
million,  or 39%. This increase was primarily  attributable  to the inclusion of
the sales and  marketing  expenses  of FAAC,  Epsilor and AoA in our results for
2004 ($2.0 million), offset to some extent by a decrease of $600,000 in expenses
related to our military batteries and a decrease in sales and marketing expenses
related to interactive use-of-force training.

         General  and  administrative   expenses.   General  and  administrative
expenses  for 2004 were $10.7  million,  compared  to $5.9  million in 2003,  an
increase of $4.8 million,  or 82%. This increase was primarily  attributable  to
the following factors:

                  >>       The  inclusion  of  the  general  and  administrative
                           expenses of FAAC,  Epsilor and AoA in our results for
                           2004 ($2.4 million);

                  >>       Expenses in 2004 in connection  with grant of options
                           and shares to employees that were not present in 2003
                           ($830,000);

                  >>       Costs associated with our compliance with Section 404
                           of the  Sarbanes-Oxley  Act of  2002  that  were  not
                           present in 2003 ($150,000); and

                  >>       Increases   in  other   general  and   administrative
                           expenses,  such as  employee  salaries  and  bonuses,
                           travel  expenses,  audit fees,  director fees,  legal
                           fees, and expenses related to due diligence performed
                           in connection to certain potential acquisitions, that
                           were not present in 2003.

         We are not  anticipating a reduction in our general and  administrative
expenses in the coming year, and we expect that our travel expenses, audit fees,
legal fees,  and due diligence  expenses will continue or increase to the extent
that we continue to pursue acquisitions in the future.



                                       53
<PAGE>

         These increases were offset to some extent by:

                  >>       Expenses  in 2003  in  connection  with a  litigation
                           settlement  agreement  that were not  present in 2004
                           ($700,000); and

                  >>       Amortization of legal and consulting expenses in 2003
                           in connection  with our  convertible  debentures that
                           were lower (by $260,000) than in 2004.

         Adjusted EBITDA. Due to the factors cited above, we had Adjusted EBITDA
of $1.8 million in 2004,  compared to Adjusted EBITDA of $(2.2) million in 2003.
For an explanation of Adjusted EBITDA, a non-GAAP measure,  and a reconciliation
with the most nearly  comparable  GAAP  measure,  see  "Results of  Operations -
Preliminary Note - Adjusted EBITDA," above.

         Financial expenses,  net. Financial expense, net of interest income and
exchange  differentials,  totaled approximately $4.2 million in 2004 compared to
$4.0 million in 2003, an increase of $190,000,  or 5%. This  difference  was due
primarily  to  amortization  of  debt  discount   related  to  the  issuance  of
convertible  debentures  and  their  conversion,  as well as  interest  expenses
related to those debentures.

         Income taxes. We and certain of our subsidiaries incurred net operating
losses during 2004 and, accordingly,  we were not required to make any provision
for income taxes.  With respect to some of our  subsidiaries  that operated at a
net profit  during 2004,  we were able to offset  federal  taxes against our net
operating loss carry  forwards.  We recorded a total of $586,000 in tax expenses
in 2004,  with  respect to certain of our  subsidiaries  that  operated at a net
profit  during 2004 and we are not able to offset  their  taxes  against our net
operating  loss carry  forwards and with respect to state  taxes.  In 2003,  tax
expenses were recorded with respect to MDT's taxable income. Out of the $586,000
tax expense  that we  recorded  in 2004,  $84,000 was related to prior years and
$(37,000) represented income from deferred taxes, net.

         Amortization of intangible  assets.  Amortization of intangible  assets
totaled $2.8 million in 2004,  compared to $865,000 in 2003, an increase of $1.9
million,  or 225%,  resulting  from the  inclusion  of the  amortization  of the
intangible assets of FAAC, Epsilor and AoA in our results in 2004 and impairment
in the  amount  of  $320,000  of  technology  previously  purchased  by IES from
Bristlecone Technologies.

         Net  loss  before   deemed   dividend   of  common   stock  to  certain
stockholders.  Due to the factors  cited  above,  we reported a net loss of $9.0
million in 2004,  compared to a net loss of $9.2  million in 2003, a decrease of
$195,000, or 2%.

         Net loss after deemed dividend of common stock to certain  stockholders
was $12.4  million due to a deemed  dividend of $3.3 million (see Notes  14.f.4.
and 14.f.5.  to the financial  statements)  compared to $9.6 million in 2003, an
increase of 2.8 million, or 29%.

     Fiscal Year 2003 compared to Fiscal Year 2002

         Revenues.   During  2003,  we  (through  our  subsidiaries)  recognized
revenues as follows:

                  >>       IES recognized  revenues from the sale of interactive
                           use-of-force  training systems and from the provision
                           of warranty services in connection with such systems;



                                       54
<PAGE>

                  >>       MDT  recognized  revenues from payments under vehicle
                           armoring  contracts  and for  service  and  repair of
                           armored vehicles;

                  >>       EFB  recognized  revenues  from the sale of batteries
                           and  adapters  to the  military,  and  under  certain
                           development contracts with the U.S. Army;

                  >>       Arocon    recognized    revenues   under   consulting
                           agreements; and

                  >>       EFL  recognized  revenues from the sale of lifejacket
                           lights  and  from  subcontracting  fees  received  in
                           connection  with  Phase  III  of  the  United  States
                           Department  of  Transportation   (DOT)  electric  bus
                           program,   which  began  in  October   2002  and  was
                           completed in March 2004. Phase IV of the DOT program,
                           which  began in October  2003,  did not result in any
                           revenues during 2003.

         Revenues from  continuing  operations  for the year ended  December 31,
2003 totaled  $17.3  million,  compared to $6.4 million for 2002, an increase of
$10.9  million,  or 170%.  This  increase was  primarily the result of increased
sales  attributable  to IES and EFB, as well as the  inclusion of IES and MDT in
our results for the full year of 2003 but only part of 2002.

         In 2003,  revenues  were $8.0 million for the  Simulation  and Security
Division  (compared to $2.0  million in 2002,  an increase of $6.0  million,  or
305%,  due primarily to the inclusion of IES in our results for the full year of
2003 but only part of 2002),  $5.9  million for the  Battery  and Power  Systems
Division (compared to $1.7 million in the comparable period in 2002, an increase
of $4.2 million,  or 249%, due primarily to increased  sales to the U.S. Army on
the part of EFB),  and $3.4  million for the Armor  Division  (compared  to $2.7
million in 2002, an increase of $691,000, or 25%, due primarily to the inclusion
of MDT in our results for the full year of 2003 but only part of 2002).

         Cost of  revenues  and gross  profit.  Cost of revenues  totaled  $11.1
million  during  2003,  compared  to $4.4  million in 2002,  an increase of $6.7
million,  or 151%, due to increased cost of goods sold,  particularly by IES and
EFB, as well as the inclusion of IES and MDT in our results for the full year of
2003 but only part of 2002.

         Direct expenses for our three  divisions  during 2003 were $7.3 million
for the Simulation and Security  Division  (compared to $2.0 million in 2002, an
increase of $5.3 million, or 259%, due primarily to increased sales attributable
to the  inclusion  of IES in our results for the full year of 2003 but only part
of 2002),  $5.9 million for the Battery and Power Systems Division  (compared to
$3.1 million in the comparable  period in 2002, an increase of $2.9 million,  or
94%, due primarily to increased sales on the part of EFB to the U.S. Army),  and
$3.6  million  for the Armor  Division  (compared  to $2.3  million in 2002,  an
increase of $1.3  million,  or 55%, due primarily to the inclusion of MDT in our
results for the full year of 2003 but only part of 2002).

         Gross  profit was $6.2 million  during  2003,  compared to $2.0 million
during 2002, an increase of $4.3 million,  or 214%. This increase was the direct
result of all factors  presented above,  most notably the increased sales of IES
and EFB,  as well as the  inclusion  of IES and MDT in our  results for the full
year of 2003 but only part of 2002. In 2003, IES contributed $4.1 million to our
gross profit, EFB contributed $1.6 million, and MDT contributed $833,000.



                                       55
<PAGE>

         Research and development  expenses.  Research and development  expenses
for 2003 were $1.1  million,  compared  to  $686,000  in 2002,  an  increase  of
$367,000,  or 54%.  This  increase was primarily  because  certain  research and
development  personnel  who had  worked  on the  discontinued  consumer  battery
operations  during  2002 (the  expenses of which are not  reflected  in the 2002
number above) were  reassigned to military  battery  research and development in
2003.

         Sales and marketing  expenses.  Sales and  marketing  expenses for 2003
were $3.5  million,  compared  to $1.3  million  in 2002,  an  increase  of $2.2
million,  or 170%.  This  increase was primarily  attributable  to the following
factors:

                  >>       The inclusion of the sales and marketing  expenses of
                           IES and MDT in our  results for the full year of 2003
                           but only part of 2002;

                  >>       An  increase  in IES's sales  activity  during  2003,
                           which resulted in both increased  sales and increased
                           sales and marketing expenses during 2003; and

                  >>       We incurred expenses for consultants in the amount of
                           $810,000 in connection with our CECOM battery program
                           with the U.S.  Army and $345,000 in  connection  with
                           our security consulting business.

         General  and  administrative   expenses.   General  and  administrative
expenses  for 2003 were $5.9  million,  compared  to $4.0  million  in 2002,  an
increase of $1.8 million,  or 46%. This increase was primarily  attributable  to
the following factors:

                  >>       The  inclusion  of  the  general  and  administrative
                           expenses  of IES and MDT in our  results for the full
                           year of 2003 but only part of 2002;

                  >>       Expenses  in 2003  in  connection  with a  litigation
                           settlement agreement, in the amount of $714,000, that
                           were not present in 2002;

                  >>       Expenses in 2003 in connection  with warrant  grants,
                           in the amount of  $199,500,  that were not present in
                           2002;

                  >>       Legal and  consulting  expenses in 2003 in connection
                           with our  convertible  debentures,  in the  amount of
                           $484,000, that were not present in 2002; and

                  >>       Expenses in 2003 in  connection  with the start-up of
                           our security consulting business in the United States
                           and with the beginning of operations of MDT Armor, in
                           the  amount of  $250,000,  that were not  present  in
                           2002.

         Adjusted EBITDA. Due to the factors cited above, we had Adjusted EBITDA
of $(2.2)  million in 2003,  compared  to Adjusted  EBITDA of $(3.5)  million in
2002.  For  an  explanation  of  Adjusted  EBITDA,  a  non-GAAP  measure,  and a
reconciliation  with the most nearly  comparable  GAAP measure,  see "Results of
Operations - Preliminary Note - Adjusted EBITDA," above.

         Financial income  (expense).  Financial  expense totaled  approximately
$4.0  million in 2003  compared to  financial  income of  $100,000  in 2002,  an
increase of $4.1 million.  This increase was due  primarily to  amortization  of
compensation  related  to the  issuance  of  convertible  debentures  issued  in
December  2002 and  during  2003 in the  amount of $3.9  million,  and  interest
expenses related to those debentures in the amount of $376,000.



                                       56
<PAGE>

         Tax expenses.  We and our Israeli subsidiary EFL incurred net operating
losses during 2003 and 2002 and,  accordingly,  we were not required to make any
provision for income taxes.  MDT and IES had taxable income,  and accordingly we
were  required to make  provision  for income taxes in the amount of $396,000 in
2003. We were able to offset IES's federal taxes against our loss carryforwards.
In 2002 we did not accrue any tax  expenses  due to our belief  that we would be
able to utilize our loss carryforwards against MDT's taxable income,  estimation
was revised in 2003. Of the amount accrued in 2003,  approximately  $352,000 was
accrued on account of income in 2002.

         Amortization   of  intangible   assets  and  in-process   research  and
development.  Amortization  of  intangible  assets  totaled  $865,000  in  2003,
compared to $649,000 in 2002, an increase of $215,000,  or 33%,  resulting  from
amortization  of these assets  subsequent to our  acquisition  of IES and MDT in
2002. Of this $215,000  increase,  $169,000 was  attributable to IES and $46,000
was attributable to MDT.

         Loss from  continuing  operations.  Due to the factors cited above,  we
reported a net loss from continuing operations of $9.3 million in 2003, compared
to a net loss of $4.9 million in 2002, an increase of $4.4 million, or 90%.

         Profit  (loss) from  discontinued  operations.  In the third quarter of
2002, we decided to discontinue  operations  relating to the retail sales of our
consumer  battery  products.  Accordingly,  all revenues and expenses related to
this segment have been  presented in our  consolidated  statements of operations
for the years ended  December 31, 2003 and 2002 in an item  entitled  "Loss from
discontinued operations."

         Income from discontinued operations in 2003 was $110,000, compared to a
loss of $13.6  million in 2002, a decrease of $13.7  million.  This decrease was
the result of the elimination of the losses from these  discontinued  operations
beginning  with  the  fourth  quarter  of 2002.  The  income  from  discontinued
operations was primarily from  cancellation of past accruals made unnecessary by
the closing of the discontinued operations.

         Net loss before deemed  dividend.  Due to the factors  cited above,  we
reported a net loss before deemed dividend of $9.2 million in 2003,  compared to
a net loss of $18.5 million in 2002, a decrease of $9.3 million, or 50%.

         Net loss after deemed dividend of common stock to certain stockholders.
Due to the factors cited above,  we reported a net loss after deemed dividend of
$9.6  million  in  2003,  compared  to a net loss of $18.5  million  in 2002,  a
decrease of $8.9 million, or 48%.

Liquidity and Capital Resources

         As of December 31, 2004,  we had $6.7 million in cash,  $7.0 million in
restricted collateral securities and restricted  held-to-maturity securities due
within one year, $4.0 million in long-term restricted deposits,  and $136,000 in
available-for-sale  marketable securities,  as compared to at December 31, 2003,
when we had $13.7 million in cash and $706,000 in  restricted  cash deposits due
within one year.  The decrease in cash was  primarily the result of the costs of
the  acquisitions  of FAAC,  Epsilor and AoA, and working  capital needed in our
other segments.



                                       57
<PAGE>

         We used available funds in 2004 primarily for  acquisitions,  sales and
marketing,  continued research and development  expenditures,  and other working
capital  needs.  We  increased  our  investment  in fixed assets by $1.7 million
during the year ended  December  31,  2004,  primarily  in the Battery and Power
Systems  Division and in the  Simulation  and Security  Division.  Our net fixed
assets amounted to $4.6 million as at year end.

         Net cash used in  operating  activities  for 2004 and 2003 was $852,000
and $3.3  million,  respectively,  a  decrease  of $2.5  million,  or 75%.  This
decrease was  primarily  the result of an increase in our adjusted net income in
2004 (net income in  statement  of  operations  less  non-cash  charges  such as
depreciation,  amortization,  non-cash  financial expenses and non-cash expenses
related to options and warrants).

         Net cash  used in  investing  activities  for  2004 and 2003 was  $50.5
million and $1.8  million,  respectively,  an increase  of $48.7  million.  This
increase was primarily the result of our investment in the  acquisition of FAAC,
Epsilor and AoA in 2004.

         Net cash provided by financing  activities  for 2004 and 2003 was $44.4
million and $17.4 million,  respectively, an increase of $27.0 million, or 156%.
This increase was primarily the result of higher amounts of funds raised through
sales of our securities in 2004 compared to 2003.

         During  2004,  certain of our  employees  exercised  options  under our
registered  employee  stock option plan.  The proceeds to us from the  exercised
options were approximately $1.1 million.

         We have  approximately  $5.5 million in long-term debt outstanding (not
including  accrued  severance  pay),  of  which  $4.5  million  was  related  to
convertible  debt  (unamortized  financial  expenses  related to the  beneficial
conversion  feature of these  convertible  debentures  amounted to approximately
$2.8 million at year end), and  approximately  $13.7 million in short-term  debt
(not  including  trade  payables  and other  accounts  payable),  of which $13.4
million relates to the earn-out  provision in connection with our acquisition of
FAAC.

         Our  debt  agreements   contain  customary   affirmative  and  negative
operations covenants that limit the discretion of our management with respect to
certain business matters and place restrictions on us, including  obligations on
our part to preserve and maintain our assets and  restrictions on our ability to
incur or guarantee  debt,  to merge with or sell our assets to another  company,
and  to  make  significant  capital  expenditures  without  the  consent  of the
debenture holders, as well as granting to our investors a right of first refusal
on any future financings,  except for underwritten public offerings in excess of
$30 million.  We do not believe that this right of first refusal will materially
limit our ability to undertake future financings.

         Based on our  internal  forecasts,  we believe  that our  present  cash
position and  anticipated  cash flows from  operations  should be  sufficient to
satisfy  our current  estimated  cash  requirements  through at least the twelve
months. This belief is based on certain assumptions that our management believes
to be reasonable,  some of which are subject to the risk factors detailed below.
Over the long term, we will need to become  profitable,  at least on a cash-flow
basis,  and  maintain  that  profitability  in  order to  avoid  future  capital
requirements.  Additionally,  we would need to raise additional capital in order
to fund any future acquisitions.



                                       58
<PAGE>

Effective Corporate Tax Rate

         We and certain of our subsidiaries incurred net operating losses during
the years ended December 31, 2002,  2003 and 2004, and  accordingly no provision
for income taxes was  required.  With  respect to some of our U.S.  subsidiaries
that operated at a net profit during 2004, we were able to offset  federal taxes
against our net operating loss carryforward, which amounted to $23 million as of
December 31, 2004. These subsidiaries are, however,  subject to state taxes that
cannot be offset  against our net operating loss  carryforward.  With respect to
certain of our Israeli  subsidiaries  that operated at a net profit during 2004,
we  were  unable  to  offset  their  taxes  against  our  net   operating   loss
carryforward,  and we are therefore exposed to Israeli taxes, at a rate of up to
35% (less,  in the case of companies that have "approved  enterprise"  status as
discussed in Note 15 to the Notes to Financial Statements).

         As of December 31, 2004, we had a U.S. net operating loss  carryforward
of approximately $23.0 million that is available to offset future taxable income
under certain  circumstances,  expiring  primarily  from 2009 through 2024,  and
foreign net  operating and capital loss  carryforwards  of  approximately  $87.0
million,  which are available indefinitely to offset future taxable income under
certain circumstances.

Contractual Obligations

         The following table lists our  contractual  obligations and commitments
as of December  31,  2004,  not  including  trade  payables  and other  accounts
payable:

<TABLE>
<CAPTION>
   Contractual Obligations                                     Payment Due by Period
------------------------------ ------------------------------------------------------------------------------------
                                    Total       Less Than 1 Year    1-3 Years        3-5 Years     More than 5 Years
------------------------------ ---------------- ---------------- ---------------- ---------------- ----------------
<S>                             <C>              <C>              <C>              <C>              <C>
Long-term debt*.................$..5,558,391     $           -    $   5,558,391    $          -     $           -
Short-term debt**...............$.13,766,677     $  13,766,677    $           -    $          -     $           -
Operating lease obligations.....$..1,427,965     $     762,636    $     641,017    $     24,312     $           -
Severance obligations***........$..1,642,801     $     223,333    $   1,240,871    $          -     $     178,597
</TABLE>

-------------------
  *  Includes  convertible   debentures  in  the  gross  amount  of  $4,537,500.
     Unamortized financial expenses related to the beneficial conversion feature
     of these convertible debentures amounted to $2,782,697 at year end.
**   Includes  sums owed in  respect  of an  earn-out  provision  related to our
     acquisition of FAAC, in the amount of $13.4 million.
***  Includes  obligations  related to special  severance  pay  arrangements  in
     addition  to the  severance  amounts due to certain  employees  pursuant to
     Israeli severance pay law.

                                  RISK FACTORS

         The  following  factors,  among others,  could cause actual  results to
differ  materially  from those contained in  forward-looking  statements made in
this Report and presented elsewhere by management from time to time.

Business-Related Risks

     We have had a history of losses and may incur future losses.

         We were  incorporated in 1990 and began our operations in 1991. We have
funded  our  operations  principally  from funds  raised in each of the  initial
public offering of our common stock in February 1994;  through subsequent public
and  private  offerings  of our  common  stock and  equity  and debt  securities
convertible or exercisable into shares of our common stock;  research  contracts
and supply contracts;  funds received under research and development grants from
the  Government of Israel;  and sales of products  that we and our  subsidiaries
manufacture.  We have  incurred  significant  net  losses  since our  inception.
Additionally,  as of  December  31,  2004,  we had  an  accumulated  deficit  of
approximately  $119.0  million.  There can be no assurance  that we will ever be
able to achieve or maintain profitability consistently or that our business will
continue to exist.



                                       59
<PAGE>

         Our existing  indebtedness  may adversely  affect our ability to obtain
additional  funds and may  increase  our  vulnerability  to economic or business
downturns.

         Our bank and certificated  indebtedness  aggregated  approximately $5.5
million  as of  December  31,  2004.  Accordingly,  we are  subject to the risks
associated with indebtedness, including:

                  o        we must  dedicate  a portion  of our cash  flows from
                           operations  to  pay  debt  service  costs  and,  as a
                           result,  we have less funds available for operations,
                           future    acquisitions    of   consumer    receivable
                           portfolios, and other purposes;

                  o        it may be more  difficult  and  expensive  to  obtain
                           additional funds through financings,  if available at
                           all;

                  o        we are more  vulnerable  to  economic  downturns  and
                           fluctuations   in  interest   rates,   less  able  to
                           withstand  competitive pressures and less flexible in
                           reacting  to  changes  in our  industry  and  general
                           economic conditions; and

                  o        if  we  default   under  any  of  our  existing  debt
                           instruments  or if our creditors  demand payment of a
                           portion or all of our  indebtedness,  we may not have
                           sufficient funds to make such payments.

The  occurrence  of any of these events could  materially  adversely  affect our
results of  operations  and financial  condition and adversely  affect our stock
price.

         The agreements  governing the terms of our debentures  contain numerous
affirmative  and negative  covenants that limit the discretion of our management
with respect to certain business matters and place restrictions on us, including
obligations on our part to preserve and maintain our assets and  restrictions on
our  ability  to incur or  guarantee  debt,  to merge with or sell our assets to
another  company,  and to make  significant  capital  expenditures  without  the
consent of the  debenture  holders.  Our  ability to comply with these and other
provisions of such agreements may be affected by changes in economic or business
conditions or other events beyond our control.

         Failure to comply with the terms of our  debentures  could  result in a
default that could have material adverse consequences for us.

         A failure to comply with the  obligations  contained  in our  debenture
agreements could result in an event of default under such agreements which could
result in an acceleration  of the debentures and the  acceleration of debt under
other instruments evidencing indebtedness that may contain cross-acceleration or
cross-default  provisions.  If the  indebtedness  under the  debentures or other
indebtedness  were to be accelerated,  there can be no assurance that our assets
would be sufficient to repay in full such indebtedness.



                                       60
<PAGE>

   We have pledged a substantial portion of our assets to secure our borrowings.

         Our debentures are secured by a substantial  portion of our assets.  If
we default under the indebtedness  secured by our assets,  those assets would be
available  to the secured  creditors to satisfy our  obligations  to the secured
creditors, which could materially adversely affect our results of operations and
financial condition and adversely affect our stock price.

     We need significant amounts of capital to operate and grow our business.

         We require  substantial  funds to market our  products  and develop and
market  new  products.  To the  extent  that we are  unable  to  fully  fund our
operations  through  profitable  sales  of our  products  and  services,  we may
continue to seek additional funding, including through the issuance of equity or
debt securities. However, there can be no assurance that we will obtain any such
additional  financing in a timely  manner,  on acceptable  terms,  or at all. If
additional funds are raised by issuing equity securities, stockholders may incur
further dilution.  If additional funding is not secured, we will have to modify,
reduce,  defer or eliminate parts of our anticipated  future  commitments and/or
programs.

     We may not be successful in operating new businesses.

         Prior to the  acquisitions of IES and MDT in 2002 and the  acquisitions
of FAAC and Epsilor in January 2004 and AoA in August 2004, our primary business
was the marketing and sale of products based on primary and refuelable  Zinc-Air
fuel cell  technology  and  advancements  in battery  technology for defense and
security  products  and  other  military  applications,  electric  vehicles  and
consumer electronics.  As a result of our acquisitions,  a substantial component
of our business is the marketing and sale of hi-tech  multimedia and interactive
training  solutions  and  sophisticated   lightweight   materials  and  advanced
engineering  processes  used  to  armor  vehicles.   These  are  relatively  new
businesses  for us and our  management  group has limited  experience  operating
these types of  businesses.  Although we have  retained our acquired  companies'
management personnel, we cannot assure that such personnel will continue to work
for us or that we will be successful in managing these new businesses. If we are
unable to  successfully  operate these new businesses,  our business,  financial
condition and results of operations could be materially impaired.

     Our acquisition strategy involves various risks.

         Part of our  strategy is to grow through the  acquisition  of companies
that will  complement  our existing  operations or provide us with an entry into
markets  we  do  not  currently  serve.  Growth  through  acquisitions  involves
substantial  risks,  including  the risk of improper  valuation  of the acquired
business and the risk of inadequate integration.  There can be no assurance that
suitable  acquisition  candidates  will  be  available,  that we will be able to
acquire  or  manage   profitably  such  additional   companies  or  that  future
acquisitions  will  produce  returns that justify our  investments  therein.  In
addition,  we may compete  for  acquisition  and  expansion  opportunities  with
companies that have  significantly  greater  resources than we do.  Furthermore,
acquisitions  could disrupt our ongoing business,  distract the attention of our
senior  officers,  make it  difficult  to maintain  our  operational  standards,
controls and  procedures  and subject us to contingent and latent risks that are
different, in nature and magnitude, than the risks we currently face.

         We may  finance  future  acquisitions  with  cash  from  operations  or
additional debt or equity financings.  There can be no assurance that we will be
able to generate  internal cash or obtain  financing  from  external  sources or
that,  if  available,  such  financing  will be on terms  acceptable  to us. The


                                       61
<PAGE>

issuance  of  additional  common  stock to  finance  acquisitions  may result in
substantial  dilution to our stockholders.  Any debt financing may significantly
increase  our  leverage and may involve  restrictive  covenants  which limit our
operations.

     We may not successfully integrate our acquisitions.

         In light of our  acquisitions  of IES, MDT, FAAC,  Epsilor and AoA, our
success will depend in part on our ability to manage the combined  operations of
these companies and to integrate the operations and personnel of these companies
along with our other  subsidiaries  and divisions  into a single  organizational
structure.  There  can be no  assurance  that we  will  be  able to  effectively
integrate  the  operations  of our  subsidiaries  and divisions and our acquired
businesses  into  a  single  organizational  structure.   Integration  of  these
operations could also place additional pressures on our management as well as on
our key technical resources. The failure to successfully manage this integration
could have an adverse material effect on us.

         If we  are  successful  in  acquiring  additional  businesses,  we  may
experience  a period of rapid  growth  that could place  significant  additional
demands on, and require us to expand,  our management,  resources and management
information  systems.  Our failure to manage any such rapid  growth  effectively
could have a material  adverse  effect on our  financial  condition,  results of
operations and cash flows.

  If we are unable to manage our growth, our operating results will be impaired.

         As a result of our acquisitions, we are currently experiencing a period
of significant  growth and development  activity which could place a significant
strain on our  personnel and  resources.  Our activity has resulted in increased
levels of responsibility for both existing and new management personnel. Many of
our management  personnel have had limited or no experience in managing  growing
companies.  We have sought to manage our current and anticipated  growth through
the  recruitment  of  additional  management  and  technical  personnel  and the
implementation of internal systems and controls.  However, our failure to manage
growth effectively could adversely affect our results of operations.

     A significant  portion of our business is dependent on government
contracts and reduction or reallocation  of defense or law enforcement  spending
could reduce our revenues.

         Many of the  customers  of IES,  FAAC and AoA to date  have been in the
public sector of the U.S.,  including the federal,  state and local governments,
and in the  public  sectors  of a number of other  countries,  and most of MDT's
customers  have been in the public sector in Israel,  in particular the Ministry
of Defense. Additionally, all of EFB's sales to date of battery products for the
military  and  defense  sectors  have been in the  public  sector in the  United
States. A significant  decrease in the overall level or allocation of defense or
law  enforcement  spending  in the U.S.  or other  countries  could  reduce  our
revenues and have a material  adverse effect on our future results of operations
and financial  condition.  MDT has already experienced a slowdown in orders from
the Ministry of Defense due to budget  constraints and a requirement of U.S. aid
to Israel that a substantial  proportion of such aid be spent in the U.S., where
MDT has only recently opened a factory.



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<PAGE>

         Sales to public  sector  customers  are  subject to a  multiplicity  of
detailed  regulatory  requirements  and public policies as well as to changes in
training and purchasing  priorities.  Contracts with public sector customers may
be conditioned upon the continuing  availability of public funds,  which in turn
depends upon  lengthy and complex  budgetary  procedures,  and may be subject to
certain pricing  constraints.  Moreover,  U.S. government contracts and those of
many  international  government  customers  may  generally be  terminated  for a
variety  of  factors  when it is in the best  interests  of the  government  and
contractors may be suspended or debarred for misconduct at the discretion of the
government.  There can be no assurance  that these  factors or others  unique to
government  contracts or the loss or suspension of necessary regulatory licenses
will not reduce our  revenues and have a material  adverse  effect on our future
results of operations and financial condition.

      Our  U.S.  government  contracts  may be  terminated  at any  time and may
contain other unfavorable provisions.

         The U.S.  government  typically  can  terminate  or  modify  any of its
contracts  with us either  for its  convenience  or if we  default by failing to
perform under the terms of the applicable contract. A termination arising out of
our default could expose us to liability and have a material  adverse  effect on
our ability to re-compete for future contracts and orders.  Our U.S.  government
contracts  contain  provisions  that allow the U.S.  government to  unilaterally
suspend us from receiving new contracts pending resolution of alleged violations
of  procurement  laws or  regulations,  reduce the value of existing  contracts,
issue  modifications  to a contract  and control and  potentially  prohibit  the
export of our products, services and associated materials.

         A negative  audit by the U.S.  government  could  adversely  affect our
business,  and we might not be  reimbursed by the  government  for costs that we
have expended on our contracts.

         Government  agencies  routinely  audit  government   contracts.   These
agencies review a contractor's  performance on its contract,  pricing practices,
cost structure and compliance with applicable  laws,  regulations and standards.
If we are  audited,  we  will  not be  reimbursed  for  any  costs  found  to be
improperly  allocated  to a specific  contract,  while we would be  required  to
refund any improper costs for which we had already been  reimbursed.  Therefore,
an  audit  could  result  in a  substantial  adjustment  to our  revenues.  If a
government audit uncovers improper or illegal  activities,  we may be subject to
civil and criminal penalties and administrative sanctions, including termination
of  contracts,  forfeitures  of  profits,  suspension  of  payments,  fines  and
suspension  or  debarment  from doing  business  with United  States  government
agencies.   We  could  suffer  serious   reputational  harm  if  allegations  of
impropriety were made against us. A governmental determination of impropriety or
illegality,  or an  allegation  of  impropriety,  could have a material  adverse
effect on our business, financial condition or results of operations.

      We may be liable for penalties  under a variety of  procurement  rules and
regulations,  and changes in government  regulations  could adversely impact our
revenues, operating expenses and profitability.

         Our defense and commercial businesses must comply with and are affected
by various  government  regulations  that  impact our  operating  costs,  profit
margins and our internal organization and operation of our businesses. Among the
most significant regulations are the following:



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<PAGE>

                  o        the  U.S.  Federal  Acquisition  Regulations,   which
                           regulate   the    formation,    administration    and
                           performance of government contracts;

                  o        the U.S.  Truth in  Negotiations  Act, which requires
                           certification  and disclosure of all cost and pricing
                           data in connection with contract negotiations; and

                  o        the U.S.  Cost  Accounting  Standards,  which  impose
                           accounting  requirements  that  govern  our  right to
                           reimbursement  under  certain  cost-based  government
                           contracts.

         These  regulations  affect how we and our customers do business and, in
some instances,  impose added costs on our businesses. Any changes in applicable
laws could adversely affect the financial  performance of the business  affected
by the changed  regulations.  With  respect to U.S.  government  contracts,  any
failure to comply with  applicable  laws could  result in contract  termination,
price or fee  reductions or suspension or debarment  from  contracting  with the
U.S. government.

      Our operating  margins may decline under our  fixed-price  contracts if we
fail to estimate  accurately  the time and  resources  necessary  to satisfy our
obligations.

         Some of our contracts are fixed-price contracts under which we bear the
risk of any cost overruns. Our profits are adversely affected if our costs under
these contracts exceed the assumptions that we used in bidding for the contract.
Often,  we are  required to fix the price for a contract  before we finalize the
project  specifications,  which  increases the risk that we will mis-price these
contracts. The complexity of many of our engagements makes accurately estimating
our time and resources more difficult.

      If we are  unable to retain our  contracts  with the U.S.  government  and
subcontracts under U.S. government prime contracts in the competitive  rebidding
process, our revenues may suffer.

         Upon expiration of a U.S.  government  contract or subcontract  under a
U.S.  government  prime contract,  if the government  customer  requires further
services of the type provided in the contract, there is frequently a competitive
rebidding  process.  We cannot  guarantee that we, or if we are a  subcontractor
that the prime contractor,  will win any particular bid, or that we will be able
to replace  business lost upon expiration or completion of a contract.  Further,
all U.S.  government  contracts  are  subject  to protest  by  competitors.  The
termination of several of our significant  contracts or nonrenewal of several of
our significant contracts, could result in significant revenue shortfalls.

      The loss of, or a significant  reduction in, U.S.  military business would
have a material adverse effect on us.

         U.S.  military  contracts  account  for a  significant  portion  of our
business.  The U.S. military funds these contracts in annual  increments.  These
contracts require subsequent  authorization and appropriation that may not occur
or that may be  greater  than or less  than the total  amount  of the  contract.
Changes in the U.S.  military's budget,  spending  allocations and the timing of
such spending could  adversely  affect our ability to receive future  contracts.
None of our contracts with the U.S. military has a minimum purchase  commitment,
and  the  U.S.  military  generally  has  the  right  to  cancel  its  contracts


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<PAGE>

unilaterally without prior notice. We manufacture for the U.S. aircraft and land
vehicle armor  systems,  protective  equipment for military  personnel and other
technologies  used to  protect  soldiers  in a variety  of  life-threatening  or
catastrophic situations,  and batteries for communications devices. The loss of,
or a significant  reduction in, U.S. military business for our aircraft and land
vehicle armor systems,  other  protective  equipment,  or batteries could have a
material  adverse  effect  on our  business,  financial  condition,  results  of
operations and liquidity.

      A  reduction  of U.S.  force  levels in Iraq may  affect  our  results  of
operations.

         Since the  invasion of Iraq by the U.S. and other forces in March 2003,
we have received steadily  increasing orders from the U.S. military for armoring
of vehicles and military batteries.  These orders are the result, in substantial
part, from the particular combat situations  encountered by the U.S. military in
Iraq. We cannot be certain,  therefore,  to what degree the U.S.  military would
continue placing orders for our products if the U.S. military were to reduce its
force levels or withdraw completely from Iraq. A significant reduction in orders
from the U.S.  military  could have a material  adverse  effect on our business,
financial condition, results of operations and liquidity.

      There  are  limited  sources  for  some of our raw  materials,  which  may
significantly curtail our manufacturing operations.

         The raw  materials  that we use in  manufacturing  our  armor  products
include  Kevlar(R),  a patented  product of E.I. du Pont de Nemours Co., Inc. We
purchase  Kevlar in the form of woven  cloth from  various  independent  weaving
companies.  In the event Du Pont and/or these independent weaving companies were
to cease, for any reason, to produce or sell Kevlar to us, we might be unable to
replace it with a material of like weight and strength,  or at all. Thus, if our
supply of Kevlar were materially  reduced or cut off or if there were a material
increase in the price of Kevlar, our manufacturing operations could be adversely
affected and our costs  increased,  and our  business,  financial  condition and
results of operations could be materially adversely affected.

      Some of the components of our products pose  potential  safety risks which
could create potential liability exposure for us.

         Some of the components of our products  contain elements that are known
to pose  potential  safety  risks.  In addition to these risks,  there can be no
assurance that accidents in our facilities will not occur. Any accident, whether
occasioned by the use of all or any part of our products or technology or by our
manufacturing  operations,  could adversely affect commercial  acceptance of our
products and could result in significant production delays or claims for damages
resulting from injuries.  Any of these  occurrences  would materially  adversely
affect our operations and financial  condition.  In the event that our products,
including  the  products  manufactured  by MDT  and  AoA,  fail  to  perform  as
specified,  users of these products may assert claims for  substantial  amounts.
These claims could have a materially  adverse effect on our financial  condition
and results of operations.  There is no assurance that the amount of the general
product  liability  insurance  that we  maintain  will be  sufficient  to  cover
potential  claims or that the present  amount of insurance  can be maintained at
the present level of cost, or at all.



                                       65
<PAGE>

     Our fields of business are highly competitive.

         The competition to develop  defense and security  products and electric
vehicle  battery  systems,  and to obtain  funding for the  development of these
products, is, and is expected to remain, intense.

         Our defense and security  products compete with other  manufacturers of
specialized  training systems,  including  Firearms  Training  Systems,  Inc., a
producer of interactive  simulation  systems designed to provide training in the
handling and use of small and  supporting  arms.  In  addition,  we compete with
manufacturers and developers of armor for cars and vans, including O'Gara-Hess &
Eisenhardt, a division of Armor Holdings, Inc.

         Our battery  technology  competes with other battery  technologies,  as
well as  other  Zinc-Air  technologies.  The  competition  in  this  area of our
business consists of development stage companies,  major international companies
and consortia of such companies,  including  battery  manufacturers,  automobile
manufacturers,  energy production and transportation  companies,  consumer goods
companies and defense contractors.

         Various battery  technologies  are being considered for use in electric
vehicles and defense and safety products by other  manufacturers and developers,
including the following: lead-acid,  nickel-cadmium,  nickel-iron,  nickel-zinc,
nickel-metal  hydride,  sodium-sulfur,   sodium-nickel  chloride,  zinc-bromine,
lithium-ion,    lithium-polymer,    lithium-iron   sulfide,   primary   lithium,
rechargeable alkaline and Zinc-Air.

         Many of our competitors have financial,  technical,  marketing,  sales,
manufacturing, distribution and other resources significantly greater than ours.
If we are  unable  to  compete  successfully  in  each of our  operating  areas,
especially  in the defense  and  security  products  area of our  business,  our
business and results of operations could be materially adversely affected.

      Our business is dependent on  proprietary  rights that may be difficult to
protect and could affect our ability to compete effectively.

         Our  ability  to  compete  effectively  will  depend on our  ability to
maintain the proprietary  nature of our technology and  manufacturing  processes
through a  combination  of patent and trade  secret  protection,  non-disclosure
agreements and licensing arrangements.

         Litigation,  or participation  in  administrative  proceedings,  may be
necessary to protect our  proprietary  rights.  This type of  litigation  can be
costly and time  consuming and could divert  company  resources  and  management
attention  to defend  our  rights,  and this could harm us even if we were to be
successful in the litigation.  In the absence of patent protection,  and despite
our reliance upon our proprietary confidential information,  our competitors may
be able to use innovations similar to those used by us to design and manufacture
products directly competitive with our products.  In addition,  no assurance can
be given that  others  will not obtain  patents  that we will need to license or
design  around.  To the extent any of our  products  are covered by  third-party
patents,  we could need to acquire a license  under such  patents to develop and
market our products.

         Despite our efforts to safeguard and maintain our  proprietary  rights,
we may not be successful in doing so. In addition,  competition is intense,  and
there can be no assurance that our competitors will not independently develop or
patent  technologies  that  are  substantially  equivalent  or  superior  to our


                                       66
<PAGE>

technology. In the event of patent litigation, we cannot assure you that a court
would  determine  that we were the first  creator of  inventions  covered by our
issued patents or pending patent  applications or that we were the first to file
patent  applications  for those  inventions.  If existing or future  third-party
patents containing broad claims were upheld by the courts or if we were found to
infringe third-party patents, we may not be able to obtain the required licenses
from the holders of such  patents on  acceptable  terms,  if at all.  Failure to
obtain these licenses could cause delays in the  introduction of our products or
necessitate  costly  attempts to design around such patents,  or could foreclose
the  development,  manufacture  or sale of our  products.  We could  also  incur
substantial costs in defending ourselves in patent infringement suits brought by
others and in prosecuting patent infringement suits against infringers.

         We also rely on trade secrets and proprietary  know-how that we seek to
protect, in part, through non-disclosure and confidentiality agreements with our
customers, employees, consultants, and entities with which we maintain strategic
relationships.  We cannot assure you that these agreements will not be breached,
that we would have  adequate  remedies for any breach or that our trade  secrets
will not otherwise become known or be independently developed by competitors.

      We are dependent on key personnel and our business would suffer if we fail
to retain them.

         We are highly  dependent  on the  presidents  of our IES,  FAAC and AoA
subsidiaries and the general managers of our MDT and Epsilor  subsidiaries,  and
the loss of the services of one or more of these persons could adversely  affect
us. We are especially  dependent on the services of our Chairman,  President and
Chief Executive Officer, Robert S. Ehrlich. The loss of Mr. Ehrlich could have a
material adverse effect on us. We are party to an employment  agreement with Mr.
Ehrlich,  which agreement  expires at the end of 2005, and we may not be able to
renew such contract on terms acceptable to us, or at all. We do not have key-man
life insurance on Mr. Ehrlich.

     There are risks involved with the international nature of our business.

         A  significant  portion  of our  sales  are made to  customers  located
outside the U.S.,  primarily in Europe and Asia. In 2004, 2003 and 2002, without
taking account of revenues derived from  discontinued  operations,  19%, 42% and
56%, respectively, of our revenues, were derived from sales to customers located
outside the U.S. We expect that our  international  customers  will  continue to
account for a substantial  portion of our revenues in the near future.  Sales to
international  customers  may  be  subject  to  political  and  economic  risks,
including political instability,  currency controls, exchange rate fluctuations,
foreign taxes,  longer payment cycles and changes in  import/export  regulations
and tariff rates. In addition,  various forms of protectionist trade legislation
have been and in the  future  may be  proposed  in the U.S.  and  certain  other
countries. Any resulting changes in current tariff structures or other trade and
monetary policies could adversely affect our sales to international customers.

     Investors  should not  purchase our common  stock with the  expectation  of
receiving cash dividends.

         We currently  intend to retain any future  earnings for funding  growth
and, as a result,  do not expect to pay any cash  dividends  in the  foreseeable
future.



                                       67
<PAGE>

Market-Related Risks

     The price of our common stock is volatile.

         The market price of our common stock has been  volatile in the past and
may change rapidly in the future. The following factors, among others, may cause
significant volatility in our stock price:

                  o        Announcements   by  us,   our   competitors   or  our
                           customers;

                  o        The  introduction  of new or  enhanced  products  and
                           services by us or our competitors;

                  o        Changes in the perceived ability to commercialize our
                           technology compared to that of our competitors;

                  o        Rumors relating to our competitors or us;

                  o        Actual or anticipated  fluctuations  in our operating
                           results;

                  o        The issuance of our securities,  including  warrants,
                           in connection with financings and acquisitions; and

                  o        General market or economic conditions.

      If our shares were to be delisted,  our stock price might decline  further
and we might be unable to raise additional capital.

         One of the  continued  listing  standards  for our stock on the  Nasdaq
National  Market is the  maintenance  of a $1.00 bid price.  Our stock price has
traded  below  $1.00 in the past.  If our bid price were to go and remain  below
$1.00 for 30 consecutive business days, Nasdaq could notify us of our failure to
meet the  continued  listing  standards,  after which we would have 180 calendar
days to correct such failure or be delisted from the Nasdaq National Market.

          Although  we would  have  the  opportunity  to  appeal  any  potential
delisting,  there  can be no  assurances  that  this  appeal  would be  resolved
favorably.  As a result,  there can be no  assurance  that our common stock will
remain  listed on the Nasdaq  National  Market.  If our common  stock were to be
delisted  from the Nasdaq  National  Market,  we might apply to be listed on the
Nasdaq  SmallCap  market;  however,  there can be no assurance  that we would be
approved  for listing on the Nasdaq  SmallCap  market,  which has the same $1.00
minimum bid and other similar  requirements as the Nasdaq National Market. If we
were to move to the Nasdaq SmallCap  market,  current Nasdaq  regulations  would
give us the  opportunity  to obtain an  additional  180-day  grace period and an
additional  90-day  grace  period  after  that if we meet  certain  net  income,
stockholders' equity or market  capitalization  criteria.  While our stock would
continue to trade on the over-the-counter bulletin board following any delisting
from the Nasdaq,  any such  delisting  of our common stock could have an adverse
effect on the market price of, and the efficiency of the trading market for, our
common stock.  Also, if in the future we were to determine  that we need to seek
additional  equity  capital,  it could have an adverse  effect on our ability to
raise capital in the public equity markets.

         In addition,  if we fail to maintain Nasdaq listing for our securities,
and no  other  exclusion  from  the  definition  of a "penny  stock"  under  the
Securities  Exchange  Act of 1934,  as amended,  is  available,  then any broker


                                       68
<PAGE>

engaging in a  transaction  in our  securities  would be required to provide any
customer with a risk disclosure  document,  disclosure of market quotations,  if
any,  disclosure of the compensation of the broker-dealer and its salesperson in
the transaction and monthly account  statements showing the market values of our
securities  held in the  customer's  account.  The bid and offer  quotation  and
compensation information must be provided prior to effecting the transaction and
must be contained on the customer's  confirmation.  If brokers become subject to
the "penny stock" rules when engaging in transactions  in our  securities,  they
would  become less  willing to engage in  transactions,  thereby  making it more
difficult for our stockholders to dispose of their shares.

     We expect  our  auditors  to report a  material  weakness  in our  internal
controls.  If we fail to achieve and  maintain  effective  internal  controls in
accordance  with  Section 404 of the  Sarbanes-Oxley  Act, we may not be able to
accurately report our financial results.

         Pursuant to Section 404 of the  Sarbanes-Oxley  Act of 2002,  beginning
with this Annual  Report on Form 10-K for the fiscal year  ending  December  31,
2004,  we are  required to furnish a report by our  management  on our  internal
control over financial reporting.

         Pursuant to Securities and Exchange  Commission  Release No.  34-50754,
which,  subject to certain conditions,  provides up to 45 additional days beyond
the due date of this Form 10-K for the filing of  management's  annual report on
internal control over financial  reporting required by Item 308(a) of Regulation
S-K, and the related  attestation  report of the independent  registered  public
accounting  firm,  as required by Item 308(b) of  Regulation  S-K,  management's
report on internal control over financial reporting and the associated report on
the audit of  management's  assessment  of the  effectiveness  of the  Company's
internal control over financial reporting as of December 31, 2004, are not filed
herein and are expected to be filed no later than May 2, 2005.

         The   internal   control   report  must  contain  (i)  a  statement  of
management's  responsibility for establishing and maintaining  adequate internal
control over financial  reporting,  (ii) a statement  identifying  the framework
used by management to conduct the required  evaluation of the  effectiveness  of
our internal control over financial reporting,  (iii) management's assessment of
the effectiveness of our internal control over financial reporting as of the end
of our most recent  fiscal  year,  including  a  statement  as to whether or not
internal  control over  financial  reporting is effective,  and (iv) a statement
that our independent registered public accounting firm has issued an attestation
report on management's assessment of internal control over financial reporting.

         We expect that our auditors will inform us,  although they have not yet
done so,  that  they  identified  significant  deficiencies  that  constitute  a
material  weakness  under  standards  established  by the American  Institute of
Certified  Public  Accountants  (AICPA).  A material  weakness is a condition in
which the design or operation of one or more of the internal control  components
does not reduce to a relatively low level the risk that misstatements  caused by
error or fraud in amounts  that would be material  in relation to the  financial
statements being audited may occur and not be detected within a timely period by
employees in the normal course of performing their assigned functions. We expect
that  our  auditors  will  report  to us that at  December  31,  2004,  we had a
significant  deficiency in our financial  statement  closing process and related
processes  because the size our accounting and finance  department and the press


                                       69
<PAGE>

of work related to our recent acquisitions caused us to be unable  independently
to comply with the selection and  application of generally  accepted  accounting
principles related to highly complex financial transactions applicable to equity
issuances and business combinations.

         As a public company, we will have significant requirements for enhanced
financial  reporting  and  internal  controls.  The  process  of  designing  and
implementing effective internal controls is a continuous effort that requires us
to  anticipate  and  react to  changes  in our  business  and the  economic  and
regulatory environments and to expend significant resources to maintain a system
of internal controls that is adequate to satisfy our reporting  obligations as a
public  company.  We cannot  assure you that the  measures we have taken or will
take to remediate any material weaknesses or that we will implement and maintain
adequate controls over our financial processes and reporting in the future as we
continue our rapid growth.

         If we are unable to establish  appropriate internal financial reporting
controls  and  procedures,  it  could  cause  us to fail to meet  our  reporting
obligations,  result in material misstatements in our financial statements, harm
our  operating  results,  cause  investors  to lose  confidence  in our reported
financial  information and have a negative effect on the market price for shares
of our common stock.

      A  substantial  number of our shares are  available for sale in the public
market and sales of those shares could adversely affect our stock price.

         Sales of a substantial number of shares of common stock into the public
market,  or the perception that those sales could occur,  could adversely affect
our stock  price or could  impair  our  ability  to obtain  capital  through  an
offering of equity securities. As of February 28, 2005, we had 80,103,668 shares
of common  stock  issued  and  outstanding.  Of these  shares,  most are  freely
transferable  without  restriction  under  the  Securities  Act of  1933,  and a
substantial  portion of the  remaining  shares may be sold subject to the volume
restrictions,  manner-of-sale  provisions and other conditions of Rule 144 under
the Securities Act of 1933.

      Exercise of our warrants,  options and  convertible  debt could  adversely
affect our stock price and will be dilutive.

         As of February 28, 2005, there were outstanding  warrants to purchase a
total of 16,961,463  shares of our common stock at a weighted  average  exercise
price of $1.55 per share, options to purchase a total of 9,102,761 shares of our
common stock at a weighted  average  exercise price of $1.28 per share, of which
7,002,390 were vested,  at a weighted average exercise price of $1.28 per share,
and outstanding  debentures  convertible into a total of 3,156,298 shares of our
common stock at a weighted average conversion price of $1.44 per share.  Holders
of our options,  warrants and convertible debt will probably exercise or convert
them only at a time  when the price of our  common  stock is higher  than  their
respective  exercise or conversion  prices.  Accordingly,  we may be required to
issue shares of our common stock at a price  substantially lower than the market
price of our stock. This could adversely affect our stock price. In addition, if
and when these  shares  are  issued,  the  percentage  of our common  stock that
existing stockholders own will be diluted.



                                       70
<PAGE>

      Our  certificate  of  incorporation  and bylaws and  Delaware  law contain
provisions that could discourage a takeover.

         Provisions of our amended and restated certificate of incorporation may
have the effect of making it more difficult for a third party to acquire,  or of
discouraging  a third party from  attempting  to acquire,  control of us.  These
provisions could limit the price that certain  investors might be willing to pay
in the future for shares of our common stock. These provisions:

                  o        divide  our board of  directors  into  three  classes
                           serving staggered three-year terms;

                  o        only permit removal of directors by stockholders "for
                           cause," and require the affirmative  vote of at least
                           85% of the outstanding common stock to so remove; and

                  o        allow us to issue preferred stock without any vote or
                           further action by the stockholders.

         The  classification  system  of  electing  directors  and  the  removal
provision  may tend to  discourage a  third-party  from making a tender offer or
otherwise  attempting to obtain control of us and may maintain the incumbency of
our  board  of  directors,  as the  classification  of the  board  of  directors
increases  the  difficulty  of  replacing  a majority  of the  directors.  These
provisions may have the effect of deferring hostile takeovers,  delaying changes
in our control or management,  or may make it more difficult for stockholders to
take certain corporate  actions.  The amendment of any of these provisions would
require approval by holders of at least 85% of the outstanding common stock.

Israel-Related Risks

      A  significant  portion of our  operations  takes place in Israel,  and we
could be adversely affected by the economic,  political and military  conditions
in that region.

         The offices and facilities of three of our  subsidiaries,  EFL, MDT and
Epsilor, are located in Israel (in Beit Shemesh,  Lod and Dimona,  respectively,
all of  which  are  within  Israel's  pre-1967  borders).  Most  of  our  senior
management is located at EFL's  facilities.  Although we expect that most of our
sales will be made to customers  outside  Israel,  we are  nonetheless  directly
affected  by  economic,  political  and  military  conditions  in that  country.
Accordingly,  any major  hostilities  involving  Israel or the  interruption  or
curtailment of trade between Israel and its present trading  partners could have
a material  adverse effect on our  operations.  Since the  establishment  of the
State of Israel in 1948, a number of armed  conflicts  have taken place  between
Israel and its Arab  neighbors and a state of  hostility,  varying in degree and
intensity, has led to security and economic problems for Israel.

         Historically,  Arab states have  boycotted any direct trade with Israel
and to varying degrees have imposed a secondary  boycott on any company carrying
on trade with or doing business in Israel.  Although in October 1994, the states
comprising the Gulf Cooperation Council (Saudi Arabia, the United Arab Emirates,
Kuwait,  Dubai,  Bahrain and Oman) announced that they would no longer adhere to
the  secondary  boycott  against  Israel,  and Israel has entered  into  certain
agreements with Egypt,  Jordan,  the Palestine  Liberation  Organization and the
Palestinian  Authority,  Israel has not entered into any peace  arrangement with
Syria or Lebanon.  Moreover,  since September 2000, there has been a significant


                                       71
<PAGE>

deterioration in Israel's  relationship  with the Palestinian  Authority,  and a
significant increase in terror and violence. Efforts to resolve the problem have
failed to result in an agreeable  solution.  Continued  hostilities  between the
Palestinian community and Israel and any failure to settle the conflict may have
a  material  adverse  effect  on our  business  and us.  Moreover,  the  current
political and security situation in the region has already had an adverse effect
on the economy of Israel, which in turn may have an adverse effect on us.


      Service of process  and  enforcement  of civil  liabilities  on us and our
officers may be difficult to obtain.

         We are  organized  under the laws of the State of Delaware  and will be
subject to service of process in the United States.  However,  approximately 22%
of our assets are located  outside the United  States.  In addition,  two of our
directors  and most of our  executive  officers  are  residents  of Israel and a
portion of the assets of such  directors  and  executive  officers  are  located
outside the United States.

         There is doubt as to the  enforceability of civil liabilities under the
Securities Act of 1933, as amended,  and the Securities Exchange Act of 1934, as
amended,  in original actions  instituted in Israel.  As a result, it may not be
possible  for  investors  to  enforce or effect  service  of process  upon these
directors and executive  officers or to judgments of U.S. courts predicated upon
the civil liability  provisions of U.S. laws against our assets,  as well as the
assets  of these  directors  and  executive  officers.  In  addition,  awards of
punitive   damages  in  actions   brought  in  the  U.S.  or  elsewhere  may  be
unenforceable in Israel.

      Exchange rate fluctuations between the U.S. dollar and the Israeli NIS may
negatively affect our earnings.

Although a substantial majority of our revenues and a substantial portion of our
expenses are  denominated  in U.S.  dollars,  a portion of our costs,  including
personnel and  facilities-related  expenses,  is incurred in New Israeli Shekels
(NIS). Inflation in Israel will have the effect of increasing the dollar cost of
our operations in Israel, unless it is offset on a timely basis by a devaluation
of the  NIS  relative  to the  dollar.  In  2004,  the  inflation  adjusted  NIS
appreciated  against  the  dollar,  which  raised the dollar cost of our Israeli
operations.

     Some of our agreements are governed by Israeli law.

         Israeli  law  governs  some  of  our  agreements,  such  as  our  lease
agreements on our subsidiaries'  premises in Israel, and the agreements pursuant
to which we purchased IES, MDT and Epsilor. While Israeli law differs in certain
respects from American law, we do not believe that these differences  materially
adversely affect our rights or remedies under these agreements.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk

         It is our policy not to enter into interest rate  derivative  financial
instruments,  except  for  hedging  of  foreign  currency  exposures.  We do not
currently have any significant interest rate exposure.



                                       72
<PAGE>

Foreign Currency Exchange Rate Risk

         Since a significant  part of our sales and expenses are  denominated in
U.S. dollars, we have experienced only insignificant  foreign exchange gains and
losses to date, and do not expect to incur  significant  foreign  exchange gains
and losses in 2005.  Our research,  development  and  production  activities are
primarily  carried out by our Israeli  subsidiary,  EFL, at its facility in Beit
Shemesh,  and  accordingly  we have sales and  expenses in New Israeli  Shekels.
Additionally,  our MDT and Epsilor subsidiaries operate primarily in New Israeli
Shekels.  However,  the  majority of our sales are made  outside  Israel in U.S.
dollars,  and a substantial  portion of our costs are incurred in U.S.  dollars.
Therefore,  our functional  currency is the U.S.  dollar.  Please see "Impact of
Inflation  and Currency  Fluctuations,"  above and Note 2.b. to the Notes to the
Consolidated Financial Statements.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

<TABLE>
<CAPTION>
                          Index to Financial Statements
                                                                                                      Page
                          Consolidated Financial Statements
                          ---------------------------------
<S>                                                                                                    <C>
                 Reports of Independent Registered Public Accounting Firms.......................    F-2
                 Consolidated Balance Sheets.....................................................    F-4
                 Consolidated Statements of Operations...........................................    F-6
                 Statements of Changes in Shareholders' Equity...................................    F-7
                 Consolidated Statements of Cash Flows...........................................    F-10
                 Notes to Consolidated Financial Statements......................................    F-14
                          Supplementary Financial Data
                          ----------------------------
                 Quarterly Financial Data (unaudited) for the two years ended December 31, 2004..    F-61
                          Financial Statement Schedule
                 Schedule II - Valuation and Qualifying Accounts.................................    F-62
</TABLE>

ITEM  9.  CHANGES  IN AND  DISAGREEMENTS  WITH  ACCOUNTANTS  ON  ACCOUNTING  AND
FINANCIAL DISCLOSURE

         None.

ITEM 9A. CONTROLS AND PROCEDURES


Evaluation of Disclosure Controls and Procedures

      During the fourth quarter of 2004, our management, including the principal
executive officer and principal financial officer, evaluated our disclosure
controls and procedures related to the recording, processing, summarization, and
reporting of information in our periodic reports that we file with the SEC.
These disclosure controls and procedures are intended to ensure that material
information relating to us, including our subsidiaries, is made known to our
management, including these officers, by other of our employees, and that this
information is recorded, processed, summarized, evaluated, and reported, as
applicable, within the time periods specified in the SEC's rules and forms. Due
to the inherent limitations of control systems, not all misstatements may be
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty and that breakdowns can occur because of simple
error or mistake. Any system of controls and procedures, no matter how well
designed and operated, can at best provide only reasonable assurance that the
objective of the system are met and management necessarily is required to apply
its judgment in evaluating the cost benefit relationship of possible controls
and procedures. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management
override of the control. Our controls and procedures are intended to provide
only reasonable, not absolute, assurance that the above objectives have been
met.

                                       73
<PAGE>

      Based on their evaluation as of December 31, 2004, and except as otherwise
described herein and below, our principal executive officer and principal
financial officer were able to conclude that our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934) were effective to ensure that the information required to
be disclosed by us in the reports that we file or submit under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the
time periods specified in SEC rules and forms.

      In light of the material weakness described below, our management
performed additional analyses and other post-closing procedures to ensure our
consolidated financial statements are prepared in accordance with generally
accepted accounting principles in the United States (U.S. GAAP). Accordingly,
management believes that the consolidated financial statements included in this
report fairly present in all material respects our financial position, results
of operations and cash flows for the periods presented.

Management's Report on Internal Control Over Financial Reporting

      Our management, including our principal executive and financial officers,
have not yet completed the evaluation of the effectiveness of its internal
controls, pursuant to the requirements of Sarbanes-Oxley Section 404, as of the
end of the period covered by this Annual Report on Form 10-K for December 31,
2004. We are eligible for a 45-day extension of time allowed by the SEC for
companies of a certain size to file this report and the attestation. We have
elected to utilize this 45-day extension, and therefore, this Form 10-K does not
include these reports. We intend to file an amendment to this Form 10-K to
include (i) the report of management on internal control over financial
reporting and the associated report of our independent registered public
accounting firm as required by Section 404 of the Sarbanes-Oxley Act and (ii)
revised certifications as required by Section 906 of the Sarbanes-Oxley Act and
Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, once we have
completed our assessment of internal control over financial reporting and our
independent registered public accounting firm has completed their audit of our
assessment.

      In accordance with the rules of the SEC, we did not assess the internal
control over financial reporting of Armour of America, Incorporated, which we
acquired in August 2004, financial statements of which reflect total assets of
2% of our consolidated assets as of December 31, 2004, and total revenues of 5%
of our consolidated revenues for the year then ended. In our Annual Report on
Form 10-K for the year ending December 31, 2005, we will be required to provide
an assessment of our compliance that takes into account an assessment of Armour
of America, Incorporated and all of our other currently existing subsidiaries as
of December 31, 2005.

      For the reasons described below, we expect to disclose that there was a
material weakness in our internal controls at December 31, 2004. In addition, we
expect that such assessment will result in an adverse opinion of our Independent
Registered Public Accounting Firm on the effectiveness of our internal controls.
We note in this connection that our Independent Registered Public Accounting
Firm also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), our consolidated financial
statements and financial statement schedule as of and for the year ended
December 31, 2004, and their report dated March 24, 2005 expressed an
unqualified opinion with respect thereto.

      On November 22, 2004, the Audit Committee of our Board of Directors, on
the recommendation of our management and after discussion with and based on a
new and revised review of accounting treatment by our Independent Registered
Public Accounting Firm, made an internal determination and concluded that our
Annual Report on Form 10-K for the year ended December 31, 2003, including the
financial statements that our Independent Registered Public Accounting Firm had
previously audited that are contained therein, contained certain errors related
to the re-pricing of warrants and grant of additional warrants to certain of our
investors and others and the amortization of debt discount arising from the
allocation of the debt discount between the convertible debentures and their
detachable warrants. The net effect of these errors, which generally related to
the timing and characterization of certain non-cash expenses, was (i) to

                                       74
<PAGE>

increase our net loss attributable to common stockholders for 2003 by
approximately $579,000 and to decrease our net loss for the first half of 2004
by approximately $608,000, and (ii) to decrease our net loss attributable to
common stockholders for the nine and three months ended September 30, 2004 by
approximately $1,583,778 and $976,129, respectively. The Audit Committee of our
Board of Directors therefore concluded to restate certain previously issued
financial statements contained in our Annual Report on Form 10-K for the year
ended December 31, 2003. The decision to restate these financial statements was
made by our Audit Committee, upon the recommendation of our management and with
the concurrence of our Independent Registered Public Accounting Firm.

      As a result of the restatement referred to in the preceding paragraph, we
expect to conclude that (i) at December 31, 2004, we had a significant
deficiency in our financial statement closing process and related processes
because the size of our accounting and finance department and the volume of work
related to our recent acquisitions caused us to be unable independently to
comply with the selection and application of generally accepted accounting
principles related to highly complex financial transactions applicable to equity
issuances and business combinations, and (ii) that this deficiency constituted a
material weakness in internal controls as defined by the standards established
by the American Institute of Certified Public Accountants (AICPA). A material
weakness is a reportable condition in which the design or operation of one or
more internal control components does not reduce to a relatively low level the
risk that errors or fraud in amounts that would be material in relation to the
financial statements being audited may occur and not be detected within a timely
period by employees in the normal course of performing their assigned functions.

      Accordingly, we have undertaken to take the following initiatives with
respect to our internal controls and procedures that we believe are reasonably
likely to improve and materially affect our internal control over financial
reporting. We anticipate that remediation will be continuing throughout fiscal
2005, during which we expect to continue pursuing appropriate corrective
actions, including the following:

      >>    Preparing appropriate written documentation of our financial control
            procedures;

      >>    Adding additional qualified staff to our finance department;

      >>    Scheduling training for accounting staff to heighten awareness of
            generally accepted accounting principles applicable to complex
            transactions;

      >>    Strengthening our internal review procedures in conjunction with our
            ongoing work to enhance our internal controls so as to enable us to
            identify and adjust items proactively;

      >>    Engaging an outside accounting firm to support our Sarbanes-Oxley
            Section 404 compliance activities and to provide technical expertise
            in the selection and application of generally accepted accounting
            principles related to complex transactions to identify areas that
            require control or process improvements and to consult with us on
            the appropriate accounting treatment applicable to complex
            transactions; and

      >>    Implementing the recommendations of our outside accounting
            consultants.

      Our management and Audit Committee will monitor closely the implementation
of our remediation plan. The effectiveness of the steps we intend to implement
is subject to continued management review, as well as Audit Committee oversight,
and we may make additional changes to our internal control over financial
reporting.

      We cannot assure you that we will not in the future identify further
material weaknesses in our internal control over financial reporting. We
currently are unable to determine when the above-mentioned material weaknesses
will be fully remediated. However, because remediation will not be completed
until we have added finance staff and strengthened pertinent controls, we
presently anticipate that we will report in our Quarterly Report on Form 10-Q
for the first quarter of fiscal 2005 that material weaknesses continue to exist.


                                       75
<PAGE>
      Currently, we are not aware of any material weaknesses in our internal
control over financial reporting other than as described above. However, we are
continuing to evaluate and test our internal control over financial reporting.
There can be no assurance that, as a result of our ongoing evaluation of our
internal control over financial reporting, we will not identify additional
material weaknesses, or that our evaluation and testing of internal control over
financial reporting will be completed by the end of the 45-day extension period.

Changes in Internal Controls Over Financial Reporting

      Except as noted above, there have been no changes in our internal control
over financial reporting that occurred during our last fiscal quarter to which
this Annual Report on Form 10-K relates that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.

ITEM 9B. OTHER INFORMATION

         None.



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<PAGE>


                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Executive Officers, Directors and Significant Employees

     Executive Officers and Directors

         Our executive  officers and directors and their ages as of February 28,
2005 were as follows:

<TABLE>
<CAPTION>
               Name               Age                                    Position
               ----               ---                                    --------
<S>                                <C>
   Robert S. Ehrlich...........    66  Chairman of the Board, President and Chief Executive Officer
   Steven Esses..................  41  Executive Vice President, Chief Operating Officer and Director
   Avihai Shen.................    37  Vice President - Finance and Chief Financial Officer
   Dr. Jay M. Eastman..........    56  Director
   Jack E. Rosenfeld...........    66  Director
   Lawrence M. Miller..........    58  Director
   Bert W. Wasserman...........    72  Director
   Edward J. Borey.............    54  Director
</TABLE>

         Our by-laws  provide for a board of directors of one or more directors.
There are  currently  seven  directors.  Under the terms of our  certificate  of
incorporation,  the board of directors  is composed of three  classes of similar
size,  each elected in a different  year, so that only one-third of the board of
directors  is  elected  in any  single  year.  Dr.  Eastman  and Mr.  Esses  are
designated  Class I directors  and have been elected for a term expiring in 2006
and until their  successors  are elected and  qualified;  Messrs.  Rosenfeld and
Miller are designated Class II directors elected for a term expiring in 2005 and
until their successors are elected and qualified; and Messrs. Ehrlich, Wasserman
and Borey are designated Class III directors  elected for a term that expires in
2007 and until their  successors  are elected and  qualified.  A majority of the
Board is "independent" under relevant SEC and Nasdaq regulations.

         Robert S. Ehrlich has been our Chairman of the Board since January 1993
and our President and Chief Executive  Officer since October 2002. From May 1991
until January 1993, Mr. Ehrlich was our Vice Chairman of the Board, and from May
1991 until October 2002 he was our Chief  Financial  Officer.  Mr. Ehrlich was a
director of Eldat,  Ltd., an Israeli  manufacturer  of electronic  shelf labels,
from June 1999 to July 2003.  From 1987 to June 2003,  Mr.  Ehrlich  served as a
director of PSC Inc.  ("PSCX"),  a manufacturer  and marketer of laser diode bar
code  scanners,  and,  between  April 1997 and June 2003,  Mr.  Ehrlich  was the
chairman of the board of PSCX. PSCX filed a voluntary  petition for relief under
Chapter 11 of the Bankruptcy Code in November 2002. Mr. Ehrlich  received a B.S.
and J.D. from Columbia University in New York, New York.

         Steven Esses has been a director since July 2002 and our Executive Vice
President  since January 2003 and Chief  Operating  Officer since February 2003.
From  2000  until  2002,  Mr.  Esses was a  principal  with  Stillwater  Capital
Partners, Inc., a New York-based investment research and advisory company (hedge
fund) specializing in alternative investment  strategies.  During this time, Mr.


                                       77
<PAGE>

Esses also acted as an independent  consultant to new and existing businesses in
the areas of finance and  business  development.  From 1995 to 2000,  Mr.  Esses
founded Dunkin' Donuts in Israel and held the position of Managing  Director and
CEO. Prior thereto,  he was Director of Retail Jewelry  Franchises with Hamilton
Jewelry,  and before that he served as Executive  Director of Operations for the
Conway Organization, a major off-price retailer with 17 locations.

         Avihai Shen has been our Vice President - Finance since  September 1999
and our Chief Financial  Officer since October 2002, and served as our corporate
Secretary  from  September  1999  to  December  2000.  Mr.  Shen  was the CFO of
Commtouch  Software Ltd., an internet  company based in California that develops
e-mail  solutions,  from 1996 to early 1999, and worked  previously at Ernst and
Young in Israel.  Mr. Shen is a certified  public  accountant  and has a B.A. in
Economics  from  Bar-Ilan  University  in Israel  and an M.B.A.  from the Hebrew
University of Jerusalem.

         Dr. Jay M. Eastman has been one of our  directors  since  October 1993.
Since November  1991,  Dr.  Eastman has served as President and Chief  Executive
Officer of Lucid,  Inc., which is developing  laser technology  applications for
medical diagnosis and treatment.  Dr. Eastman served as Senior Vice President of
Strategic  Planning of PSCX from December 1995 through October 1997. Dr. Eastman
is also a director of Dimension Technologies, Inc., a developer and manufacturer
of 3D displays for computer and video  displays.  From 1981 until  January 1983,
Dr. Eastman was Director of the  University of Rochester's  Laboratory for Laser
Energetics,  where he was a member of the staff from September 1975 to 1981. Dr.
Eastman holds a B.S. and a Ph.D.  in Optics from the  University of Rochester in
New York.

         Jack E. Rosenfeld has been one of our directors since October 1993. Mr.
Rosenfeld  was  President and Chief  Executive  Officer of Potpourri  Group Inc.
("Potpourri"),  a specialty catalog direct marketer,  from April 1998 until June
2003;  from June 2003 until February 2005, Mr.  Rosenfeld  served as Chairman of
Potpourri's  Board of Directors  and as its CEO, and since  February  2005,  Mr.
Rosenfeld has been Executive  Chairman of the Potpourri Board of Directors.  Mr.
Rosenfeld was President and Chief  Executive  Officer of Hanover  Direct,  Inc.,
formerly Horn & Hardart Co., which  operates a direct mail  marketing  business,
from  September  1990 until  December  1995,  and had been  President  and Chief
Executive  Officer  of its  direct  marketing  subsidiary,  from May 1988  until
September 1990. Mr.  Rosenfeld  holds a B.A. from Cornell  University in Ithaca,
New York and an LL.B. from Harvard University in Cambridge, Massachusetts.

         Lawrence M. Miller was  elected to the board of  directors  in November
1996. Mr. Miller has been a senior  partner in the  Washington  D.C. law firm of
Schwartz,  Woods and Miller  since 1990.  He served from August 1993 through May
1996 as a member of the board of  directors of The Phoenix  Resource  Companies,
Inc., a publicly  traded energy  exploration  and production  company,  and as a
member of the Audit and Compensation  Committee of that board.  That company was
merged  into  Apache  Corporation  in May 1996.  Mr.  Miller  holds a B.A.  from
Dickinson  College in Carlisle,  Pennsylvania and a J.D. with honors from George
Washington  University  in  Washington,  D.C. He is a member of the  District of
Columbia bar.

         Bert W.  Wasserman has served as a director  since  February  2003. Mr.
Wasserman served as Executive Vice President and Chief Financial Officer of Time
Warner,  Inc. from 1990 until his  retirement in 1995 and served on the Board of
Directors  of  Time   Warner,   Inc.  and  its   predecessor   company,   Warner
Communications, Inc. from 1981 to 1995. He joined Warner Communications, Inc. in
1966 and had been an  officer of that  company  since  1970.  Mr.  Wasserman  is
director of several  investment  companies in the Dreyfus Family of Funds. He is


                                       78
<PAGE>

also a director of Malibu  Entertainment,  Inc.,  Lillian Vernon Corporation and
InforMedix, Inc. Mr. Wasserman is a certified public accountant; he holds a B.A.
from Baruch  College in New York City,  of whose Board of Trustees he has served
as Vice President and President, and an LL.B from Brooklyn Law School.

         Edward J. Borey has served as a director since December 2003. Mr. Borey
has been Chairman and Chief Executive Officer of WatchGuard Technologies,  Inc.,
a leading provider of network security  solutions  (NasdaqNM:  WGRD), since July
2004. From December 2000 to September 2003, Mr. Borey served as President, Chief
Executive  Officer and a director of PSCX.  PSCX filed a voluntary  petition for
relief  under  Chapter 11 of the  Bankruptcy  Code in  November  2002.  Prior to
joining PSCX, Mr. Borey was President and CEO of TranSenda (May 2000 to December
2000).  Previously,  Mr.  Borey held  senior  positions  in the  automated  data
collection industry. At Intermec Technologies  Corporation  (1995-1999),  he was
Executive  Vice  President  and Chief  Operating  Officer  and also  Senior Vice
President/General Manager of the Intermec Media subsidiary. Currently, Mr. Borey
serves as a Board member at Mbrane (foremerly known as Centura Software), and he
is on the  Advisory  Board of TranSenda  Software and NextRx.  Mr. Borey holds a
B.S. in Economics from the State University of New York,  College of Oswego;  an
M.A. in Public Administration from the University of Oklahoma;  and an M.B.A. in
Finance from Santa Clara University.

     Committees of the Board of Directors

         Our  board  of  directors  has  an  Audit  Committee,   a  Compensation
Committee, a Nominating Committee and an Executive and Finance Committee.

         Created in  December  1993,  the purpose of the Audit  Committee  is to
review with management and our independent auditors the scope and results of the
annual  audit,  the nature of any other  services  provided  by the  independent
auditors,  changes in the accounting  principles  applied to the presentation of
our financial  statements,  and any comments by the independent  auditors on our
policies  and  procedures  with  respect to internal  accounting,  auditing  and
financial  controls.  The Audit  Committee was  established  in accordance  with
Section  3(a)(58)(A)  of the  Securities  Exchange Act of 1934,  as amended.  In
addition,  the Audit  Committee  is charged with the  responsibility  for making
decisions on the  engagement of  independent  auditors.  As required by law, the
Audit Committee operates pursuant to a charter.  The Audit Committee consists of
Messrs.  Wasserman  (Chair),  Miller and Rosenfeld.  We have determined that Mr.
Wasserman  qualifies as an "audit committee  financial  expert" under applicable
SEC and Nasdaq regulations.  Mr. Wasserman,  as well as all the other members of
the Audit  Committee,  is  "independent,"  as  independence  is  defined in Rule
4200(a)(15) of the National Association of Securities Dealers' listing standards
and under Item 7(d)(3)(iv) of Schedule 14A of the proxy rules under the Exchange
Act.

         The Compensation  Committee,  also created in December 1993, recommends
annual  compensation  arrangements  for the Chief  Executive  Officer  and Chief
Financial Officer and reviews annual compensation  arrangements for all officers
and significant  employees.  The Compensation  Committee consists of Dr. Eastman
(Chair)  and  Messrs.  Wasserman  and  Rosenfeld,  all of whom  are  independent
non-employee directors.



                                       79
<PAGE>

         The Executive and Finance  Committee,  created in July 2001,  exercises
the powers of the Board during the intervals  between  meetings of the Board, in
the management of the property, business and affairs of the Company (except with
respect  to certain  extraordinary  transactions).  The  Executive  and  Finance
Committee consists of Messrs. Ehrlich (Chair), Miller, Borey and Esses.

         The  Nominating  Committee,  created  in  March  2003,  identifies  and
proposes  candidates  to serve as  members of the Board of  Directors.  Proposed
nominees  for  membership  on the Board of  Directors  submitted  in  writing by
stockholders to the Secretary of the Company will be brought to the attention of
the Nominating  Committee.  The Nominating  Committee  consists of Mr. Rosenfeld
(Chair),  Dr. Eastman and Mr. Borey,  all of whom are  independent  non-employee
directors. The Nominating Committee operates under a formal charter that governs
its duties. The Nominating  Committee's  charter is publicly available through a
hyperlink   located  on  the  investor   relations  page  of  our  website,   at
http://www.arotech.com/compro/investor.html.

     Code of Ethics

         We have  adopted  a Code of  Ethics,  as  required  by  Nasdaq  listing
standards  and the rules of the SEC,  that  applies to our  principal  executive
officer,  our principal financial officer, and our principal accounting officer.
The Code of Ethics is  publicly  available  through a  hyperlink  located on the
investor        relations       page       of       our       website,        at
http://www.arotech.com/compro/investor.html.  If we make substantive  amendments
to the Code of Ethics or grant any waiver,  including any implicit waiver,  that
applies to anyone subject to the Code of Ethics,  we will disclose the nature of
such amendment or waiver on the website or in a report on Form 8-K in accordance
with applicable Nasdaq and SEC rules.

     Code of Conduct

         We have  adopted a  general  Code of  Conduct,  as  required  by Nasdaq
listing  standards  and  the  rules  of  the  SEC,  that  applies  to all of our
employees. The Code of Conduct is publicly available through a hyperlink located
on     the     investor     relations     page     of    our     website,     at
http://www.arotech.com/compro/investor.html.

     Whistleblower Policy

         We have adopted a Whistleblower  Policy,  as required by Nasdaq listing
standards,   in  order  to  ensure   compliance   with  the  provisions  of  the
Sarbanes-Oxley  Act of 2002.  The  Whistleblower  Policy is  publicly  available
through a hyperlink  located on the investor  relations page of our website,  at
http://www.arotech.com/compro/investor.html. Employees with complaints about our
compliance  with  applicable  legal  and  regulatory  requirements  relating  to
accounting, auditing and internal control matters may submit their complaints in
person, by mail or other written  communication or by telephone to our Complaint
Administrator.  The Complaint  Administrator  can be contacted  anonymously,  by
submitting    the    form    located    on    our    corporate     website    at
http://arotech.com/compro/complaint.html.  Complaints  sent in this  manner will
automatically be stripped of all  computer-encoded  information  identifying the
originating  e-mail  address,  and will then  automatically  be forwarded to the
Complaint Administrator's regular e-mail address at Arotech.



                                       80
<PAGE>

     Director Compensation

         Non-employee  members of our board of  directors  are paid $2,500 (plus
expenses) for each board of directors meeting  attended,  $2,000 (plus expenses)
for each meeting of the audit committee of the board of directors attended,  and
$1,000 (plus expenses) for each meeting of all other  committees of the board of
directors attended.  In addition,  we have adopted a Non-Employee Director Stock
Option Plan pursuant to which non-employee directors receive an initial grant of
options to purchase 40,000 shares of our common stock upon the effective date of
such plan or upon the date of his or her  election  as a  director.  Thereafter,
non-employee  directors  will receive  options to purchase  25,000 shares of our
common stock for each year of service on the board. All such options are granted
at fair  market  value and vest  ratably  over three  years from the date of the
grant.

     Significant Employees

         Our significant employees as of February 28, 2005, and their ages as of
December 31, 2004, are as follows:

<TABLE>
<CAPTION>
               Name                   Age                                Position
               ----                   ---                                --------
<S>                                   <C>
Arik Arad..........................   52  Executive Vice President of Arotech and Chairman of IES
Jonathan Whartman..................   50  Senior Vice President
Dr. Neal Naimer....................   46  Vice President and Chief Technology Officer
William Graham.....................   46  Vice President of Government Affairs
Yoel Gilon.........................   52  Vice President - Electric Vehicle Technologies
Kim Kelly..........................   40  Vice President - Corporate Communications
Yaakov Har-Oz......................   47  Vice President, General Counsel and Secretary
Danny Waldner......................   33  Controller
Greg Otte..........................   45  President, IES Interactive Training, Inc.
Alan G. Jordan.....................   51  CEO, FAAC Incorporated
Yosef Bar..........................   62  General Manager, MDT Protective Industries
Hezy Aspis.........................   54  General Manager, Epsilor Electronics Industries, Ltd.
John R. Nehmens....................   53  Chief Operating Officer, Armour of America
Graydon Hansen.....................     46President, Electric Fuel Battery Corporation
</TABLE>

         Arik Arad has  served as IES's  Chairman  since  August  2003 and as an
Executive  Vice  President of Arotech since May 2004. Mr. Arad has served in the
military,  law  enforcement  and  private-sector  security  business,  servicing
clientele from among the Fortune 500(TM) companies.  In that capacity,  Mr. Arad
has participated in the process of reassessing security  requirements,  security
design,  security  implementation,  security  training  programs  and  proactive
security  follow-up.  Mr. Arad has been exposed to issues pertinent to companies
whose worldwide  operations pose potential for terrorist  activity.  He has also
gained  worldwide  experience in securing major airports,  shopping  centers and
other high profile  facilities.  Mr. Arad served as a Lieutenant  Colonel in the
Israel  Defense  Forces.  Mr.  Arad is a graduate of the  International  Seminar
Management  Program (ISMP) of the Harvard  Business  School and holds a B.Sc. in
psychology and political sciences from the Haifa University in Israel.



                                       81
<PAGE>

         Jonathan  Whartman has been Senior Vice President  since December 2000,
and Vice  President of  Marketing  from 1994 to December  2000.  From 1991 until
1994, Mr. Whartman was our Director of Special  Projects.  Mr. Whartman was also
Director of Marketing of Amtec from its  inception in 1989 through the merger of
Amtec into Arotech in 1991.  Before joining Amtec,  Mr.  Whartman was Manager of
Program  Management at Luz, Program Manager for desk-top  publishing at ITT Qume
in San Jose,  California  from 1986 to 1987,  and  Marketing  Director at Kidron
Digital Systems, an Israeli computer developer,  from 1982 to 1986. Mr. Whartman
holds a B.A. in Economics and an M.B.A. from the Hebrew  University,  Jerusalem,
Israel.

         Dr. Neal Naimer has been a Vice President since June 1997 and our Chief
Technology  Officer  since  December  2002.  From 1989 to 1997,  Dr.  Naimer was
Director of Electrode Engineering of our Air Electrode development program. From
1987 to 1989, he was the Manager of the Chemical Vapor  Deposition  (Thin Films)
Group at Intel  Electronics in Jerusalem,  and was Project  Manager of the photo
voltaic IR  detector  development  program at Tadiran  Semiconductor  Devices in
Jerusalem  from 1984 to 1987.  Dr. Naimer was educated at University  College of
London, England, where he received his B.Sc. in Chemical Engineering and a Ph.D.
in Chemical Engineering.

         William  Graham joined us as Vice  President of  Government  Affairs in
January 2005,  after twenty years of military  service  highlighted  by multiple
commands  and six years of Pentagon  experience.  During this time,  Mr.  Graham
interacted  continuously  with  Senators and their staffs to develop and execute
the strategy for presenting  the $300+ billion  defense  budget.  After retiring
from the Army as a Colonel in 2001, Mr. Graham joined Washington  Operations for
Time Domain  Corporation (TDC) as a Director to help the company secure Pentagon
contracts and congressional  support for those programs.  Mr. Graham completed a
B.S. in General  Engineering at the U.S.  Military Academy (West Point) in 1980,
earned his masters from Central  Michigan  University  in 1991 and was graduated
from the U.S. Army War College in 1999.

         Yoel Gilon has been our Vice President - Electric Vehicle  Technologies
since  2001;   prior  to  that,  he  served  as  Director  of  Electric  Vehicle
Technologies at our Beit Shemesh facility since joining us in 1994. From 1991 to
1994, Mr. Gilon was Project Development Manager at Ormat Industries. Previously,
Mr.  Gilon  was  Vice  President  of  System  Engineering   Development  at  Luz
Industries.  Mr. Gilon holds a B.Sc. in  Mathematics  and Physics and a M.Sc. in
Mathematics  from the Hebrew  University of  Jerusalem.  He also holds a B.A. in
Fine Arts from the Bezalel Academy in Jerusalem.

         Kim Kelly has served as our Vice  President - Corporate  Communications
since November 2004.  From 1993 to 2004, Ms Kelly held a variety of positions at
ECI Telecom Ltd., a Nasdaq-listed  company,  including serving as ECI's Director
of  Corporate  Communications,  where  she  played a  significant  role in ECI's
communications strategy, investor relations program and competitive intelligence
analysis.  Ms Kelly  holds a B.A.  in Social Work from  Bar-Ilan  University  in
Tel-Aviv and an M.B.A. from Ben-Gurion University in Beersheva, Israel.



                                       82
<PAGE>

         Yaakov  Har-Oz has served as our Vice  President  and  General  Counsel
since October 2000 and as our corporate Secretary since December 2000. From 1994
until  October  2000,  Mr.  Har-Oz  was a partner in the  Jerusalem  law firm of
Ben-Ze'ev,  Hacohen  & Co.  Prior  to  moving  to  Israel  in  1993,  he  was an
administrative  law judge and in private law  practice in New York.  Mr.  Har-Oz
holds a B.A. from Brandeis University in Waltham,  Massachusetts and a J.D. from
Vanderbilt  Law School  (where he was an editor of the law review) in Nashville,
Tennessee.  He is a  member  of the  New  York  bar and the  Israel  Chamber  of
Advocates.

         Danny Waldner has served as our Controller  since March 2000 and as our
chief accounting  officer since October 2002. Prior thereto,  Mr. Waldner was an
accountant  at KPMG in Israel  from 1996 to 2000.  Mr.  Waldner  is a  Certified
Public Accountant and holds a B.A. in Accounting and Business Administration and
an M.B.A. from the Rishon Lezion College of Administration in Israel, as well as
an LL.M from Bar-Ilan University in Tel-Aviv.

         Greg Otte has served as IES's  President  since January 2001. From 1994
to 2001, Mr. Otte was in charge of IES's North American marketing efforts. Prior
to this, he was responsible for sales,  product placement and national contracts
with  Tuxall  Uniform  &  Equipment,  a  national  supplier  of law  enforcement
equipment.  Mr. Otte holds a bachelor's  degree in Marketing from the University
of Colorado.

         Alan G. Jordan started at First Ann Arbor Corporation,  the predecessor
of FAAC, in 1978 as a junior  engineer.  He subsequently was promoted to section
head, program manager, group head, director of operations,  vice president,  and
finally president, which position he has held for more than the past five years.
Effective January 1, 2005, Mr. Jordan stepped down as President,  remaining FAAC
CEO.  Prior to joining  FAAC,  Mr. Jordan was an engineer in the U.S. Navy civil
service.  Mr. Jordan  maintains  Department of Defense "secret"  clearance.  Mr.
Jordan  holds a  bachelor's  degree  in  Systems  Science  from  Michigan  State
University.

         Yosef Bar established  MDT Protective  Industries in 1989 as one of the
first  bulletproofing  companies in Israel.  Under the direction of Mr. Bar, MDT
moved from its initial emphasis on vandalism  protection to  bulletproofing  not
just  windshields  but the  entire  vehicle,  as a result  of which  MDT  became
Israel's leader in the  state-of-the art lightweight  armoring of vehicles.  Mr.
Bar served in the Israel Defense Forces, reaching the rank of Lieutenant Colonel
of the  paratroop  regiment  with  over  1,000  jumps  to his  credit.  He  also
participated in several anti-terrorism courses.

         Hezy Aspis has headed Epsilor Electronic  Industries,  Ltd. since 1991.
Prior to this, he was an engineer with Tadiran Batteries Ltd.,  Israel's leading
lithium battery  manufacturer.  Mr. Aspis holds a B.Sc. in electric  engineering
from the Technion Israel Institute of Technology in Haifa, Israel, and an M.B.A.
from Tel-Aviv University in Israel.

         John R. Nehmens has served as General Manager of AoA since 1996, and as
Chief  Operating  Officer  since 2004.  Mr.  Nehmens has over 28 years of direct
aerospace manufacturing experience, having owned his own air frame manufacturing
company  for  seven  years.   In  addition,   Mr.  Nehmens  spent  13  years  at
Lockheed-Martin  Company,  the last three as Director of Quality Assurance.  Mr.
Nehmens attended California  Polytechnic  College,  Pomona,  California,  with a
major in international business.



                                       83
<PAGE>

         Graydon  Hansen has served as  President  of EFBC since  January  2005.
Prior thereto,  Mr. Hansen was Senior Vice  President of Engineering  with Elpac
Electronics,  Inc.  From March 2002 until  February  2004,  Mr.  Hansen was Vice
President of  Engineering at Trojan  Battery  Corporation,  where his management
responsibilities  included  commercial product  development and design activity,
plus  leadership  of the Quality  and  Production  Engineering  groups in all of
Trojan's  manufacturing  facilities.  Previously,  Mr. Hansen worked at Lockheed
Missiles and Space  Company.  Mr. Hansen holds a B.Sc.  in electric  engineering
from the University of California at Berkeley, and is a Registered  Professional
Engineer.

     Section 16(a) Beneficial Ownership Reporting Compliance

         Under the securities laws of the United States, our directors,  certain
of our  officers  and any  persons  holding  more than ten percent of our common
stock are required to report their ownership of our common stock and any changes
in that ownership to the Securities and Exchange Commission.  Specific due dates
for these  reports  have been  established  and we are  required  to report  any
failure to file by these dates  during 2004.  We are not aware of any  instances
during 2004,  not  previously  disclosed by us, where such  "reporting  persons"
failed to file the required reports on or before the specified dates,  except as
follows:

         (i)      Mr.  Ehrlich  was  required  to file a Form 4 on or  prior  to
                  December 12, 2004 in connection with his acquisition of 75,000
                  restricted  shares on December  10,  2004.  He  reported  this
                  transaction   in  a  Form  4  filed  on  December   14,  2004.
                  Additionally,  Mr. Ehrlich was required to file a Form 4 on or
                  prior to August 11,  2004 in  connection  with his  receipt of
                  50,000  stock  options on August 9,  2004.  He  reported  this
                  transaction in a Form 5 filed on February 14, 2005.

         (ii)     Mr.  Esses was  required to file a Form 4 on or prior to April
                  10, 2004 in  connection  with his  exercise and sale of 50,000
                  stock options on April 8, 2004.  He reported this  transaction
                  in a Form 4 filed on April 12, 2004.

         (iii)    Mr. Shen was required to file a Form 4 on or prior to December
                  12,  2004  in  connection   with  his  acquisition  of  30,000
                  restricted  shares on December  10,  2004.  He  reported  this
                  transaction   in  a  Form  4  filed  on  December   14,  2004.
                  Additionally,  Mr.  Shen was  required  to file a Form 4 on or
                  prior to August 11,  2004 in  connection  with his  receipt of
                  18,750  stock  options on August 9,  2004.  He  reported  this
                  transaction in a Form 5 filed on February 14, 2005.


ITEM 11. EXECUTIVE COMPENSATION

Cash and Other Compensation

     General

         Our Chief  Executive  Officer  and the  other  highest  paid  executive
officers (of which there were two) who were  compensated  at a rate of more than
$100,000  in  salary  and  bonuses  during  the year  ended  December  31,  2004
(collectively,  the "Named Executive Officers") are Israeli residents,  and thus
certain  elements  of the  compensation  that we pay  them is  structured  as is
customary in Israel.



                                       84
<PAGE>

         During  2004,  2003  and  2002,  compensation  to our  Named  Executive
Officers took several forms:

                  >>       cash salary;

                  >>       bonus,  some of which was paid in cash in the year in
                           which it was earned and some of which was  accrued in
                           the year in which it was earned but paid in cash in a
                           subsequent year;

                  >>       cash  reimbursement  for  taxes  paid  by  the  Named
                           Executive  Officer and reimbursed by us in accordance
                           with Israeli tax regulations;

                  >>       accruals  (but  not  cash  payments)  in  respect  of
                           contractual termination compensation in excess of the
                           Israeli statutory minimum;

                  >>       accruals  (but  not  cash  payments)  in  respect  of
                           pension plans,  which consist of a savings plan, life
                           insurance and statutory severance pay benefits, and a
                           continuing   education   fund  (as  is  customary  in
                           Israel);

                  >>       stock  options,  including  (in  the  case  of  2002)
                           options  issued  in  exchange  for a waiver of salary
                           under the  "options-for-salary"  program discussed in
                           more detail below

                  >>       grants of  restricted  stock,  where the sale of such
                           stock is  prohibited  for a period  of two  years and
                           such   stock  is  forfeit  to  us  should  the  Named
                           Executive  Officer's  employment  be  terminated  for
                           cause,  as  defined  in such  Executive's  employment
                           agreement   (e.g.,   fraud,   reckless   or   willful
                           misconduct, etc.); and

                  >>       other  benefits,   primarily   consisting  of  annual
                           statutory holiday pay.

         The specific  amounts of each form of  compensation  paid to each Named
Executive Officer appear in the summary compensation table and the notes thereto
appearing under "Summary Compensation Table," below.

     Summary Compensation Table

         The  following  table,  which  should be read in  conjunction  with the
explanations  provided above,  shows the compensation that we paid (or accrued),
in  connection  with  services  rendered for 2004,  2003 and 2002,  to our Named
Executive Officers.

<TABLE>
<CAPTION>
                              Annual Compensation                        Long Term Compensation
                             -------------------------------------------------------------------



                                                                         Securities  Restricted
                                                                Tax      Underlying    Stock
 Name and Principal Position    Year    Salary     Bonus   Reimbursement  Options     Awards(2)
<S>                          <C>  <C>          <C>          <C>                 <C>         <C>
Robert S. Ehrlich            2004 $  275,907 $  175,000     $   29,103      50,000     $ 626,350
Chairman of the Board,       2003 $  259,989 $  180,000(4)  $   27,211   2,035,000             0
   President, Chief          2002 $  202,962 $   99,750     $   15,232     262,500(6)  $       0
   Executive Officer and
   director

<CAPTION>


                                All Other Compensation
                            ---------------------------------------
                              Changes in
                             Accruals for
                                Sick Days,    Payment to
                             Vacation Days    Pension and
                             and Termination,  Education
 Name and Principal Position Compensation         Funds     Others
<S>                                    <C>          <C>    <C>
Robert S. Ehrlich             $  133,898(3)   $   48,477  $   19,893
Chairman of the Board,        $   80,713(5)   $   48,228  $      678
   President, Chief           $  170,691(7)   $   22,256  $      654
   Executive Officer and
   director
</TABLE>



                                       85
<PAGE>


<TABLE>
<CAPTION>
                              Annual Compensation                        Long Term Compensation     All Other Compensation
                             -------------------------------------------------------------------------------------------------------
                                                                                            Changes in
                                                                                            Accruals for
                                                                                             Sick Days,      Payment to
                                                                    Securities  Restricted  Vacation Days    Pension and
                                                           Tax      Underlying    Stock     and Termination,  Education
 Name and Principal Position Year   Salary     Bonus   Reimbursement  Options     Awards(2)  Compensation      Funds     Others

<S>                          <C>  <C>          <C>          <C>                 <C>         <C>            <C>        <C>
Steven Esses                 2004 $   65,506(8)$  106,000(9)$   25,273          0 $221,100  $    3,759(12) $   12,116 $   12,940
Executive Vice President,    2003 $        0   $        0   $        0  1,035,000 $      0  $        0     $        0 $        0
   Chief Operating Officer   2002 $        0   $        0   $        0          0 $      0  $        0     $        0 $  120,480(11)
   and director*


Avihai Shen                  2004 $  155,845  $   97,000   $    6,407     18,750  $54,900   $   34,972(12) $   26,889 $      476
Vice President - Finance and 2003 $  123,988  $        0   $    8,653    608,750  $     0   $    6,471(13) $   23,133 $      463
   Chief Financial Officer   2002 $   93,641  $        0   $   18,857     48,935  $     0   $    9,847(14) $   20,394 $    6,894(15)
</TABLE>
-------------------------------------

   *  Mr. Esses became an executive officer in January 2003. His compensation as
      an officer during 2003 consisted solely of stock options. Prior to January
      2003,  Mr.  Esses was a director  (from July 2002),  in which  position he
      received  certain  compensation as a consultant,  in addition to the stock
      options and per-meeting fees payable to directors  generally (which is not
      reflected above).
  (1) We paid the  amounts  reported  for each named  executive  officer in U.S.
      dollars and/or New Israeli Shekels (NIS). We have translated  amounts paid
      in NIS into U.S.  dollars at the exchange rate of NIS into U.S. dollars at
      the time of payment or accrual.
  (2) Based on the  closing  market  price  of our  stock  on the  Nasdaq  Stock
      Exchange the date of grant multiplied by the number of shares awarded.  As
      of December 31, 2004, our Named Executive Officers held 635,000 restricted
      shares. Of these shares,  the restrictions on 530,000 shares are scheduled
      to expire on August 4, 2006, and the restrictions on 105,000 are scheduled
      to expire on December 8, 2006. The value of the restricted  shares held by
      our Named  Executive  Officers on December 31, 2004,  based on the closing
      price  of our  stock  on the  Nasdaq  Stock  Exchange  on that  date.  was
      $902,350.
  (3) Of this amount,  $76,766  represents  our accrual for  severance  pay that
      would be payable to Mr.  Ehrlich  upon a "change of  control"  or upon the
      occurrence of certain other events; $28,603 represents the increase of the
      accrual for vacation redeemable by Mr. Ehrlich; and $28,529 represents the
      increase  of our accrual  for  severance  pay that would be payable to Mr.
      Ehrlich  under the laws of the State of Israel if we were to terminate his
      employment.
  (4) We paid Mr. Ehrlich $180,000 during 2004 in satisfaction of his bonus from
      2003 to which he was entitled  according to his contract.  Of this amount,
      we accrued  $99,750 for Mr. Ehrlich in  satisfaction  of the 2003 bonus to
      which he was entitled  according to his  contract;  the  remainder was the
      result of the approval in 2004 by the  Compensation  Committee of a higher
      bonus for 2003 than Mr. Ehrlich's contractual minimum.
  (5) Of this amount,  $92,075  represents  our accrual for  severance  pay that
      would be payable to Mr.  Ehrlich  upon a "change of  control"  or upon the
      occurrence of certain other events;  $3,451 represents the increase of the
      accrual  for sick  leave  and  vacation  redeemable  by Mr.  Ehrlich;  and
      $(14,813)  represents  the decrease of our accrual for  severance pay that
      would be payable to Mr.  Ehrlich  under the laws of the State of Israel if
      we were to terminate his employment.
  (6) Of this amount,  262,500  options were in exchange for a total of $105,000
      in  salary   waived  by  Mr.   Ehrlich   during   2002   pursuant  to  the
      options-for-salary  program  instituted  by us beginning in May 2001.  See
      "Options-for-Salary Program," below.
  (7) Of this amount,  $109,935  represents  our accrual for  severance pay that
      would be payable to Mr.  Ehrlich  upon a "change of  control"  or upon the
      occurrence of certain other events; $17,571 represents the increase of the
      accrual for sick leave and vacation redeemable by Mr. Ehrlich; and $43,725
      represents  the  increase of our accrual for  severance  pay that would be
      payable to Mr. Ehrlich under the laws of the State of Israel if we were to
      terminate his employment.
  (8) Does  not  include  $208,100  that we paid in  consulting  fees to  Sampen
      Corporation,  a New York  corporation  owned by members of Steven  Esses's
      immediate  family from which Mr.  Esses  receives a salary.  See "Item 13.
      Certain Relationships and Related Transactions - Consulting Agreement with
      Sampen Corporation," below.
  (9) Does not include $110,000 that we paid as a bonus to Sampen Corporation, a
      New York corporation  owned by members of Steven Esses's  immediate family
      from  which  Mr.  Esses   receives  a  salary.   See  "Item  13.   Certain
      Relationships and Related  Transactions - Consulting Agreement with Sampen
      Corporation," below.


                                       86
<PAGE>

 (10) Represents  the  increase of the accrual for vacation  redeemable  by Mr.
      Esses.
 (11) Represents consulting fees paid in 2002.
 (12) Of this  amount,  $21,568  represents  the  increase  in our  accrual  for
      vacation  redeemable by Mr. Shen;  and $13,404  represents the increase of
      our accrual for  severance pay that would be payable to Mr. Shen under the
      laws of the State of Israel if we were to terminate his employment.
 (13) Of this amount, $8,369 represents the increase of the accrual for vacation
      redeemable  by Mr.  Shen;  and  $(1,628)  represents  the  decrease of our
      accrual for severance pay that would be payable to Mr. Shen under the laws
      of the State of Israel if we were to terminate his employment.
 (14) Of this amount, $1,062 represents the increase of the accrual for vacation
      redeemable by Mr. Shen; and $8,785  represents the increase of our accrual
      for  severance pay that would be payable to Mr. Shen under the laws of the
      State of Israel if we were to terminate his employment.
 (15) Of this amount,  $6,500  represents the value of shares issued to Mr. Shen
      as a stock bonus and $394  represents  other  benefits that we paid to Mr.
      Shen in 2002.

     Executive Loans

         In  1999,  2000 and  2002,  we  extended  certain  loans  to our  Named
Executive  Officers.  These loans are summarized in the following table, and are
further described under "Item 13. Certain Relationships and Related Transactions
- Officer Loans," below.

<TABLE>
<CAPTION>
                                           Original        Amount
                                           Principal    Outstanding
    Name of Borrower      Date of Loan  Amount of Loan as of 12/31/04                Terms of Loan
    ----------------      ------------  -------------- --------------                -------------
<S>                        <C>   <C>    <C>             <C>
Robert S. Ehrlich.......   12/28/99     $    167,975    $    201,570  Ten-year non-recourse loan to purchase our
                                                                        stock, secured by the shares of stock
                                                                        purchased.
Robert S. Ehrlich.......   02/09/00     $    789,991    $    684,006  Twenty-five-year non-recourse loan to
                                                                        purchase our stock, secured by the
                                                                        shares of stock purchased.
Robert S. Ehrlich.......   06/10/02     $     36,500    $     38,719  Twenty-five-year non-recourse loan to
                                                                        purchase our stock, secured by the
                                                                        shares of stock purchased.
</TABLE>

     Options-for-Salary Program

         Between May 2001 and December 2002, we conducted an  options-for-salary
program  designed to conserve our cash and to offer  incentives  to employees to
remain with us despite lower cash compensation.  Under this program, most of our
salaried  employees  permanently  waived a portion of their salaries in exchange
for options to  purchase  shares of our common  stock,  at a ratio of options to
purchase  2.5  shares  of our stock for each  dollar  in salary  waived.  Social
benefits (such as pension) and contractual  bonuses for such employees continued
to  be   calculated   based  on  their   salaries   prior  to   reduction.   The
options-for-salary program was ended on December 31, 2002.

         During 2002,  options  were accrued  quarterly in advance for the Named
Executive Officers, and annually in advance for other employees.

         During  2002,  in  exchange  for  waiver of  $364,209  in  salary,  our
employees  other than the Named Executive  Officers  received a total of 910,522
options,  which  options were granted  based on the lowest  closing price of our
common  stock  during  the  month of  December  2002  ($0.61).  Named  Executive
Officers,  in exchange  for waiver of  $119,774  in salary,  received a total of
299,435  options  during 2002,  which  options were granted  based on the lowest
closing  prices of our common stock during each quarter of 2002, as set forth in
the table below.



                                       87
<PAGE>

         Following is a table setting forth the number of options that we issued
to each of our Named  Executive  Officers under the  options-for-salary  program
during  each  fiscal  quarter in 2002,  and the range of trading  prices for our
common stock during each such fiscal quarter:

<TABLE>
<CAPTION>
                                                                                             Low Trading                   Closing
                            Fiscal    Amount of      Number of    Number of      Average      Price     High Trading      Price
                           Quarter      Salary        Options      Options      Exercise      During    Price During   on Last Day
Named Executive Officer     Ended       Waived        Accrued       Issued        Price      Quarter       Quarter     of Quarter
------------------------ -------------------------- -------------------------- -----------------------------------------------------
<S>                        <C>   <C>  <C>               <C>          <C>          <C>         <C>           <C>           <C>
Robert S. Ehrlich......    03/31/02   $   26,250        65,625       65,625       $1.42       $1.35         $2.41         $1.55
                           06/30/02   $   26,250        65,625       65,625       $0.73       $0.73         $1.79         $0.91
                           09/30/02   $   26,250        65,625       65,625       $0.85       $0.79         $1.70         $1.05
                           12/31/02   $   26,250        65,625       65,625       $0.61       $0.61         $1.17         $0.64

Avihai Shen............    03/31/02   $    3,262         8,153        8,153       $1.42       $1.35         $2.41         $1.55
                           06/30/02   $    3,262         8,153        8,153       $0.73       $0.73         $1.79         $0.91
                           09/30/02   $    3,262        12,476       12,476       $0.85       $0.79         $1.70         $1.05
                           12/31/02   $    3,262         8,153        8,153       $0.61       $0.61         $1.17         $0.64
</TABLE>

Stock Options

         The table below sets forth  information  with respect to stock  options
granted to the Named Executive Officers for the fiscal year 2004.

<TABLE>
<CAPTION>

                        Option Grants in Last Fiscal Year

            Name              Individual Grants
      ---------------    ----------------------------
                         Number of       % of Total
                                          Options                                      Potential Realizable Value
                         Securities      granted to      Exercise                        of Assumed Annual Rates
                         Underlying      Employees       or Based                        of Stock Price Appreciation
                           Options       in Fiscal       Price          Expiration            for Option Term(1)
                                                                                      ------------------------------
         Name              Granted           Year            ($/Sh)         Date            5% ($)          10% ($)
      ---------------    -----------    -------------    -----------    ----------    -------------    -------------
<S>                       <C>                 <C>          <C>          <C>   <C>      <C>              <C>
Robert S. Ehrlich.....    50,000              3.3%         $1.20        08/09/09       $   16,577       $   36,631
Avihai Shen...........    18,750              1.2%         $1.20        08/09/09       $    6,216       $   13,736
</TABLE>

 ---------------------------------

 (1)The potential realizable value illustrates value that might be realized upon
    exercise of the options  immediately prior to the expiration of their terms,
    assuming the specified  compounded rates of appreciation of the market price
    per  share  from the date of grant  to the end of the  option  term.  Actual
    gains,  if any, on stock  option  exercise  are  dependent  upon a number of
    factors, including the future performance of the common stock and the timing
    of option exercises, as well as the executive officer's continued employment
    through the vesting  period.  The gains shown are net of the option exercise
    price,  but do not include  deductions for taxes and other expenses  payable
    upon the exercise of the option or for sale of  underlying  shares of common
    stock. The 5% and 10% rates of appreciation are mandated by the rules of the
    Securities  and Exchange  Commission  and do not  represent  our estimate or
    projection  of future  increases in the price of our stock.  There can be no
    assurance  that the amounts  reflected in this table will be  achieved,  and
    unless the  market  price of our common  stock  appreciates  over the option
    term, no value will be realized from the option grants made to the executive
    officers.

         The table below sets forth information for the Named Executive Officers
with respect to aggregated  option  exercises during fiscal 2004 and fiscal 2004
year-end option values.



                                       88
<PAGE>

<TABLE>
<CAPTION>
                           Aggregated Option Exercises and Fiscal Year-End Option Values

                                                         Number of Securities             Value of Unexercised
                                                       Underlying Unexercised            In-the-Money Options
                       Shares                         Options at Fiscal Year End          at Fiscal-Year-End(1)
                     Acquired on       Value          ------------------------------ ----------------------------------
        Name          Exercise        Realized         Exercisable   Unexercisable     Exercisable     Unexercisable
 --------------------------------- ------------------ -------------- --------------- ---------------- -----------------
<S>                      <C>        <C>                  <C>             <C>          <C>              <C>
Robert S. Ehrlich....    19,000     $         (665)      2,384,166       500,000      $    2,062,541   $      426,000
Steven Esses.........    50,000     $      128,500         641,808       178,333      $      457,134   $      299,282
Avihai Shen..........         -     $            -         309,653       310,000      $      280,438   $            0
</TABLE>

-----------------------------------

(1)  Options that are "in-the-money" are options for which the fair market value
     of the  underlying  securities  on December  31, 2004  ($1.62)  exceeds the
     exercise or base price of the option.

Employment Contracts

         Mr. Ehrlich is party to an employment agreement with us effective as of
January 1, 2000. The term of this employment agreement, as extended,  expires on
December 31, 2005, and is extended  automatically  for  additional  terms of two
years each unless either Mr. Ehrlich or we terminate the agreement sooner.

         The  employment  agreement  provides  for a base  salary of $20,000 per
month, as adjusted annually for Israeli inflation and devaluation of the Israeli
shekel  against  the U.S.  dollar,  if any.  Additionally,  the board may at its
discretion  raise Mr.  Ehrlich's base salary.  In January 2002, the board raised
Mr. Ehrlich's base salary to $23,750 per month effective January 1, 2002; during
2002 and 2003, Mr.  Ehrlich  elected to waive this increase in his salary and to
receive options instead, under our salary for options program.

         The  employment  agreement  provides  that if the  results we  actually
attain  in a given  year are at  least  80% of the  amount  we  budgeted  at the
beginning of the year,  we will pay a bonus,  on a sliding  scale,  in an amount
equal to a minimum of 35% of Mr. Ehrlich's annual base salary then in effect, up
to a maximum of 90% of his annual  base  salary then in effect if the results we
actually  attain  for the year in  question  are 120% or more of the  amount  we
budgeted at the beginning of the year.

         The employment  agreement also contains various  benefits  customary in
Israel for senior executives (please see "Item 1. Business - Employees," above),
tax  and   financial   planning   expenses  and  an   automobile,   and  contain
confidentiality  and  non-competition  covenants.  Pursuant  to  the  employment
agreements,  we granted Mr. Ehrlich demand and "piggyback"  registration  rights
covering shares of our common stock held by him.

         We can terminate  Mr.  Ehrlich's  employment  agreement in the event of
death or  disability or for "Cause"  (defined as  conviction of certain  crimes,
willful  failure  to carry out  directives  of our board of  directors  or gross
negligence or willful  misconduct).  Mr.  Ehrlich has the right to terminate his
employment  upon a change in our control or for "Good  Reason," which is defined
to include adverse changes in employment status or compensation, our insolvency,
material breaches and certain other events. Additionally, Mr. Ehrlich may retire
(after age 68) or terminate  his agreement for any reason upon 150 days' notice.
Upon termination of employment, the employment agreement provides for payment of
all  accrued  and  unpaid  compensation,  and  (unless  we have  terminated  the
agreement for Cause or Mr.  Ehrlich has  terminated  the agreement  without Good
Reason and without  giving us 150 days' notice of  termination)  bonuses due for
the year in which  employment is  terminated  and severance pay in the amount of
three years' base salary (or, in the case of  termination  by Mr. Ehrlich on 150
days' notice,  a lump sum payment of $520,000).  Furthermore,  certain  benefits
will continue and all outstanding options will be fully vested.



                                       89
<PAGE>

         Mr. Esses is not a party to an employment  agreement  with us. See also
"Item 13. Certain  Relationships and Related Transactions - Consulting Agreement
with Sampen Corporation," below.

         Mr.  Shen  has  signed  our  standard  employee  employment  agreement,
described below.

         Other  employees  (including  Mr. Shen) have  entered  into  individual
employment  agreements with us. These  agreements  govern the basic terms of the
individual's  employment,  such as salary,  vacation,  overtime  pay,  severance
arrangements  and  pension  plans.  Subject to Israeli  law,  which  restricts a
company's  right to  relocate  an  employee  to a work site  farther  than sixty
kilometers  from his or her regular  work site,  we have  retained  the right to
transfer certain  employees to other locations  and/or  positions  provided that
such  transfers do not result in a decrease in salary or benefits.  All of these
agreements also contain provisions  governing the confidentiality of information
and ownership of intellectual  property  learned or created during the course of
the employee's  tenure with us. Under the terms of these  provisions,  employees
must keep  confidential  all  information  regarding our operations  (other than
information  which is already  publicly  available)  received  or learned by the
employee  during the course of employment.  This provision  remains in force for
five  years  after the  employee  has left our  service.  Further,  intellectual
property created during the course of the employment relationship belongs to us.

         A number of the individual employment agreements,  but not all, contain
non-competition  provisions  which  restrict  the  employee's  rights to compete
against us or work for an enterprise  which competes against us. Such provisions
remain  in force  for a period of two  years  after  the  employee  has left our
service.

         Under the laws of Israel,  an employee  of ours who has been  dismissed
from service,  died in service,  retired from service upon attaining  retirement
age, or left due to poor health, maternity or certain other reasons, is entitled
to severance pay at the rate of one month's salary for each year of service.  We
currently fund this  obligation by making monthly  payments to approved  private
provident  funds  and by  its  accrual  for  severance  pay in the  consolidated
financial statements.  See Note 2.s. of the Notes to the Consolidated  Financial
Statements.

Compensation Committee Interlocks and Insider Participation

         The  Compensation  Committee  of our  board of  directors  for the 2004
fiscal year  consisted  of Dr. Jay M.  Eastman,  Jack E.  Rosenfeld  and Bert W.
Wasserman. None of the members has served as our officers or employees.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Security Ownership of Certain Beneficial Owners and Management

         The  following  table sets forth  information  regarding  the  security
ownership,  as of March 10, 2005, of those persons  owning of record or known by
us to own beneficially more than 5% of our common stock and of each of our Named
Executive Officers and directors,  and the shares of common stock held by all of
our directors and executive officers as a group.


                                       90
<PAGE>

<TABLE>
<CAPTION>
                                                                                           Percentage of Total
        Name and Address of Beneficial Owner(1)           Shares Beneficially Owned(2)(3) Shares Outstanding(3)
        ---------------------------------------           ------------------------------- ---------------------
<S>                                                               <C>                             <C>
Robert S. Ehrlich.......................................          3,219,546(4)                    3.9%
Steven Esses............................................            806,808(5)                    1.0%
Avihai Shen.............................................            528,904(6)                     *
Dr. Jay M. Eastman......................................             95,001(7)                     *
Jack E. Rosenfeld.......................................             97,001(8)                     *
Lawrence M. Miller......................................            543,580(9)                     *
Bert W. Wasserman.......................................             20,001(10)                    *
Edward J. Borey.........................................             36,001(11)                    *
All of our directors and executive officers as a group
(9 persons).............................................          5,346,842(12)                   6.4%
</TABLE>

  ------------------------------------

    *Less than one percent.

(1)   The address of each named beneficial owner is in care of Arotech
      Corporation, 250 West 57th Street, Suite 310, New York, New York 10107.

(2)   Unless otherwise indicated in these footnotes, each of the persons or
      entities named in the table has sole voting and sole investment power with
      respect to all shares shown as beneficially owned by that person, subject
      to applicable community property laws.

(3)   Based on 80,103,668 shares of common stock outstanding as of March 10,
      2005. For purposes of determining beneficial ownership of our common
      stock, owners of options exercisable within sixty days are considered to
      be the beneficial owners of the shares of common stock for which such
      securities are exercisable. The percentage ownership of the outstanding
      common stock reported herein is based on the assumption (expressly
      required by the applicable rules of the Securities and Exchange
      Commission) that only the person whose ownership is being reported has
      converted his options into shares of common stock.

(4)   Includes 50,000 shares held by Mr. Ehrlich's wife (in which shares Mr.
      Ehrlich disclaims beneficial ownership), 161,381 shares held in Mr.
      Ehrlich's pension plan, 3,000 shares held by children sharing the same
      household (in which shares Mr. Ehrlich disclaims beneficial ownership),
      and 2,387,000 shares issuable upon exercise of options exercisable within
      60 days.

(5)   Includes 641,808 shares issuable upon exercise of options exercisable
      within 60 days.

(6)   Includes 488,404 shares issuable upon exercise of options exercisable
      within 60 days.

(7)   Consists of 95,001 shares issuable upon exercise of options exercisable
      within 60 days.

(8)   Includes 95,001 shares issuable upon exercise of options exercisable
      within 60 days.

(9)   Includes 441,665 shares held by Leon S. Gross and Lawrence M. Miller as
      co-trustees of the Rose Gross Charitable Foundation, and 90,001 shares
      issuable upon exercise of options exercisable within 60 days.

(10)  Consists of 20,001 shares issuable upon exercise of options exercisable
      within 60 days.

(11)  Includes 20,001 shares issuable upon exercise of options exercisable
      within 60 days.

(12)  Includes 3,837,217 shares issuable upon exercise of options exercisable
      within 60 days.

Securities Authorized for Issuance Under Equity Compensation Plans

         The following table sets forth certain information,  as of December 31,
2004, with respect to our 1991, 1993, 1995, 1998 and 2004 stock option plans, as
well as any other stock options and warrants  previously issued by us (including
individual compensation arrangements) as compensation for goods and services:



                                       91
<PAGE>

<TABLE>
<CAPTION>
                      Equity Compensation Plan Information
                                                                                       Number of securities
                                                                                       remaining available
                                                                                       for future issuance
                              Number of securities                                         under equity
                                to be issued upon            Weighted-average           compensation plans
                                   exercise of              exercise price of         (excluding securities
                              outstanding options,         outstanding options,        reflected in column
                               warrants and rights         warrants and rights                 (a))

       Plan Category                     (a)                       (b)                           (c)
---------------------------- ------------------------     -----------------------     -----------------------
<S>                                   <C>                          <C>                        <C>
Equity compensation                   6,715,343                    $1.19                      5,523,931
  plans approved by
  security holders.....
Equity compensation
  plans not approved
  by security
  holders(2)(3)........               2,399,417                    $1.54                            291
                                      ---------                    -----                  -------------
Total..................               9,114,760                    $1.28                      5,524,222
                                      =========                    =====                      =========
</TABLE>

    -------------------------------------

    (1)In October 1998,  the Board of Directors  adopted the 1998  Non-Executive
       Stock Option and Restricted Stock Purchase Plan, which under Delaware law
       did not  require  shareholder  approval  since  directors  and  executive
       officers were ineligible to participate in it.  Participation in the 1998
       Plan is limited to those of our employees and consultants who are neither
       executive  officers nor otherwise subject to Section 16 of the Securities
       Exchange  Act of 1934,  as  amended,  or Section  162(m) of the  Internal
       Revenue Code of 1986, as amended.  The 1998 Plan is  administered  by the
       Compensation  Committee of our Board of Directors,  which  determined the
       conditions of grant.  Options issued under the 1998 Plan generally expire
       no more than ten  years  from the date of grant,  and  incentive  options
       issued under the 1998 Plan may be granted  only at exercise  prices equal
       to the fair  market  value of our common  stock on the date the option is
       granted.
    (2)For a  description  of the  material  features  of grants of options  and
       warrants  other than  options  granted  under our  employee  stock option
       plans,  please see Note 14.f. and 14.g. of the Notes to the  Consolidated
       Financial Statements.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Officer Loans

         On December 3, 1999,  Robert S. Ehrlich purchased 125,000 shares of our
common  stock out of our  treasury at the closing  price of the common  stock on
December  2,  1999.  Payment  was  rendered  by  Mr.  Ehrlich  in  the  form  of
non-recourse  promissory  notes due in 2009 in the amount of  $167,975,  bearing
simple  annual  interest at a rate of 2%,  secured by the shares of common stock
purchased  and other  shares  of  common  stock  previously  held by him.  As of
December 31, 2003, the aggregate amount outstanding  pursuant to this promissory
note was $201,570.

         On February 9, 2000, Mr. Ehrlich exercised  131,665 stock options.  Mr.
Ehrlich paid the exercise  price of the stock  options and certain taxes that we
paid on his behalf by giving us a  non-recourse  promissory  note due in 2025 in
the amount of $789,991,  bearing annual interest (i) as to $329,163,  at 1% over
the  then-current  federal  funds rate  announced  from time to time by the Wall
Street Journal, and (ii) as to $460,828, at 4% over the then-current  percentage
increase in the Israeli  consumer  price index  between the date of the loan and


                                       92
<PAGE>

the date of the annual interest calculation, secured by the shares of our common
stock acquired through the exercise of the options and certain  compensation due
to Mr. Ehrlich upon  termination.  As of December 31, 2003, the aggregate amount
outstanding pursuant to this promissory note was $657,146.

         On June 10, 2002,  Mr.  Ehrlich  exercised  50,000 stock  options.  Mr.
Ehrlich paid the exercise price of the stock options by giving us a non-recourse
promissory  note due in 2012 in the amount of  $36,500,  bearing  simple  annual
interest  at a rate  equal  to the  lesser  of (i)  5.75%,  and (ii) 1% over the
then-current  federal  funds rate  announced  from time to time,  secured by the
shares of our common stock acquired  through the exercise of the options.  As of
December 31, 2003, the aggregate amount outstanding  pursuant to this promissory
note was $37,810.

Director Consulting Agreements

         Beginning in February  2002,  Mr. Steven  Esses,  who became one of our
directors in July 2002,  entered into an oral  consulting  arrangement  with us,
whereby he performed periodic financial and other consulting for us. We paid Mr.
Esses a total of $120,480 in  consulting  fees in 2002.  Beginning in July 2002,
when Mr. Esses became a director, this consulting arrangement ceased.

         Beginning in January 2004,  Mr. Edward J. Borey,  who became one of our
directors in December 2003, entered into a consulting agreement with us pursuant
to which he agreed to aid us in identifying potential acquisition  candidates in
exchange for  transaction  fees in respect of  acquisitions  in which he plays a
"critical  role" (as  determined by us in our sole and absolute  discretion)  in
identifying  and/or initiating and/or  negotiating the transaction in the amount
of (i) 1.5% of the value of the transaction up to $10,000,000, plus (ii) 1.0% of
the value of the  transaction  in excess of $10,000,000  and up to  $50,000,000,
plus (iii) 0.5% of the value of the  transaction  in excess of  $50,000,000.  We
also agreed to issue to Mr. Borey, at par value, a total of 32,000 shares of our
common  stock,  the value of which is to be deducted from any  transaction  fees
paid. 16,000 of these shares were earned and issued prior to termination of this
agreement in August 2004.

Consulting Agreement with Sampen Corporation

         We have a consulting agreement with Sampen Corporation that we executed
in March 2005, effective as of January 1, 2005. Sampen is a New York corporation
owned by  members  of  Steven  Esses's  immediate  family,  and Mr.  Esses is an
employee of Sampen.  The term of this consulting  agreement  expires on December
31, 2006, and is extended  automatically  for additional terms of two years each
unless either Sampen or we terminate the agreement sooner.

         Pursuant to the terms of our agreement with Sampen, Sampen provides one
of its  employees  to us for  such  employee  to  serve  as our  Executive  Vice
President and Chief Operating Officer.  We pay Sampen $12,800 per month, plus an
annual  bonus,  on a sliding  scale,  in an amount  equal to a minimum of 25% of
Sampen's annual base  compensation then in effect, up to a maximum of 75% of its
annual base  compensation  then in effect if the results we actually  attain for
the year in question are 120% or more of the amount we budgeted at the beginning
of the  year.  We also  pay  Sampen,  to cover  the cost of our use of  Sampen's
offices as an  ancillary  New York office life and the  attendant  expenses  and
insurance  costs,  an  amount  equal  to 16% of  each  monthly  payment  of base
compensation.



                                       93
<PAGE>

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

         In accordance with the requirements of the  Sarbanes-Oxley  Act of 2002
and the Audit  Committee's  charter,  all audit and  audit-related  work and all
non-audit work performed by our independent  accountants,  Kost, Forer, Gabbay &
Kassierer, is approved in advance by the Audit Committee, including the proposed
fees for such work.  The Audit  Committee is informed of each  service  actually
rendered.

         >>       Audit  Fees.  Audit fees billed or expected to be billed to us
                  by  Kost,  Forer,  Gabbay  &  Kassierer  for the  audit of the
                  financial  statements  included  in our Annual  Report on Form
                  10-K, and reviews of the financial  statements included in our
                  Quarterly  Reports on Form 10-Q,  for the years ended December
                  31, 2003 and 2004 totaled approximately $177,000 and $594,924,
                  respectively.

         >>       Audit-Related  Fees. Kost, Forer, Gabbay & Kassierer billed us
                  $34,500 and $214,659  for the fiscal years ended  December 31,
                  2003  and  2004,  respectively,   for  assurance  and  related
                  services that are reasonably related to the performance of the
                  audit  or  review  of our  financial  statements  and  are not
                  reported under the caption "Audit Fees," above.

         >>       Tax  Fees.  Kost,  Forer,  Gabbay  &  Kassierer  billed  us an
                  aggregate  of $24,320  and $9,491 for the fiscal  years  ended
                  December 31, 2003 and 2004,  respectively,  for tax  services,
                  principally  advice  regarding the  preparation  of income tax
                  returns.

         >>       All Other Fees. The Audit  Committee of the Board of Directors
                  has  considered  whether the  provision  of the  Audit-Related
                  Fees,  Tax  Fees  and  all  other  fees  are  compatible  with
                  maintaining the independence of our principal accountant.

         Applicable  law and  regulations  provide  an  exemption  that  permits
certain  services to be provided  by our outside  auditors  even if they are not
pre-approved.  We have  not  relied  on this  exemption  at any time  since  the
Sarbanes-Oxley Act was enacted.


                                       94
<PAGE>


                                     PART IV

ITEM 15.          EXHIBITS, FINANCIAL STATEMENT SCHEDULES

(a) The following documents are filed as part of this report:

      (1)   Financial Statements - See Index to Financial Statements on page
            73 above.
      (2)   Financial  Statements  Schedules  -  Schedule  II  -  Valuation  and
            Qualifying Accounts. All schedules other than those listed above are
            omitted  because of the absence of  conditions  under which they are
            required or because the  required  information  is  presented in the
            financial statements or related notes thereto.
      (3)   Exhibits - The following  Exhibits are either filed herewith or have
            previously  been filed with the Securities  and Exchange  Commission
            and are  referred to and  incorporated  herein by  reference to such
            filings:

<TABLE>
<CAPTION>
      Exhibit No.                              Description
<S>   <C>
   (8)3.1.........Amended and Restated Certificate of Incorporation
  (15)3.1.1.......Amendment to our Amended and Restated Certificate of Incorporation
  (24)3.1.2.......Amendment to our Amended and Restated Certificate of Incorporation
    **3.1.3.......Amendment to our Amended and Restated Certificate of Incorporation
   (2)3.2.........Amended and Restated By-Laws
    **4.1.........Specimen Certificate for shares of common stock, $.01 par value
 +                (6)10.6........Amended  and  Restated  1993  Stock  Option and
                  Restricted Stock Purchase Plan dated November 11, 1996
 + (1)10.7.1......Form of Management Employment Agreements
+ *   10.7.2......General Employee Agreements
   (1)
 * (1)10.8........Office of Chief Scientist documents
   (2)10.8.1......Letter from the Office of Chief Scientist to us dated January 4, 1995
 + (3)10.12.......Amended and Restated 1995 Non-Employee Director Stock Option Plan
   (4)10.14.......Stock Purchase Agreement between us and Leon S. Gross ("Gross") dated September 30, 1996
   (4)10.15.......Registration Rights Agreement between us and Gross dated September 30, 1996
 + (5)10.20.......Amended  and  Restated  Employment  Agreement  dated as of October 1, 1996  between  us, EFL and
                  Robert S. Ehrlich
+ (15)10.20.1.....Second Amended and Restated  Employment  Agreement,  effective as of January 1, 2000 between us,
                  EFL and Robert S. Ehrlich
   (6)10.26.......Amendment No. 2 to the Registration  Rights Agreement  between us, Gross,  Robert S. Ehrlich and
                  Yehuda Harats dated December 10, 1997
   (7)10.27.......1998 Non-Executive Stock Option and Restricted Stock Purchase Plan
   (9)10.31.......Form of Warrant dated December 28, 1999
  (10)10.35.1.....Promissory Note dated January 3, 1993, from Robert S. Ehrlich to us
  (10)10.35.2.....Amendment  dated April 1, 1998,  to  Promissory  Note dated  January 3, 1993  between  Robert S.
                  Ehrlich and us
  (10)10.37.......Promissory Note dated December 3, 1999, from Robert S. Ehrlich to us
</TABLE>


                                       95
<PAGE>
<TABLE>
<CAPTION>
      Exhibit No.                              Description
<S>   <C>
  (10)10.39.......Promissory Note dated February 9, 2000, from Robert S. Ehrlich to us
  (11)10.48.......Series A Stock Purchase Warrant issued to Capital Ventures International dated November 17, 2000
  (11)10.49.......Series B Stock Purchase Warrant issued to Capital Ventures International dated November 17, 2000
  (11)10.50.......Stock Purchase Warrant issued to Josephthal & Co., Inc. dated November 17, 2000
  (12)10.52.......Promissory Note dated January 12, 2001, from Robert S. Ehrlich to us
  (12)10.54.......Agreement of Lease dated December 5, 2000 between us as tenant and  Renaissance 632 Broadway LLC
                  as landlord
  (13)10.55.......Series C Stock Purchase Warrant issued to Capital Ventures International dated May 3, 2001
  (14)10.56.......Form of Common Stock Purchase Warrant dated May 8, 2001
  (15)10.63.......Securities Purchase Agreement dated December 31, 2002 between us and the Investors
  (15)10.64.......Form of 9% Secured Convertible Debenture due June 30, 2005
  (15)10.65.......Form of Warrant dated December 31, 2002
  (15)10.66.......Form of Security Agreement dated December 31, 2002
  (15)10.67.......Form of Intellectual Property Security Agreement dated December 31, 2002
 +(16)10.68.......Settlement Agreement and Release between us and Yehuda Harats dated December 31, 2002
  (16)10.69.1.....Commercial lease agreement  between  Commerce Square  Associates  L.L.C. and I.E.S.  Electronics
                  Industries U.S.A., Inc. dated September 24, 1997
  (16)10.69.2.....Amendment to Commercial  lease agreement  between Commerce Square  Associates  L.L.C. and I.E.S.
                  Electronics Industries U.S.A., Inc. dated as of May 1, 2000
  (16)10.70.......Agreement  of Lease dated  December 6, 2000 between  Janet  Nissim et al. and M.D.T.  Protection
                  (2000) Ltd. [English summary of Hebrew original]
  (16)10.71.......Agreement of Lease dated August 22, 2001 between Aviod Building and  Earthworks  Company Ltd. et
                  al. and M.D.T. Protective Industries Ltd. [English summary of Hebrew original]
  (22)10.72.......Promissory Note dated July 1, 2002 from Robert S. Ehrlich to us
  (17)10.73.......Securities  Purchase  Agreement  dated  September  30, 2003 between us and the  Investors  named
                  therein
  (17)10.74.......Form of 8% Secured Convertible Debenture due September 30, 2006
  (17)10.75.......Form of Warrant dated September 30, 2003
  (17)10.76.......Form of Security Agreement dated September 30, 2003
  (17)10.77.......Form of Intellectual Property Security Agreement dated September 30, 2003
  (18)1010.78..   Form of Amendment and Exercise Agreement dated December 10, 2003
  (18)10.79.......Form of Supplemental Warrant dated December 18, 2003
  (19)10.80.......Stock Purchase and Sale Agreement dated January 7, 2004 between us and the  shareholders of FAAC
                  Incorporated
</TABLE>

                                       96
<PAGE>
<TABLE>
<CAPTION>
      Exhibit No.                              Description
<S>   <C>
  (19)10.81.......Securities Purchase Agreement dated January 7, 2004 between us and the Investors named therein
  (19)10.82.......Registration Rights Agreement dated January 7, 2004 between us and the Investors named therein
  (19)10.83.......Form of Warrant dated January __, 2004
  (20)10.84.......Share  Purchase  Agreement  dated  January __, 2004 between us and the  shareholders  of Epsilor
                  Electronics Industries, Ltd.
  (20)10.85.......Management Agreement dated January __, 2004 among us, Office Line Ltd. and Hezy Aspis
 *(21)10.86.......Settlement Agreement between us and I.E.S. Electronics Industries, Ltd. dated February 4, 2004
 +(22)10.86.......Consulting agreement dated January 1, 2004 between us and Edward J. Borey
  (22)10.87.......Lease dated April 8, 1997, between AMR Holdings, L.L.C. and FAAC Incorporated
  (22)10.88.......Lease dated as of March 22, 2004 between us and Fisk Building Associates L.L.C.
  (23)10.89.......Stock  Purchase  Agreement  dated  as of  July  15,  2004  between  us and  Armour  of  America,
                  Incorporated and its sole shareholder
  (24)10.90.......Securities  Purchase Agreement dated as of July 15, 2004, by and among us and various investors
   +**10.91.......Consulting Agreement, effective as of January 1, 2005, between us and Sampen Corporation
  (22)14.1........Code of Ethics
    **21.1........List of Subsidiaries of the Registrant
    **23.1........Consent of Kost, Forer, Gabbay & Kassierer, a member of Ernst & Young Global
    **23.2........Consent of Stark Winter Schenkein & Co., LLP
    **31.1........Certification of Principal  Executive Officer pursuant to Section 302 of the  Sarbanes-Oxley Act
                  of 2002
    **31.2........Certification of Principal  Financial Officer pursuant to Section 302 of the  Sarbanes-Oxley Act
                  of 2002
    **32.1........Certification  of Principal  Executive  Officer  pursuant to 18 U.S.C.  Section 1350, as adopted
                  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
    **32.2........Certification  of Principal  Financial  Officer  pursuant to 18 U.S.C.  Section 1350, as adopted
                  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
</TABLE>

-------------------------------------

    *English translation or summary from original Hebrew
   **Filed herewith
    +Includes management contracts and compensation plans and arrangements

(1)Incorporated  by  reference  to  our  Registration   Statement  on  Form  S-1
   (Registration No. 33-73256), which became effective on February 23, 1994
(2)Incorporated  by  reference  to  our  Registration   Statement  on  Form  S-1
   (Registration No. 33-97944), which became effective on February 5, 1996
(3)Incorporated  by  reference  to our  Annual  Report on Form 10-K for the year
   ended December 31, 1995
(4)Incorporated  by reference to our Current Report on Form 8-K dated October 4,
   1996


                                       97
<PAGE>

(5)Incorporated  by  reference  to our  Annual  Report on Form 10-K for the year
   ended December 31, 1996, as amended
(6)Incorporated  by  reference  to our  Annual  Report on Form 10-K for the year
   ended December 31, 1997, as amended
(7)Incorporated  by  reference  to  our  Registration   Statement  on  Form  S-8
   (Registration No. 333- 74197), which became effective on March 10, 1998
(8)Incorporated  by  reference  to our  Annual  Report on Form 10-K for the year
   ended December 31, 1998
(9)Incorporated  by reference to our Current Report on Form 8-K filed January 7,
   2000
(10)Incorporated  by  reference  to our Annual  Report on Form 10-K for the year
    ended December 31, 1999
(11)Incorporated  by reference to our Current  Report on Form 8-K filed November
    17, 2000
(12)Incorporated  by  reference  to our Annual  Report on Form 10-K for the year
    ended December 31, 2000
(13)Incorporated  by  reference  to our Current  Report on Form 8-K filed May 7,
    2001 (EDGAR Film No. 1623996)
(14)Incorporated  by  reference  to our Current  Report on Form 8-K filed May 7,
    2001 (EDGAR Film No. 1623989)
(15)Incorporated by reference to our Current Report on Form 8-K filed January 6,
    2003
(16)Incorporated  by  reference  to our Annual  Report on Form 10-K for the year
    ended December 31, 2002
(17)Incorporated by reference to our Current Report on Form 8-K filed October 3,
    2003
(18)Incorporated  by reference to our Current  Report on Form 8-K filed December
    23, 2003
(19)Incorporated by reference to our Current Report on Form 8-K filed January 9,
    2004
(20)Incorporated  by reference to our Current  Report on Form 8-K filed February
    4, 2004
(21)Incorporated  by reference to our Current  Report on Form 8-K filed February
    5, 2004
(22)Incorporated  by  reference  to our Annual  Report on Form 10-K for the year
    ended December 31, 2003
(23)Incorporated  by  reference  to our  Quarterly  Report  on Form 10-Q for the
    quarter ended June 30, 2004  (24)Incorporated by reference to our Current
    Report on Form 8-K filed July 15, 2004


                                       98
<PAGE>

                                   SIGNATURES

         Pursuant to the  requirements  of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on March 31 , 2005.

                                    AROTECH CORPORATION


                                    By: /s/  Robert S. Ehrlich
                                        ----------------------------------------
                                         Name:   Robert S. Ehrlich
                                         Title:  Chairman, President and
                                         Chief Executive Officer

         Pursuant to the  requirements  of the Securities  Exchange Act of 1934,
this  report has been  signed  below by the  following  persons on behalf of the
registrant and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
     Signature                                   Title                                   Date
     ---------                                   -----                                   ----
<S>                                              <C>                                     <C>
                            Chairman, President, Chief Executive Officer and
  /s/ Robert S. Ehrlich                         Director
------------------------
     Robert S. Ehrlich               (Principal Executive Officer)                March   31  , 2005
                                                                                        ------

       /s/ Avihai Shen                 Vice President - Finance                   March   31  , 2005
-----------------------                                                                 ------
       Avihai Shen                  (Principal Financial Officer)

     /s/ Danny Waldner                        Controller                          March   31  , 2005
-----------------------                                                                 ------
       Danny Waldner                 (Principal Accounting Officer)

      /s/ Steven Esses    Executive Vice President, Chief Operating Officer       March   31  , 2005
-----------------------                                                                 ------
      Steven Esses                          and Director

    /s/ Jay M. Eastman                        Director                            March   31  , 2005
-----------------------                                                                 ------
   Dr. Jay M. Eastman

  /s/ Lawrence M. Miller                      Director                            March   31  , 2005
-------------------------                                                               ------
      Lawrence M. Miller

  /s/ Jack E. Rosenfeld                       Director                            March   31  , 2005
------------------------                                                                ------
      Jack E. Rosenfeld

  /s/ Bert W. Wasserman                       Director                            March   31  , 2005
------------------------                                                                ------
      Bert W. Wasserman

   /s/ Edward J. Borey                        Director                            March   31  , 2005
-----------------------                                                                 ------
       Edward J. Borey

</TABLE>


                                       99
<PAGE>

                    AROTECH CORPORATION AND ITS SUBSIDIARIES

                        CONSOLIDATED FINANCIAL STATEMENTS

                             AS OF DECEMBER 31, 2004

                                 IN U.S. DOLLARS

                                      INDEX


                                                                        Page
                                                                 ---------------
Reports of Independent Registered Public Accounting Firms              2 - 3
Consolidated Balance Sheets                                            4 - 5
Consolidated Statements of Operations                                      6
Statements of Changes in Stockholders' Equity                          7 - 9
Consolidated Statements of Cash Flows                                10 - 13
Notes to Consolidated Financial Statements                           14 - 60

<PAGE>

[logo] ERNST & YOUNG

             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

                             To the Stockholders of

                               AROTECH CORPORATION

        We have audited the accompanying consolidated balance sheets of Arotech
Corporation (the "Company") and its subsidiaries as of December 31, 2004 and
2003, and the related consolidated statements of operations, changes in
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 2004. Our audits also included the financial statement
schedule listed in Item 15(a)(2) of the Company's 10-K. These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits. We did not audit the financial statements of
"Armor of America," a wholly-owned subsidiary of the Company, financial
statements of which reflect total assets of 4% of the consolidated assets of the
Company as of December 31, 2004, and total revenues of 5% of the consolidated
revenues of the Company for the year then ended. Those statements were audited
by other auditors whose report has been furnished to us, and our opinion,
insofar as it relates to the data included for this subsidiary, is based solely
on the report of the other auditors.

        We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

        In our opinion based on our audits and the other auditors the
consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of the Company and its
subsidiaries as of December 31, 2004 and 2003, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2004, in conformity with U.S. generally accepted accounting
principles. Additionally, in our opinion the related financial statement
schedule, when considered in relation to the basic financial statements and
schedule taken as a whole, present fairly in all material respects the
information set forth therein.

        As discussed in Note 1.b., the Consolidated Financial Statements at
December 31, 2003 and for the year then ended have been restated for the matters
set forth therein.

Tel Aviv, Israel                                 KOST, FORER, GABBAY & KASIERER
March 24, 2005                                  A Member of Ernst & Young Global


                                      F-2
<PAGE>

                                     [logo]

                             STARK WINTER SCHENKEIN


             Report of Independent Registered Public Accounting Firm

To the Shareholder
Armour of America, Inc.
Gardena, California

We have audited the accompanying balance sheets of Armour of America, Inc. as of
December 31, 2004, and the related statements of income, stockholder's equity
and cash flows for the period August 11, 2004 to December 31, 2004. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Armour of America, Inc. as of
December 31, 2004, and the results of its operations, stockholder's equity and
cash flows for the period August 11, 2004 to December 31, 2004, in conformity
with accounting principles generally accepted in the United States of America.

/s/ Stark Winter Schenkein & Co., LLP

Denver, Colorado
January 31, 2005


       STARK  WINTER  SCHENKEIN & CO., LLP  Certified Public Accountants
                                Financial Consultants
--------------------------------------------------------------------------------

         7535 EAST HAMPDEN AVENUE  SUITE 109  DENVER, COLORADO 80231
      PHONE: 303.694.6700  FAX: 303.694.6761  TOLL FREE: 888.766.3985
                                WWW.SWSCPAS.COM

                                      F-3
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
In U.S. dollars

<TABLE>
<CAPTION>
                                                                                              December 31,
                                                                                -----------------------------------------
                                                                                      2004                   2003*
                                                                                ------------------     ------------------
<S>                                                                              <C>                    <C>
         ASSETS

CURRENT ASSETS:
     Cash and cash equivalents                                                   $     6,734,512        $    13,685,125
      Restricted collateral deposits and restricted held-to-maturity
           securities                                                                  6,962,110                706,180
      Available for sale marketable securities                                           135,568                      -
      Trade receivables (net of allowance for doubtful accounts in the
        amounts of $55,394 and $61,282 as of December 31, 2004 and 2003,
        respectively)                                                                  8,266,880              4,706,423

     Unbilled receivables                                                              2,881,468                      -
     Other accounts receivable and prepaid expenses                                    1,339,393              1,187,371
     Inventories                                                                       7,277,301              1,914,748
     Assets of discontinued operations                                                         -                 66,068
                                                                                ------------------     ------------------
Total current assets                                                                  33,597,232             22,265,915
                                                                                ------------------     ------------------
SEVERANCE PAY FUND                                                                     1,980,047              1,023,342

RESTRICTED DEPOSITS                                                                    4,000,000                      -

PROPERTY AND EQUIPMENT, NET                                                            4,600,691              2,292,741

OTHER INTANGIBLE ASSETS, NET                                                          14,368,701              2,375,195

GOODWILL                                                                              39,745,516              5,064,555
                                                                                ------------------     ------------------

                                                                                 $    98,292,187        $    33,021,748
                                                                                ==================     ==================
</TABLE>

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


                                      F-4
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
In U.S. dollars

<TABLE>
<CAPTION>
                                                                                              December 31,
                                                                                ------------------------------------------
                                                                                       2004                    2003*
                                                                                -------------------     ------------------
<S>                                                                              <C>                     <C>
         LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
     Trade payables                                                              $     6,177,546         $     1,967,448
     Other accounts payable and accrued expenses                                       5,818,188               4,030,411 **
     Current portion of promissory notes due to purchase of subsidiaries              13,585,325                 150,000
     Short term bank credit and current portion of long term loans                       181,352                  40,849
     Deferred revenues                                                                   618,229                 140,936 **
     Liabilities of discontinued operations                                                    -                 380,108
                                                                                -------------------     ------------------
Total current liabilities                                                             26,380,640               6,709,752
                                                                                -------------------     ------------------

LONG TERM LIABILITIES
     Accrued severance pay                                                             3,422,951               2,814,492
     Convertible debenture                                                             1,754,803               1,450,194
     Deferred revenues                                                                   163,781                 220,143
     Long term loan                                                                       20,891                       -
     Long-term portion of promissory note due to purchase of subsidiaries                980,296                 150,000
                                                                                -------------------     ------------------
Total long-term liabilities                                                            6,342,722               4,634,829
                                                                                -------------------     ------------------
COMMITMENTS AND CONTINGENT LIABILITIES (Note 12)

MINORITY INTEREST                                                                         95,842                  51,290
                                                                                -------------------     ------------------
STOCKHOLDERS' EQUITY:
     Share capital -
     Common stock - $0.01 par value each;
         Authorized: 250,000,000 shares and 100,000,000 shares as of December
           31, 2004 and 2003, respectively; Issued: 80,576,902 shares and
           47,972,407 shares as of December 31, 2004 and 2003, respectively;
           Outstanding - 80,021,569 shares and 47,417,074 shares as of
           December 31, 2004 and 2003, respectively                                      805,769                 479,726
     Preferred shares - $0.01 par value each;
         Authorized: 1,000,000 shares as of December 31, 2004 and 2003; No
           shares issued and outstanding as of December 31, 2004 and 2003                      -                       -
     Additional paid-in capital                                                      189,266,704             135,702,413
     Accumulated deficit                                                            (118,953,553)           (109,911,240)
     Deferred stock compensation                                                      (1,258,295)                 (8,464)
     Treasury stock, at cost (common stock - 555,333 shares as of December 31,
       2004 and 2003)                                                                 (3,537,106)             (3,537,106)
     Notes receivable from stockholders                                               (1,222,871)             (1,203,881)
     Accumulated other comprehensive income                                              372,335                 104,429
                                                                                -------------------     ------------------
Total stockholders' equity                                                            65,472,983              21,625,877
                                                                                -------------------     ------------------
                                                                                 $    98,292,187         $    33,021,748
                                                                                ===================     ==================
</TABLE>

----------------------------
*  Restated (see Note 1.b.).
**   Reclassified.


                                      F-5
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
--------------------------------------------------------------------------------
In U.S. dollars

<TABLE>
<CAPTION>
                                                                             Year ended December 31,
                                                           -------------------------------------------------------------
                                                                 2004                 2003*                 2002
                                                           ------------------  -------------------   -------------------
<S>                                                           <C>                 <C>                   <C>
Revenues                                                      $   49,953,846      $   17,326,641        $    6,406,739

Cost of revenues                                                  34,011,094          11,087,840             4,421,748
                                                           ------------------  -------------------   -------------------

Gross profit                                                      15,942,752           6,238,801             1,984,991
                                                           ------------------  -------------------   -------------------

Operating expenses:
   Research and development, net                                   1,731,379           1,053,408               685,919
   Selling and marketing expenses                                  4,922,217           3,532,636             1,309,669
   General and administrative expenses                            10,656,866           5,857,876             4,023,103
   Amortization of intangible assets and impairment losses         2,814,835             864,910               623,543
   In-process research and development write-off                           -                   -                26,000
                                                           ------------------  -------------------   -------------------

Total operating costs and expenses                                20,125,297          11,308,830             6,668,234
                                                           ------------------  -------------------   -------------------

Operating loss                                                    (4,182,545)         (5,070,029)           (4,683,243)
Financial income (expenses), net                                  (4,228,965)         (4,038,709)              100,451
                                                           ------------------  -------------------   -------------------

Loss before minorities interests in loss (earnings) of a
   subsidiaries and tax expenses                                  (8,411,510)         (9,108,738)           (4,582,792)
Income taxes                                                        (586,109)           (396,193)                    -
Minorities interests in loss (earnings) of a subsidiaries            (44,694)            156,900              (355,360)
                                                           ------------------  -------------------   -------------------
Loss from continuing operations                                   (9,042,313)         (9,348,031)           (4,938,152)

Income (loss) from discontinued operations (including
   loss on disposal of $4,446,684 during 2002)                             -             110,410           (13,566,206)
                                                           ------------------  -------------------   -------------------
Net loss                                                      $   (9,042,313)     $   (9,237,621)       $  (18,504,358)

Deemed dividend to certain stockholders                       $   (3,328,952)     $     (350,000)       $            -
                                                           ------------------  -------------------   -------------------

Net loss attributable to common stockholders                  $  (12,371,265)     $   (9,587,621)       $  (18,504,358)
                                                           ==================  ===================   ===================

Basic and diluted net loss per share from continuing
  operations                                                  $      (0.13)       $      (0.24)         $      (0.15)
                                                           ==================  ===================   ===================
Basic and diluted net loss per share from discontinued        $       0.00        $       0.00          $      (0.42)
  operations
                                                           ==================  ===================   ===================
Basic and diluted net loss per share                          $      (0.18)       $      (0.25)         $      (0.57)
                                                           ==================  ===================   ===================

Weighted average number of shares used in computing basic
  and diluted net loss per share                                  69,933,057          38,890,174            32,381,502
                                                           ==================  ===================   ===================
</TABLE>

----------------------------------
   *  Restated (see Note 1.b.).


                                      F-6
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
--------------------------------------------------------------------------------
In U.S. dollars


<TABLE>
<CAPTION>

                                         Common stock          Additional                   Deferred
                                  ---------------------------    paid-in      Accumulated     stock        Treasury
                                     Shares        Amount        capital        deficit     compensation      stock
                                  ------------- -------------  ------------- -------------- -------------- -------------
<S>                                     <C>           <C>             <C>        <C>           <C>                <C>
Balance as of January 1, 2002       29,059,469      $290,596   $105,686,909  $(82,169,261)      $(18,000)  $(3,537,106)
  Adjustment of notes from
    stockholders
  Repayment of notes from
    employees
  Issuance of shares to investors    2,041,176        20,412      3,209,588
  Issuance of shares to service
    providers                          368,468         3,685        539,068
  Issuance of shares to lender
    in respect of prepaid
    interest expenses                  387,301         3,873        232,377
  Exercise of options by
    employees                          191,542         1,915        184,435
  Amortization of deferred stock
    compensation                                                                                    6,000
  Stock compensation related to
    options issued to employees         13,000           130         12,870
  Issuance of shares in respect
    of acquisition                   3,640,638        36,406      4,056,600
  Accrued interest on notes
    receivable                                                      160,737
  Other comprehensive loss
    Foreign currency translation
    adjustment
  Net loss                                                                    (18,504,358)
                                  ------------- -------------  ------------- -------------- -------------- -------------
  Total comprehensive loss


  Balance as of December 31, 2002   35,701,594     $ 357,017   $114,082,584  $(100,673,619)   $  (12,000)  $(3,537,106)
                                  ============= =============  ============= ============== ============== =============


<CAPTION>

                                                          Notes      Accumulated
                                         Total           receivable      other         Total
                                       comprehensive       from      comprehensive  stockholders'
                                            loss         stockholders      loss          equity
                                        ----------       ------------- -------------- --------------
<S>                                        <C>               <C>              <C>         <C>
Balance as of January 1, 2002                              $(845,081)       $      -    $19,408,057
  Adjustment of notes from
    stockholders                                            (178,579)                     (178,579)
  Repayment of notes from
    employees                                                  43,308                        43,308
  Issuance of shares to investors                                                         3,230,000
  Issuance of shares to service
    providers                                                                               542,753
  Issuance of shares to lender
    in respect of prepaid
    interest expenses                                                                       236,250
  Exercise of options by
    employees                                                (36,500)                       149,850
  Amortization of deferred stock
    compensation                                                                              6,000
  Stock compensation related to
    options issued to employees                                                              13,000
  Issuance of shares in respect
    of acquisition                                                                        4,093,006
  Accrued interest on notes
    receivable                                              (160,737)                             -
  Other comprehensive loss
    Foreign currency translation
    adjustment                             $   (1,786)                       (1,786)        (1,786)
  Net loss                                (18,504,358)                                 (18,504,358)
                                        ---------------  ------------- -------------- --------------
  Total comprehensive loss              $ (18,506,144)
                                        ===============

  Balance as of December 31, 2002                        $(1,177,589)     $  (1,786)    $ 9,037,501
                                                         ============= ============== ==============

</TABLE>

                                      F-7
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
--------------------------------------------------------------------------------
In U.S. dollars

<TABLE>
<CAPTION>

                                         Common stock          Additional                   Deferred
                                  ---------------------------    paid-in      Accumulated     stock        Treasury
                                     Shares        Amount        capital        deficit     compensation      stock
                                  ------------- -------------  ------------- -------------- -------------- -------------
<S>                                     <C>           <C>             <C>        <C>           <C>                <C>
Balance as of January 1, 2003*      35,701,594     $ 357,017   $114,082,584  $(100,673,619)   $  (12,000)  $(3,537,106)
  Compensation related to
    warrants issued to the
    holders of convertible
    debentures                                                    5,157,500
  Compensation related to
    beneficial conversion
    feature of convertible
    debentures                                                    5,695,543
  Issuance of shares on
    conversion of convertible
    debentures                       6,969,605        69,696      6,064,981
  Issuance of shares on exercise
    of warrants                      3,682,997        36,831      3,259,422
  Issuance of shares to
    consultants                        223,600         2,236        159,711
  Compensation related to grant
    and reprcing of warrants and
    options issued to
    consultants                                                     229,259
  Compensation related to
    non-recourse loan granted to
    shareholder                                                      38,500
  Deferred stock compensation                                         4,750                       (4,750)
  Amortization of deferred stock
    compensation                                                                                    8,286
  Exercise of options by
    employees                          689,640         6,896        426,668
  Exercise of options by
    consultants                         15,000           150          7,200
  Conversion of convertible
    promissory note                    563,971         5,640        438,720
  Increase in investment in
    subsidiary against common
    stock issuance                     126,000         1,260        120,960
  Accrued interest on notes
    receivable from stockholders                                     16,615
  Other comprehensive income -
    foreign currency translation
    adjustment
  Net loss                                                                     (9,237,621)
                                  ------------- -------------  ------------- -------------- -------------- -------------


  Balance as of December 31, 2003   47,972,407     $ 479,726   $135,702,413  $(109,911,240)  $    (8,464)  $(3,537,106)
                                  ============= =============  ============= ============== ============== =============

<CAPTION>

                                                       Notes      Accumulated
                                     Total         receivable      other         Total
                                 comprehensive       from      comprehensive  stockholders'
                                        loss       stockholders      loss          equity
                                   --------------- ------------- -------------- --------------
<S>                                   <C>              <C>              <C>         <C>
Balance as of January 1, 2003*     $(1,177,589)     $  (1,786)                    $ 9,037,501
  Compensation related to
    warrants issued to the
    holders of convertible
    debentures                                                                      5,157,500
  Compensation related to
    beneficial conversion
    feature of convertible
    debentures                                                                      5,695,543
  Issuance of shares on
    conversion of convertible
    debentures                         (9,677)                                      6,125,000
  Issuance of shares on exercise
    of warrants                                                                     3,296,253
  Issuance of shares to
    consultants                                                                       161,947
  Compensation related to grant
    and reprcing of warrants and
    options issued to
    consultants                                                                        229,259
  Compensation related to
    non-recourse loan granted to
    shareholder                                                                        38,500
  Deferred stock compensation                                                               -
  Amortization of deferred stock
    compensation                                                                        8,286
  Exercise of options by
    employees                                                                         433,564
  Exercise of options by
    consultants                                                                         7,350
  Conversion of convertible
    promissory note                                                                   444,360
  Increase in investment in
    subsidiary against common
    stock issuance                                                                    122,220
  Accrued interest on notes
    receivable from stockholders      (16,615)                                              -
  Other comprehensive income -
    foreign currency translation
    adjustment                                        106,215      $   106,215        106,215
  Net loss                                                          (9,237,621)    (9,237,621)
                                   ------------  -------------- ---------------- --------------
                                                                  $ (9,131,406)
                                                                ================
  Balance as of December 31, 2003  $(1,203,881)     $ 104,429                     $ 21,625,877
                                   ============  ==============                  ==============
</TABLE>

-----------------------
  *      Restated (see Note 1.b.).

                                      F-8
<PAGE>



AROTECH CORPORATION AND ITS SUBSIDIARIES
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
--------------------------------------------------------------------------------
In U.S. dollars

<TABLE>
<CAPTION>

                                         Common stock          Additional                   Deferred
                                  ---------------------------    paid-in      Accumulated     stock        Treasury
                                     Shares        Amount        capital        deficit     compensation      stock
                                  ------------- -------------  ------------- -------------- -------------- -------------
<S>                                     <C>           <C>             <C>        <C>           <C>                <C>
Balance as of January 1, 2004       47,972,407     $ 479,726   $135,702,413  $(109,911,240)  $    (8,464)  $(3,537,106)
  Issuance of shares, net           14,138,491       141,384     24,252,939
  Issuance of shares and
    warrants due to settlement
    of litigation                      450,000         4,500      1,244,328
  Issuance of shares to employees       40,000           400         92,800
  Conversion of convertible
    debentures                       3,843,728        38,437      3,754,279
  Exercise of warrants by
    investors and others            11,363,342       113,633     19,119,638
  Issuance of shares to
    consultants                         90,215           902        198,489
  Reclassification to liability
    in connection with warrants
    granted                                                    (10,841,020)
  Reclassification of liability
    to equity related to the
    fair value of warrants                                       10,514,181
  Compensation related to
    non-recourse loan granted to
    shareholder                                                    (10,000)
  Deferred stock compensation
    related to options and
    restricted stock                   740,000         7,400      2,074,057                   (2,081,457)
  Amortization of deferred stock
    compensation                                                                                  831,626
  Exercise of options by
    employees                          897,248         8,972      1,101,172
  Exercise of options by
    consultants                         37,615           376         50,799
  Issuance of shares in respect
    of FAAC acquisition              1,003,856        10,039      1,993,639
  Accrued interest on notes
    receivable from stockholders                                     18,990
  Other comprehensive income -
    foreign currency translation
    adjustment
  Other comprehensive income -
    realized gain on available
    for sale marketable
    securities
  Net loss                                                                     (9,042,313)
                                  ------------- -------------  ------------- -------------- -------------- -------------




  Balance as of December 31, 2004   80,576,902      $805,769   $189,266,704  $(118,953,553)  $(1,258,295)  $(3,537,106)
                                  ============= =============  ============= ============== ============== =============

<CAPTION>

                                                        Notes      Accumulated
                                      Total         receivable      other         Total
                                  comprehensive       from      comprehensive  stockholders'
                                         loss       stockholders      loss          equity
                                    --------------- ------------- -------------- --------------
<S>                                    <C>              <C>              <C>         <C>
Balance as of January 1, 2004       $(1,203,881)     $ 104,429                     $ 21,625,877
  Issuance of shares, net                                                            24,394,323
  Issuance of shares and
    warrants due to settlement
    of litigation                                                                     1,248,828
  Issuance of shares to employees                                                        93,200
  Conversion of convertible
    debentures                                                                        3,792,716
  Exercise of warrants by
    investors and others                                                             19,233,271
  Issuance of shares to
    consultants                                                                         199,391
  Reclassification to liability
    in connection with warrants
    granted                                                                        (10,841,020)
  Reclassification of liability
    to equity related to the
    fair value of warrants                                                           10,514,181
  Compensation related to
    non-recourse loan granted to
    shareholder                                                                        (10,000)
  Deferred stock compensation
    related to options and
    restricted stock                                                                          -
  Amortization of deferred stock
    compensation                                                                        831,626
  Exercise of options by
    employees                                                                         1,110,144
  Exercise of options by
    consultants                                                                          51,175
  Issuance of shares in respect
    of FAAC acquisition                                                               2,003,678
  Accrued interest on notes
    receivable from stockholders       (18,990)                                               -
  Other comprehensive income -
    foreign currency translation
    adjustment                                          263,404      $   263,404        263,404
  Other comprehensive income -
    realized gain on available
    for sale marketable
    securities                                            4,502           4,502           4,502
  Net loss                                                           (9,042,313)     (9,042,313)
                                    ------------  -------------- ---------------- --------------

                                                                     $(8,774,407)
                                                                 ================
  Balance as of December 31, 2004   $(1,222,871)       $372,335                     $65,472,983
                                    ============  ==============                  ==============


</TABLE>


                                      F-9
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
In U.S. dollars

<TABLE>
<CAPTION>
                                                                                 Year ended December 31,
                                                                -----------------------------------------------------------
                                                                      2004                  2003*               2002
                                                                ------------------   ------------------   -----------------
<S>                                                              <C>                  <C>                  <C>
Cash flows from operating activities:
   Net loss                                                      $   (9,042,313)      $   (9,237,621)      $ (18,504,358)
     Less loss (profit) for the period from discontinued
       operations                                                             -             (110,410)         13,566,206
   Adjustments required to reconcile net loss to net cash used
    in operating activities:
     Minorities interests in earnings (loss) of subsidiary               44,694             (156,900)            355,360
     Depreciation                                                     1,199,465              730,159             473,739
     Amortization of intangible assets, capitalized software
       costs and impairment of intangible assets                      2,888,226              879,311             623,543
     Remeasurement of liability in connection to warrants
       granted                                                         (326,839)                   -                   -
     In-process research and development write-off                            -                    -              26,000
     Accrued severance pay, net                                        (441,610)               3,693            (357,808)
     Amortization of deferred stock compensation and
       compensation related to shares issued to employees               884,826                8,286              19,000
     (Mark up) write-off of loans to stockholders                       (32,397)             (12,519)            542,317
     Write-off of inventories                                           121,322               96,350             116,008
     Impairment of property and equipment                                     -               68,945                   -
     Amortization of compensation related to warrants issued
       to the holders of convertible debentures and beneficial
       conversion feature                                             4,142,109            3,928,237                   -
     Amortization of deferred charges related to convertible
       debentures issuance                                              222,732              483,713                   -
     Amortization of prepaid financial expenses                               -              236,250                   -
     Stock-based compensation related to grant of new warrants
       and repricing of warrants granted to consultants                       -              229,259                   -
     Stock-based compensation related to shares issued and to
       be issued to consultants and shares granted as a
       donation                                                          89,078              161,947                   -
     Stock-based compensation related to non-recourse note
       granted to stockholder                                           (10,000)              38,500                   -
     Interest accrued on promissory notes due to acquisition             39,311              (66,793)             29,829
     Interest accrued on restricted collateral deposits                (267,179)                   -              (3,213)
     Capital gain from sale of marketable securities                     (4,247)                   -                   -
     Amortization of premium related to restricted held to
       maturity securities                                              202,467                    -                   -
     Capital gain from sale of property and equipment                   (16,479)             (11,504)             (4,444)
     Decrease (increase) in trade receivables                           732,828             (820,137)            389,516
     (Increase) decrease in other accounts receivable and
       prepaid expenses                                                 (49,513)              40,520             257,218
     Decrease in deferred tax assets                                    (89,823)                   -                   -
     Increase in inventories                                         (2,040,854)            (193,222)           (520,408)
     Increase in unbilled revenues                                   (1,581,080)                   -                   -

     Decrease in deferred revenues                                      (91,271)                   -                   -
     Decrease in trade payables                                       2,913,623             (986,022)            (62,536)
     Increase (decrease) in other accounts payable and accrued
       expenses                                                        (125,231)           1,677,668            (423,664)
                                                                ------------------   ------------------   -----------------
     Net cash used in operating activities from continuing             (638,155)          (3,012,290)         (3,477,695)
       operations (reconciled from continuing operations)

     Net cash used in operating activities from discontinued
        operations (reconciled from discontinued operations)           (214,041)            (313,454)         (5,456,912)
                                                                ------------------   ------------------   -----------------

Net cash used in operating activities                            $     (852,196)      $   (3,325,744)      $  (8,934,607)
                                                                ------------------   ------------------   -----------------
</TABLE>

---------------------------------
  *  Restated. (see Note 1.b.)


                                      F-10
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
In U.S. dollars

<TABLE>
<CAPTION>
                                                                                 Year ended December 31,
                                                                 ---------------------------------------------------------
                                                                       2004                2003*               2002
                                                                 -----------------   -----------------   -----------------
<S>                                                                   <C>                   <C>                 <C>
Cash flows from investing activities:
     Purchase of property and equipment                               (1,659,688)           (580,949)           (314,876)
     Increase in capitalized software costs                             (365,350)           (209,616)                  -
     Loans granted to stockholders                                        (1,036)            (13,737)             (4,529)
     Repayment of loans granted to stockholders                           32,397               9,280                   -
     Proceeds from sale of property and equipment                        114,275              16,753               8,199
     Proceeds from sale of marketable securities                          90,016                   -                   -
     Investment in marketable securities                                 (89,204)                  -                   -
     Acquisition of IES (1)                                                    -                   -          (2,958,083)
     Acquisition of MDT (2)                                                    -                   -          (1,201,843)
     Acquisition of Epsilor (3)                                       (7,190,777)                  -                   -
     Acquisition of FAAC (4)                                         (12,129,103)                  -                   -
     Acquisition of AoA (5)                                          (17,339,522)                  -                   -
     Repayment of promissory notes related to acquisition of
       subsidiaries                                                   (2,000,000)           (750,000)                  -
     Purchase of certain tangible and intangible assets                 (150,000)           (196,331)                  -
     Increase in restricted cash and held to maturity securities      (9,809,091)            (72,840)           (595,341)
     Net cash used in discontinued operations (purchase of
       property and equipment)                                                 -                   -            (290,650)
                                                                  --------------      --------------      --------------
Net cash used in investing activities                                (50,497,083)         (1,797,440)         (5,357,123)
                                                                  --------------      --------------      --------------
Cash flows from financing activities:
     Proceeds from issuance of shares, net                            24,361,750              (6,900)          3,230,000
     Proceeds from exercise of options to employees and
       consultants                                                     1,148,819             440,914             113,350
     Proceeds from exercise of warrants                               19,233,271           3,296,254                   -
     Proceeds from issuance of convertible debentures, net                     -          13,708,662                   -
     Payment of interest and principal on notes receivable from
       stockholders                                                            -                   -              43,308
     Profit distribution to minority                                           -                   -            (412,231)
     Long term loan received                                              69,638                   -                   -
     Repayment of long term loan                                         (65,674)                  -                   -
     Increase (decrease) in short term bank credit                      (376,783)            (74,158)            108,659
     Payment on capital lease obligation                                  (4,145)             (4,427)             (5,584)
                                                                  --------------      --------------      --------------
Net cash provided by financing activities                             44,366,876          17,360,345           3,077,502
                                                                  --------------      --------------      --------------
Increase (decrease) in cash and cash equivalents                      (6,982,403)         12,237,161         (11,214,228)
Cash erosion due to exchange rate differences                             31,790              (9,562)                  -
Cash and cash equivalents at the beginning of the year                13,685,125           1,457,526          12,671,754
                                                                  --------------      --------------      --------------
Cash and cash equivalents at the end of the year                  $    6,734,512      $   13,685,125      $    1,457,526
                                                                  ==============      ==============      ==============
Supplementary information on non-cash transactions:
Issuance of shares and warrants against accrued expenses and
   restricted deposit                                             $    1,310,394      $            -      $            -
                                                                  ==============      ==============      ==============
Issuance of shares to consultants in respect of prepaid
   interest expenses                                              $            -      $            -      $      236,250
                                                                  ==============      ==============      ==============
Exercise of options against notes receivable                      $            -      $            -      $       36,500
                                                                  ==============      ==============      ==============
 Purchase of intangible assets against note receivable            $            -      $      300,000      $            -
                                                                  ==============      ==============      ==============
 Increase of investment in subsidiary against issuance of
   shares of common stock                                         $            -      $      123,480      $            -
                                                                  ==============      ==============      ==============
 Conversion of promissory note to shares of common stock          $            -      $      450,000      $            -
                                                                  ==============      ==============      ==============
 Conversion of convertible debenture to shares of common stock    $    3,837,500      $    6,125,000      $            -
                                                                  ==============      ==============      ==============
 Benefit due to convertible debentures and warrants               $            -      $   10,853,043      $            -
                                                                  ==============      ==============      ==============
Accrual for earn out in regard to subsidiary acquisition          $   13,435,325      $            -      $            -
                                                                  ==============      ==============      ==============

         Interest                                                 $      532,750      $       39,412      $       10,640
                                                                  ==============      ==============      ==============
         Taxes on income                                          $      969,009      $      527,053      $      114,901
                                                                  ==============      ==============      ==============
</TABLE>

---------------------------------
*  Restated (see Note 1.b.).


                                      F-11
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
In U.S. dollars

(1)  In July 2002, the Company acquired substantially all of the assets of
     I.E.S. Electronics Industries U.S.A., Inc. ("IES"). The net fair value of
     the assets acquired and the liabilities assumed, at the date of
     acquisition, was as follows:

Working capital, excluding cash and                                 $ 1,233,000
   cash equivalents
 Property and equipment, net                                            396,776
 Capital lease obligation                                               (15,526)
 Technology                                                           1,515,000
 Existing contracts                                                      46,000
 Covenants not to compete                                                99,000
 In process research and development                                     26,000
 Customer list                                                          527,000
 Trademarks                                                             439,000
 Goodwill                                                             4,032,726
                                                                    -----------
                                                                    -----------

                                                                      8,298,976
Issuance of shares                                                   (3,653,929)
Issuance of promissory note                                          (1,686,964)
                                                                    -----------
                                                                    -----------

                                                                    $ 2,958,083
                                                                    ===========

(2)  In July 2002, the Company acquired 51% of the outstanding ordinary shares
     of MDT Protective Industries Ltd. ("MDT"). The fair value of the assets
     acquired and liabilities assumed, at the date of acquisition, was as
     follows:

Working capital, excluding cash and                                 $   350,085
   cash and cash equivalents
Property, and equipment, net                                            139,623
Minority rights                                                        (300,043)
Technology                                                              280,000
Customer base                                                           285,000
Goodwill                                                                886,255
                                                                    -----------
                                                                    -----------
                                                                      1,640,920
Issuance of shares                                                     (439,077)
                                                                    -----------
                                                                    $ 1,201,843
                                                                    ===========


(3)  In January 2004, the Company acquired substantially all of the outstanding
     ordinary shares of Epsilor Electronic Industries, Ltd. ("Epsilor"). The net
     fair value of the assets acquired and the liabilities assumed, at the date
     of acquisition, was as follows:

Working capital, excluding cash and cash equivalents               $   (849,992)
Property and equipment                                                  709,847
Intangible assets and goodwill                                       10,284,407
                                                                   ------------
                                                                   ------------
                                                                     10,144,262
Issuance of shares in respect to transaction costs                      (12,500)
Issuance of promissory note *)                                       (2,940,985)
                                                                   ------------
                                                                   ------------
                                                                   $  7,190,777
                                                                   ============

*) During the year 2004 amount of $2,000,000 was repaid to the former
shareholders of Epsilor.

                                      F-12
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Cont.)
--------------------------------------------------------------------------------
In U.S. dollars

 (4) In January 2004, the Company acquired all of the outstanding common stock
     of FAAC Incorporated ("FAAC"). The net fair value of the assets acquired
     and the liabilities assumed at the date of acquisition was as follows:

Working capital, excluding cash and cash equivalents               $  1,796,791
Property and equipment                                                  263,669
Intangible assets and goodwill                                       25,507,646
                                                                   ------------
                                                                     27,568,106
Accrual of earn out payment                                         (13,435,325)
Issuance of shares, net                                              (2,003,678)
                                                                   ------------
                                                                   $ 12,129,103
                                                                   ============


(5)  In August 2004, the Company acquired all of the outstanding common stock of
     Armour of America, Incorporated ("AoA"). The net fair value of the assets
     acquired and the liabilities assumed at the date of acquisition was as
     follows:

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


                                      F-13
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars

NOTE 1:-          GENERAL

a. Arotech Corporation, f/k/a Electric Fuel Corporation ("Arotech" or the
"Company") and its subsidiaries are engaged in the development, manufacture and
marketing of defense and security products, including advanced hi-tech
multimedia and interactive digital solutions for training of military, law
enforcement and security personnel and sophisticated lightweight materials and
advanced engineering processes to armor vehicles, and in the design, development
and commercialization of its proprietary zinc-air battery technology for
electric vehicles and defense applications. The Company is primarily operating
through IES Interactive Training, Inc. ("IES"), a wholly-owned subsidiary based
in Littleton, Colorado; FAAC Corporation, a wholly-owned subsidiary based in Ann
Arbor, Michigan, and FAAC's 80%-owned United Kingdom subsidiary FAAC Limited;
Electric Fuel Battery Corporation, a wholly-owned subsidiary based in Auburn,
Alabama; Electric Fuel Ltd. ("EFL") a wholly-owned subsidiary based in Beit
Shemesh, Israel; Epsilor Electronic Industries, Ltd., a wholly-owned subsidiary
located in Dimona, Israel; MDT Protective Industries, Ltd. ("MDT"), a
majority-owned subsidiary based in Lod, Israel; MDT Armor Corporation, a
majority-owned subsidiary based in Auburn, Alabama; and Armour of America,
Incorporated, a wholly-owned subsidiary based in Los Angeles, California.

Revenues derived from the Company's largest customers in 2004, 2003 and 2002 are
described in Note 18.


b. Restatement of previously-issued financial statements:

During management's review of the Company's interim financial statements for the
period ended September 30, 2004 the Company, after discussion with and based on
a new and revised review of accounting treatment by its independent auditors,
conducted a comprehensive review of the re-pricing of warrants and grant of new
warrants to certain of its investors and others during 2003 and 2004. As a
result of that review, the Company, upon recommendation of management and with
the approval of the Audit Committee of the Board of Directors after discussion
with the Company's independent auditors, reconsidered the accounting related to
these transactions and reclassified certain expenses as a deemed dividend, a
non-cash item, instead of as general and administrative expenses due to the
recognition of these transactions as capital transactions that should not be
expensed. These restatements do not affect the balance sheet, the stockholders'
equity or the cash flow statements. In addition and as a result of the
remeasurement described above, the Company has reviewed assumptions used in the
calculation of fair value of all warrants granted during the year 2003. As a
result of this comprehensive review, the Company has decreased its general and
administrative expenses in the amount of $150,000, related to errors found in
the valuation of warrants granted in a litigation settlement.

In addition, during management's review of the Company's interim financial
statements for the period ended September 30, 2004, the Company also reviewed
its calculation of amortization of debt discount attributable to the beneficial
conversion feature associated with the convertible debentures. As a result of
this review, the Company found errors which increased its financial expenses in
the amount of $568,000 for the year ended December 31, 2003. The errors were
related to the amortization of debt discount attributable to the warrants and
their related convertible debentures, whereby the Company understated the amount
of amortization for the year ended December 31, 2003 attributable to certain of
the convertible debentures. See Note 13.

                                      F-14
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars

Similar errors were also noted in the Company's interim financial statements in
the three-month period ended June 30, 2003, the nine-month period ended
September 30, 2003, and the three and six-month periods ended March 31 and June
30, 2004.

The impacts of these restatements with respect to the year ended December 31,
2003 are summarized below:


Statement of Operations Data:

<TABLE>
<CAPTION>
                                                             For the Year ended December 31, 2003
                                                  -----------------------------------------------------------
                                                     Previously           Adjustment          As Restated
                                                      Reported
                                                  -----------------    -----------------    -----------------
<S>                                                <C>                  <C>                  <C>
General and administrative expenses..............  $    6,196,779       $     (338,903)      $    5,857,876
Operating loss...................................       5,408,932             (338,903)           5,070,029
Financial expenses, net..........................       3,470,459              568,250            4,038,709

Loss from continuing operations..................       9,118,684              229,347            9,348,031
                                                  -----------------    -----------------    -----------------
Net loss.........................................       9,008,274              229,347            9,237,621
Deemed dividend to certain stockholders of
   common stock.................................                -              350,000              350,000
                                                  -----------------    -----------------    -----------------
Net loss attributable to common stockholders.....  $    9,008,274       $      579,347       $    9,587,621
                                                  =================    =================    =================

Basic and diluted net loss per share from
  continuing operations..........................  $     0.23           $     0.01           $     0.24
                                                  =================    =================    =================
Basic and diluted net loss per share.............  $     0.23           $     0.02           $     0.25
                                                  =================    =================    =================

<CAPTION>

Balance sheet data:

                                                             As of December 31, 2003
                                      -----------------------------------------------------------------------
                                      Previously Reported           Adjustment              As Restated
                                      ---------------------    ---------------------    ---------------------
<S>                                    <C>                      <C>                      <C>
Other accounts payable and accrued     $      4,180,411         $      (150,000)         $      4,030,411
   expenses..........................
Total current liabilities............         6,859,752                (150,000)                6,709,752
Convertible debenture................           881,944                 568,250                 1,450,194
Total long term liabilities..........         4,066,579                 568,250                 4,634,829

Additional paid in capital...........       135,891,316                (188,903)              135,702,413
Accumulated deficit..................      (109,681,893)               (229,347)             (109,911,240)
Total stockholders' equity...........        22,044,127                (418,250)               21,625,877

Cash flow data:
</TABLE>

                                      F-15
<PAGE>


AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars


<TABLE>
<CAPTION>
                                                             For the Year ended December 31, 2003
                                                  -----------------------------------------------------------
                                                     Previously           Adjustment          As Restated
                                                      Reported
                                                  -----------------    -----------------    -----------------
<S>                                                <C>                  <C>                  <C>
Net loss.........................................  $    9,008,274       $      229,347       $    9,237,621
Stock based compensation related to repricing of
  warrants granted to investors and the grant of
  new warrants...................................         388,403             (188,903)             199,500
Increase in other accounts payable and accrued
  expenses.......................................       1,827,668             (150,000)           1,677,668

Amortization of compensation related to warrants
  issued to the holders of convertible
  debentures and beneficial conversion feature...       3,359,987              568,250            3,928,237
</TABLE>

c. Acquisition of Epsilor:

In January 2004, the Company entered into a stock purchase agreement between
itself and all of the shareholders of Epsilor Electronic Industries, Ltd.
("Epsilor"), pursuant to the terms of which the Company purchased all of the
outstanding shares of Epsilor from Epsilor's existing shareholders. Epsilor
develops and sells rechargeable and primary lithium batteries and smart chargers
to the military, and to private industry in the Middle East, Europe and Asia.

The Acquisition was accounted under the purchase method accounting. Accordingly,
all assets and liabilities acquired were recorded at their estimated market
values as of the date of acquisition, and results of Epsilor's operations have
been included in the consolidated financial statements commencing the date of
acquisition. The total consideration of $10,144,262 (including transaction
costs) for the shares purchased consisted of (i) cash in the amount of
$7,000,000, and (ii) a series of three $1,000,000 promissory notes, due on the
first, second and third anniversaries of the agreement, which were recorded at
their fair value of $2,940,985.

Based upon a valuation of tangible and intangible assets acquired, Arotech has
allocated the total cost of the acquisition to Epsilor's net assets as follows:

Tangible assets acquired                                              2,239,848
Intangible assets

         Customer list                                                5,092,395
         Goodwill                                                     5,192,012
Liabilities assumed                                                  (2,379,993)
                                                                   ------------
Total consideration                                                $ 10,144,262
                                                                   ============

Customer list in the amount of $5,092,395 has a useful life of approximately ten
years.

                                      F-16
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars


In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets,"
goodwill arising from acquisitions will not be amortized. In lieu of
amortization, Arotech is required to perform an annual impairment test. If
Arotech determines, through the impairment review process, that goodwill has
been impaired, it will record the impairment charge in its statement of
operations. Arotech will also assess the impairment of goodwill whenever events
or changes in circumstances indicate that the carrying value may not be
recoverable.

The value assigned to tangible, intangible assets and liabilities was determined
as follows:

1.       To determine the estimated market value of Epsilor's net current
         assets, property and equipment, and net liabilities, the "Cost
         Approach" was used. According to the valuation made, the book values
         for the current assets and liabilities were reasonable proxies for
         their market values.

2.       The customer list is the asset that generates most of the Company's
         sales. Hence, the "Income Approach" was used to estimate its value,
         resulting in a value of $5,092,395.

See Note 1.h. for pro forma financial information.

d. Acquisition of FAAC:

In January of 2004, the Company entered into a stock purchase agreement with the
stockholders of FAAC Incorporated ("FAAC"), pursuant to the terms of which it
acquired all of the issued and outstanding common stock of FAAC, a provider of
driving simulators, systems engineering and software products to the United
States military, government and private industry.

The Acquisition was accounted under the purchase method accounting. Accordingly,
all assets and liabilities were recorded at their estimated market values as of
the date acquired, and results of FAAC's operations have been included in the
consolidated financial statements commencing the date of acquisition. The
consideration for the purchase consisted of (i) cash in the amount of $12.0
million, and (ii) the issuance of a total of 1,003,856 shares of our common
stock, $0.01 par value per share, having a value of approximately $2.0 million.
Additionally, there is an earn-out based on 2004 net pretax income, with an
additional earn-out on the 2005 pretax income from certain specific and limited
programs. Based on FAAC's 2004 net pretax income, the Company estimates its
earn-out obligation at $13.4 million, of which $6.0 million was pre-paid into
escrow in the form of restricted cash (See Note 3). In March 2005, the Company
and the former stockholders of FAAC signed an agreement pursuant to which the
Company will transfer the restricted cash to the former stockholders of FAAC by
March 31, 2005, and will issue to the former stockholders of FAAC $10.0 million
in Arotech stock by April 30, 2005, with such stock to be registered and sold on
behalf of the former stockholders of FAAC by March 31, 2006 until the earn-out
shall have been paid in full (with any remaining shares of Arotech stock after
proceeds of the sales reach $7.4 million to be returned to the Company) ; should
the proceeds of the sales be less than $7.4 million, the Company will pay any
shortfall in cash). The total consideration of $27.6 million (including the
earn-out as well as $135,131 of transaction costs) was determined based upon
arm's-length negotiations between the Company and FAAC's stockholders.

                                      F-17
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars


Based upon a valuation of tangible and intangible assets acquired, Arotech has
allocated the total cost of the acquisition to FAAC's assets and liabilities as
follows:

Tangible assets acquired                                           $  4,833,553
Intangible assets
         Technology                                                   4,610,000
         Backlog                                                        636,000
         Customer list                                                1,125,000
         Trademarks                                                     374,000
         Goodwill                                                    18,762,646
Liabilities assumed                                                  (2,770,843)
                                                                   ------------
Total consideration                                                $ 27,570,356
                                                                   ============

Intangible assets which are subject to amortization, excluding trademarks, which
are not subject to amortization, in the amount of $6,371,000 have a
weighted-average useful life of approximately eight years.

In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets,"
goodwill arising from acquisitions will not be amortized. In lieu of
amortization, Arotech is required to perform an annual impairment test. If
Arotech determines, through the impairment review process, that goodwill has
been impaired, it will record the impairment charge in its statement of
operations. Arotech will also assess the impairment of goodwill whenever events
or changes in circumstances indicate that the carrying value may not be
recoverable.

         The value assigned to tangible, intangibles assets and liabilities was
determined as follows:

1.       To determine the estimated fair value of FAAC's net current assets,
         property and equipment, and net liabilities, the "Cost Approach" was
         used. According to the valuation made, the book values for the current
         assets and liabilities were reasonable proxies for their market values.

2.       The amount of the cost attributable to technology of the software,
         documentation and know-how that drives the vehicle simulators and the
         high-speed missile fly-out simulators is $4,610,000 and was determined
         using the "Income Approach."

3.       FAAC's sales are all made on a contractual basis, most of which are
         over a relatively long period of time. At the date of the purchase FAAC
         had several signed contracts at various stages of completion. The value
         of the existing contracts was determined using the Income approach and
         resulting in a value of $636,000.

4.       FAAC's customer list includes various branches of the U.S. military,
         major defense contractors, various city and country governments and
         others. Since customer relationship represent one of the most important
         revenue generating assets for FAAC, its value was estimated using the
         Income Approach, resulting in a value of $1,125,000.

                                      F-18
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars


5.       FAAC's trade name value represents the name recognition value of the
         FAAC brand name as a result of advertising spending by the company. The
         Cost Approach was used to determine the value of FAAC's trade name in
         the amount of $374,000.

See Note 1.h. for pro forma financial information.

e. Acquisition of AoA:

In August 2004, the Company purchased all of the outstanding stock of Armour of
America, Incorporated, a California corporation ("AoA"), from AoA's existing
shareholder. The assets acquired through the purchase of all of AoA's
outstanding stock consisted of all of AoA's assets, including AoA's current
assets, property and equipment, and other assets (including intangible assets
such as intellectual property and contractual rights).

The total purchase price consisted of $19,000,000 in cash, with additional
possible earn-outs if AoA is awarded certain material contracts. An additional
$3,000,000 was to be paid into an escrow account pursuant to the terms of an
escrow agreement, to secure a portion of the Earnout Consideration. Pursuant to
the purchase agreement, the total consideration, sale price plus Earnout
Consideration, will not be in excess of $40,000,000. When the contingency on the
earn-out provision is resolved, the additional consideration, if any, will be
recorded as additional purchase price. The purchase price also included $121,192
of transaction costs. The transaction has been accounted for using the purchase
method of accounting, and accordingly, the purchase price has been allocated to
the assets acquired and liabilities assumed based upon their fair values at the
date the acquisition was completed.

Based upon a valuation of tangible and intangible assets acquired, Arotech has
allocated the total cost of the acquisition to AoA's assets and liabilities as
follows :

Tangible assets acquired                                              6,346,316
Intangible assets
         Certifications                                                 246,969
         Backlog                                                      1,512,000
         Customer relationships                                         490,000
         Tradename /Trademark                                            70,000
         Covenants not to compete                                       260,000
         Goodwill                                                    10,543,677
Liabilities assumed                                                    (347,770)
                                                                   ------------
Total consideration                                                $ 19,121,192
                                                                   ============

Intangible assets, excluding trademarks, which are not subject to amortization,
in the amount of $2,508,969 have a weighted-average useful life of approximately
two years.

In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets,"
goodwill arising from acquisitions will not be amortized. In lieu of
amortization, Arotech is required to perform an annual impairment test. If
Arotech determines, through the impairment review process, that goodwill has
been impaired, it will record the impairment charge in its statement of
operations. Arotech will also assess the impairment of goodwill whenever events
or changes in circumstances indicate that the carrying value may not be
recoverable.

                                      F-19
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars


See Note 1.h. for pro forma financial information.

f. Acquisition of IES:

In August 2, 2002, the Company entered into an asset purchase agreement among
I.E.S. Electronics Industries U.S.A., Inc. ("IES"), its direct and certain of
its indirect shareholders, and its wholly-owned Israeli subsidiary, EFL,
pursuant to the terms of which it acquired substantially all the assets, subject
to substantially all the liabilities, of IES, a developer, manufacturer and
marketer of advanced hi-tech multimedia and interactive digital solutions for
training of military, law enforcement and security personnel. The Company
intends to continue to use the assets purchased in the conduct of the business
formerly conducted by IES (the "Business"). The acquisition has been accounted
under the purchase method of accounting. Accordingly, all assets and liabilities
were acquired as at the values on such date, and the Company consolidated IES's
results with its own commencing at such date.

The assets purchased consisted of the current assets, property and equipment,
and other intangible assets used by IES in the conduct of the Business. The
consideration for the assets and liabilities purchased consisted of (i) cash and
promissory notes in an aggregate amount of $4,800,000 ($3,000,000 in cash and
$1,800,000 in promissory notes, which was recorded at its fair value in the
amount of $1,686,964) (see Note 10), and (ii) the issuance, with registration
rights, of a total of 3,250,000 shares of our common stock, $.01 par value per
share, having a value of approximately $3,653,929, which shares are the subject
of a voting agreement on the part of IES and certain of its affiliated
companies. The value of 3,250,000 shares issued was determined based on the
average market price of Arotech's Common stock over the period including two
days before and after the terms of the acquisition were agreed to and announced.
The total consideration of $8,354,893 (including $14,000 of transaction costs)
was determined based upon arm's-length negotiations between the Company and IES
and IES's shareholders.


                                      F-20
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars


Based upon a valuation of tangible and intangible assets acquired, Arotech has
allocated the total cost of the acquisition to IES's assets as follows:


Tangible assets acquired                                            $ 2,856,951

Intangible assets
     Technology                                                       1,515,000
     Existing contracts                                                  46,000
     Covenants not to compete                                            99,000
     In process research and development                                 26,000
     Customer                                                           527,000
     Trademarks                                                         439,000
     Goodwill                                                         4,032,726
Liabilities assumed                                                  (1,186,784)
                                                                    -----------

Total consideration                                                 $ 8,354,893
                                                                    ===========


In September 2003, the Company's IES subsidiary purchased selected assets of
Bristlecone Corporation. The assets purchased consisted of inventories, customer
lists, and certain other assets (including intangible assets such as
intellectual property and customer lists), including the name "Bristlecone
Training Products" and the patents for the Heads Up Display (HUD) and a remote
trigger device, used by Bristlecone in connection with its designing and
manufacturing firearms training devices, for a total consideration of $183,688
in cash and $300,000 in promissory notes, payable in four equal semi-annual
payments of $75,000 each, to become due and payable on March 1, 2004, August 31,
2004, February 28, 2005 and August 31, 2005. The acquired patents are used in
the IES's Range FDU (firearm diagnostics unit).

The purchase consideration was estimated as follows:


Cash consideration                                                       183,688
Present value of promissory notes                                        289,333
Transaction expenses                                                      12,643
                                                                        --------
Total consideration                                                     $485,664
                                                                        ========

Based upon a valuation of tangible and intangible assets acquired, the Company
has allocated the total cost of the acquisition of Bristlecone's assets as
follows:


Tangible assets acquired                                                $ 33,668
Intangible assets
         Technology and patents                                          436,746
         Customer list                                                    15,250
                                                                        --------
                                                                        --------
Total consideration                                                     $485,664
                                                                        ========

The Company believes that the acquisition of Bristlecone is not material to its
business.

                                      F-21
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars


g. Acquisition of MDT:

On July 1, 2002, the Company entered into a stock purchase agreement with all of
the shareholders of M.D.T. Protective Industries Ltd. ("MDT"), pursuant to the
terms of which the Company purchased 51% of the issued and outstanding shares of
MDT, a privately-held Israeli company that specializes in using sophisticated
lightweight materials and advanced engineering processes to armor vehicles. The
Company also entered into certain other ancillary agreements with MDT and its
shareholders and other affiliated companies. The Acquisition was accounted under
the purchase method accounting and results of MDT's operations have been
included in the consolidated financial statements since that date. The total
consideration of $1,767,877 for the shares purchased consisted of (i) cash in
the aggregate amount of 5,814,000 New Israeli Shekels ($1,231,780), and (ii) the
issuance, with registration rights, of an aggregate of 390,638 shares of our
common stock, $0.01 par value per share, having a value of approximately
$439,077. The value of 390,638 shares issued was determined based on the average
market price of Arotech's Common stock over the period including two days before
and after the terms of the acquisition were agreed to and announced.

Based upon a valuation of tangible and intangible assets acquired, Arotech has
allocated the total cost of the acquisition to MDT's assets as follows:

Tangible assets acquired                                            $ 1,337,048
Intangible assets
   Technology                                                           280,000
   Customer base                                                        285,000
   Goodwill                                                             886,255
Liabilities assumed                                                  (1,020,426)
                                                                    -----------
Total consideration                                                 $ 1,767,877
                                                                    ===========


In September 2003, the Company increased its holdings in both of its vehicle
armoring subsidiaries. The Company now holds 88% of MDT Armor Corporation
(compared to 76% before this transaction) and 75.5% of MDT Protective Industries
Ltd. (compared to 51% before this transaction). The Company acquired the
additional stake in MDT from AGA Means of Protection and Commerce Ltd. in
exchange for the issuance to AGA of 126,000 shares of its common stock, valued
at $0.98 per share based on the closing price of the Company's common stock on
the closing date of September 4, 2003, or a total of $123,480. Of this amount, a
total of $75,941 was allocated to intangible assets. The Company did not obtain
a valuation due to the immaterial nature of this acquisition.

h. Pro forma results:

In January 2004, the Company acquired FAAC and Epsilor, as more fully described
in "Note 1.c. - Acquisition of Epsilor" and "Note 1.d. - Acquisition of FAAC,"
above, in August 2004, the Company acquired AoA, as more fully described in
"Note 1.e. - Acquisition of AoA," above (the "Acquisitions") and in the year
2002 the Company acquired IES and MDT as more fully described in Note 1.f and
Note 1.g (the "2002 Acquisitions"). The following summary pro forma information
includes the effects of the Acquisitions on the operating results of the
Company. The following unaudited pro forma data for 2004 and 2003 are presented
as if the Acquisitions had been completed on January 1, 2004 and 2003,
respectively. The unaudited pro forma data for 2002 are presented as if 2002
Acquisitions had been completed on January 1, 2002.

                                      F-22
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars


This pro forma financial information does not purport to be indicative of the
results of operations that would have occurred had the Acquisitions taken place
at the beginning of the period, nor do they purport to be indicative of the
results of operations that will be obtained in the future.

<TABLE>
<CAPTION>
                                                         Year Ended December 31,
                                             --------------------------------------------
                                                2004             2003*            2002
                                             ------------    ------------    ------------
                                                             (Unaudited)
<S>                                          <C>             <C>             <C>
Total revenues                               $ 61,086,697    $ 39,680,394    $ 12,997,289
                                             ============    ============    ============
Gross profit                                   22,528,254      17,214,249       4,424,952
                                             ============    ============    ============
Net loss                                       (5,810,114)     (6,959,174)     (6,103,771)
                                             ============    ============    ============
Deemed dividend of common stock
   attributable to certain stockholders        (3,328,952)       (350,000)             --
                                             ============    ============    ============
Net loss attributable to stockholders of
   common stock                              $ (9,139,066)   $ (7,309,174)   $ (6,103,771)
                                             ============    ============    ============

Basic and diluted net loss per share         $      (0.13)   $      (0.14)   $      (0.18)
                                             ============    ============    ============
Weighted average number of shares used in      69,933,057      52,966,330      34,495,185
   computing basic net loss per share
                                             ============    ============    ============
</TABLE>

----------
        *Restated.


i. Discontinued operations:

In September 2002, the Company committed to a plan to discontinue the operations
of its retail sales of consumer battery products. The Company ceased the
operation and disposed of all assets related to this segment by an abandonment.
The operations and cash flows of consumer battery business have been eliminated
from the operations of the Company as a result of the disposal transactions. The
Company has no intent of continuing its activity in the consumer battery
business. The Company's plan of discontinuance involved (i) termination of all
employees whose time was substantially devoted to the consumer battery line and
who could not be used elsewhere in the Company's operations, including payment
of all statutory and contractual severance sums, by the end of the fourth
quarter of 2002, and (ii) disposal of the raw materials, equipment and inventory
used exclusively in the consumer battery business, since the Company has no
reasonable expectation of being able to sell such raw materials, equipment or
inventory for any sum substantially greater than the cost of disposal or
shipping, by the end of the first quarter of 2003. The Company had previously
reported its consumer battery business as a separate segment (Consumer
Batteries) as called for by Statement of Financial Standards No. 131,
"Disclosures About Segments of an Enterprise and Related Information" ("SFAS No.
131").

The results of operations including revenue, operating expenses, other income
and expense of the retail sales of consumer battery products business unit for
2003 and 2002 have been reclassified in the accompanying statements of
operations as a discontinued operation. The Company's balance sheets at December
31, 2003 reflect the net liabilities of the retail sales of consumer battery
products business as net liabilities and net assets of discontinued operation
within current liabilities and current assets.

                                      F-23
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars


At December 31, 2002, the estimated net losses associated with the disposition
of the retail sales of consumer battery products business were $13,566,206 for
2002. These losses included approximately $6,508,522 in losses from operations
for the period from January 1, 2002 through the measurement date of December 31,
2002 and $7,057,684, reflecting a write-down of inventory and net property and
equipment of the retail sales of consumer battery products business, as follows:

                                                               December 31, 2002
                                                                      ----------
Write-off of inventories                                              $2,611,000
Impairment of property and equipment                                   4,446,684
                                                                      ----------
                                                                      $7,057,684
                                                                      ==========

As a result of the discontinuance of consumer battery segment, the Company
ceased to use property and equipment related to this segment. In accordance with
Statement of Financial Accounting Standard No. 144 "Accounting for the
Impairment or Disposal of Long- Lived Assets" ("SFAS No. 144") such assets was
considered to be impaired. The impairment to be recognized was measured by the
amount by which the carrying amount of the assets exceeds the fair value of the
assets.

Obligations to employees for severance and other benefits resulting from the
discontinuation have been reflected in the financial statements on an accrual
basis.

Summary operating results from the discontinued operation for the years ended
December 31, 2004, 2003 and 2002 are as follows:

<TABLE>
<CAPTION>
                                                            Year Ended December 31,
                                          -------------------------------------------------------------
                                                2004                  2003                  2002
                                          -----------------      ----------------     -----------------
<S>                                        <C>                    <C>                  <C>
             Revenues                      $          -           $    117,267         $   1,100,442
             Cost of sales (1)                        -                      -            (5,293,120)
                                          -----------------      ----------------     -----------------

             Gross profit (loss)                      -                117,267            (4,192,678)
             Operating expenses, net                  -                  6,857             4,926,844
             Impairment of fixed assets               -                      -             4,446,684
                                          -----------------      ----------------     -----------------
             Operating profit (loss)       $          -           $    110,410         $ (13,566,206)
                                          =================      ================     =================
</TABLE>
----------
(1) Including write-off of inventory in the amount of $0, $0 and $2,611,000 for
the years ended December 31, 2004, 2003 and 2002.


                                      F-24
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars

NOTE 2:-          SIGNIFICANT ACCOUNTING POLICIES

The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles in the United States ("U.S. GAAP").

a. Use of estimates:

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.

b. Financial statements in U.S. dollars:

A majority of the revenues of the Company and most of its subsidiaries is
generated in U.S. dollars. In addition, a substantial portion of the Company's
and most of its subsidiaries costs are incurred in U.S. dollars ("dollar").
Management believes that the dollar is the primary currency of the economic
environment in which the Company and most of its subsidiaries operate. Thus, the
functional and reporting currency of the Company and most of its subsidiaries is
the dollar. Accordingly, monetary accounts maintained in currencies other than
the U.S. dollar are remeasured into U.S. dollars in accordance with Statement of
Financial Accounting Standards No. 52 "Foreign Currency Translation" ("SFAS No.
52"). All transaction, gains and losses from the remeasured monetary balance
sheet items are reflected in the consolidated statements of operations as
financial income or expenses, as appropriate.

The majority of transactions of MDT and Epsilor are in New Israel Shekel ("NIS")
and a substantial portion of MDT's and Epsilor's costs is incurred in NIS.
Management believes that the NIS is the functional currency of MDT and Epsilor.
Accordingly, the financial statements of MDT and Epsilor have been translated
into U.S. dollars. All balance sheet accounts have been translated using the
exchange rates in effect at the balance sheet date. Statement of operations
amounts has been translated using the weighted average exchange rate for the
period. The resulting translation adjustments are reported as a component of
accumulated other comprehensive loss in stockholders' equity

c. Principles of consolidation:

The consolidated financial statements include the accounts of the Company and
its wholly and majority owned subsidiaries. Intercompany balances and
transactions have been eliminated upon consolidation.

d. Cash equivalents:

Cash equivalents are short-term highly liquid investments that are readily
convertible to cash with maturities of three months or less when acquired.

                                      F-25
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars


e. Restricted collateral deposits

Restricted cash is primarily invested in highly liquid deposits,
held-to-maturity marketable securities and long-term deposits, which are used as
a security for the Company's guarantee performance and its liability to former
shareholders of its acquired subsidiaries.

f. Marketable securities

The Company and its subsidiaries account for investments in debt and equity
securities in accordance with Statement of Financial Accounting Standard No.
115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS
No. 115"). Management determines the appropriate classification of its
investments in debt and equity securities at the time of purchase and
reevaluates such determinations at each balance sheet date.

At December 31, 2004 the Company and its subsidiaries classified its investment
in marketable securities as held-to-maturity and available-for-sale.

Debt securities are classified as held-to-maturity, when the Company has the
positive intent and ability to hold the securities to maturity, and are stated
at amortized cost. The cost of held-to-maturity securities is adjusted for
amortization of premiums and accretion of discounts to maturity. Such
amortization, accretion and interest are included in financial income, net.

Investment in trust funds are classified as available-for-sale and stated at
fair value, with unrealized gains and losses reported in accumulated other
comprehensive income (loss), a separate component of stockholders' equity, net
of taxes. Realized gains and losses on sales of investments, as determined on a
specific identification basis, are included in the consolidated statements of
income.

g. Inventories:

Inventories are stated at the lower of cost or market value. Inventory
write-offs and write-down provisions are provided to cover risks arising from
slow-moving items or technological obsolescence and for market prices lower than
cost. The Company periodically evaluates the quantities on hand relative to
current and historical selling prices and historical and projected sales volume.
Based on this evaluation, provisions are made to write inventory down to its
market value. In 2002, 2003 and 2004, the Company wrote off $116,008, $96,350
and $121,322 of obsolete inventory respectively, which has been included in the
cost of revenues.

Cost is determined as follows:

Raw and packaging materials - by the average cost method.

Work in progress - represents the cost of manufacturing with additions of
allocable indirect manufacturing cost.

Finished products - on the basis of direct manufacturing costs with additions of
allocable indirect manufacturing costs.

                                      F-26
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars


h. Property and equipment:

Property and equipment are stated at cost net of accumulated depreciation and
investment grants (no investment grants were received during 2004, 2003 and
2002).

Depreciation is calculated by the straight-line method over the estimated useful
lives of the assets, at the following annual rates:

                                                                  %
                                                     ---------------------------

      Computers and related equipment                            33
      Motor vehicles                                             15
      Office furniture and equipment                           6 - 10
      Machinery and equipment                            10 - 25 (mainly 10)
      Leasehold improvements                         By the shorter of the term
                                                      of the lease and the life
                                                            of the asset

i. Goodwill:

Goodwill represents the excess of cost over the fair value of the net assets of
businesses acquired. Under Statement of Financial Accounting Standard No. 142,
"Goodwill and Other Intangible Assets" ("SFAS No, 142") goodwill acquired in a
business combination on or after July 1, 2001, is not amortized after January 1,
2002.

SFAS No. 142 requires goodwill to be tested for impairment on adoption of the
Statement and at least annually thereafter or between annual tests in certain
circumstances, and written down when impaired, rather than being amortized as
previous accounting standards required. Goodwill is tested for impairment by
comparing the fair value of the Company's reportable units with their carrying
value. Fair value is determined using discounted cash flows. Significant
estimates used in the methodologies include estimates of future cash flows,
future short-term and long-term growth rates, weighted average cost of capital
and estimates of market multiples for the reportable units.

The Company performed the required annual impairment test of goodwill. Based on
the management projections and using expected future discounted operating cash
flows, no indication of goodwill impairment was identified.

j. Long-lived assets:

Intangible assets acquired in a business combination that are subject to
amortization are amortized over their useful life using a method of amortization
that reflects the pattern in which the economic benefits of the intangible
assets are consumed or otherwise used up, in accordance with SFAS No. 142.

The acquired trademarks and tradenames are deemed to have an indefinite useful
life because they are expected to contribute to cash flows indefinitely.
Therefore, the trademarks will not be amortized until their useful life is no
longer indefinite. The trademarks and tradenames are tested annually for
impairment in accordance FAS 142.

                                      F-27
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars


The Company and its subsidiaries' long-lived assets and certain identifiable
intangibles are reviewed for impairment in accordance with Statement of
Financial Accounting Standard No. 144 "Accounting for the Impairment or Disposal
of Long-Lived Assets" ("SFAS No. 144") whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of the carrying amount of assets to be held and used
is measured by a comparison of the carrying amount of the assets to the future
undiscounted cash flows expected to be generated by the assets. If such assets
are considered to be impaired, the impairment to be recognized is measured by
the amount by which the carrying amount of the assets exceeds the fair value of
the assets. As of December 31, 2004 the Company identified an impairment of the
technology previously purchased from Bristlecone and as a result has recorded an
impairment loss in the amount of $320,000.

k. Revenue recognition:

The Company is a defense and security products and services company, engaged in
three business areas: interactive simulation for military, law enforcement and
commercial markets; batteries and charging systems for the military; and
high-level armoring for military, paramilitary and commercial vehicles. During
2004, the Company and its subsidiaries recognized revenues as follows: (i) from
the sale and customization of interactive training systems and from the
maintenance services in connection with such systems (Interactive Training
Division); (ii) from revenues under armor contracts and for service and repair
of armored vehicles (Armoring Division); (iii) from the sale of batteries,
chargers and adapters to the military, and under certain development contracts
with the U.S. Army (Battery Division); and (iv) from the sale of lifejacket
lights (Battery Division.

Revenues from the Battery division products and Armoring division are recognized
in accordance with SEC Staff Accounting Bulletin No. 104, "Revenue Recognition"
when persuasive evidence of an agreement exists, delivery has occurred, the fee
is fixed or determinable, collectability is probably, and no further obligation
remains.

Revenues from products not delivered upon customers' request due to lack of
storage space at the customers' facilities during the integration are recognized
when the criteria of Staff Accounting Bulletin No. 104 ("SAB No. 104") for
bill-and-hold transactions are met.

Revenues from contracts that involve customization of FAAC's simulation system
to customer specific specifications are recognized in accordance with Statement
Of Position 81-1, "Accounting for Performance of Construction-Type and Certain
Production-Type Contracts," using contract accounting on a percentage of
completion method, in accordance with the "Input Method." The amount of revenue
recognized is based on the percentage to completion achieved. The percentage to
completion is measured by monitoring progress using records of actual time
incurred to date in the project compared to the total estimated project
requirement, which corresponds to the costs related to earned revenues.
Estimates of total project requirements are based on prior experience of
customization, delivery and acceptance of the same or similar technology and are
reviewed and updated regularly by management. Provisions for estimated losses on
uncompleted contracts are made in the period in which such losses are first
determined, in the amount of the estimated loss on the entire contract. As of
December 31, 2004 no such estimated losses were identified.

                                      F-28
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars


The Company believes that the use of the percentage of completion method is
appropriate as the Company has the ability to make reasonably dependable
estimates of the extent of progress towards completion, contract revenues and
contract costs. In addition, contracts executed include provisions that clearly
specify the enforceable rights regarding services to be provided and received by
the parties to the contracts, the consideration to be exchanged and the manner
and the terms of settlement, including in cases of terminations for convenience.
In all cases the Company expects to perform its contractual obligations and its
customers are expected to satisfy their obligations under the contract.

Revenues from simulators, which do not require significant customization, are
recognized in accordance with Statement of Position 97-2, "Software Revenue
Recognition," ("SOP 97-2"). SOP 97-2 generally requires revenue earned on
software arrangements involving multiple elements to be allocated to each
element based on the relative fair value of the elements. The Company has
adopted Statement of Position 98-9, "Modification of SOP 97-2, Software Revenue
Recognition with Respect to Certain Transactions" ("SOP 98-9"). According to SOP
No. 98-9, revenues are allocated to the different elements in the arrangement
under the "residual method" when Vendor Specific Objective Evidence ("VSOE") of
fair value exists for all undelivered elements and no VSOE exists for the
delivered elements. Under the residual method, at the outset of the arrangement
with the customer, the Company defers revenue for the fair value of its
undelivered elements (maintenance and support) and recognizes revenue for the
remainder of the arrangement fee attributable to the elements initially
delivered in the arrangement (software product) when all other criteria in SOP
97-2 have been met.


Revenue from such simulators is recognized when persuasive evidence of an
agreement exists, delivery has occurred, no significant obligations with regard
to implementation remain, the fee is fixed or determinable and collectibility is
probable.

Maintenance and support revenue included in multiple element arrangements is
deferred and recognized on a straight-line basis over the term of the
maintenance and support services. Revenues from training are recognized when its
performed. The VSOE of fair value of the maintenance, training and support
services is determined based on the price charged when sold separately or when
renewed.

Unbilled receivables include cost and gross profit earned in excess of billing.

Deferred revenues include unearned amounts received under maintenance and
support services and billing in excess of costs and estimated earnings on
uncompleted contracts.

                                      F-29
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars


l. Right of return:

When a right of return exists, the Company defers its revenues until the
expiration of the period in which returns are permitted.

m. Research and development cost:

Research and development costs, net of grants received, are charged to the
statements of operations as incurred.

Software development costs incurred by the Company's subsidiaries between
completion of the working model and the point at which the product is ready for
general release, are capitalized.

Capitalized software costs are amortized by using the straight-line method over
the estimated useful life of the product (three to five years). The Company
assesses the recoverability of this intangible asset on a regular basis by
determining whether the amortization of the asset over its remaining life can be
recovered through future gross revenues from the specific software product sold.
Based on its most recent analyses, management identified an impairment of
software development costs previously capitalized and as a result has recorded
an impairment loss in the amount of $26,000.

n. Income taxes:

The Company and its subsidiaries account for income taxes in accordance with
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes" ("SFAS No. 109"). This Statement prescribes the use of the liability
method, whereby deferred tax assets and liability account balances are
determined based on differences between financial reporting and tax bases of
assets and liabilities and are measured using the enacted tax rates and laws
that will be in effect when the differences are expected to reverse. The Company
and its subsidiaries provide a valuation allowance, if necessary, to reduce
deferred tax assets to it's estimated realizable value.

o. Concentrations of credit risk:

Financial instruments that potentially subject the Company and its subsidiaries
to concentrations of credit risk consist principally of cash and cash
equivalents, restricted collateral deposit and restricted held-to-maturity
securities, trade receivables and available for sale marketable securities. Cash
and cash equivalents are invested mainly in U.S. dollar deposits with major
Israeli and U.S. banks. Such deposits in the U.S. may be in excess of insured
limits and are not insured in other jurisdictions. Management believes that the
financial institutions that hold the Company's investments are financially sound
and, accordingly, minimal credit risk exists with respect to these investments.

The trade receivables of the Company and its subsidiaries are mainly derived
from sales to customers located primarily in the United States, Europe and
Israel. Management believes that credit risks are moderated by the diversity of
its end customers and geographical sales areas. The Company performs ongoing
credit evaluations of its customers' financial condition. An allowance for
doubtful accounts is determined with respect to those accounts that the Company
has determined to be doubtful of collection.

                                      F-30
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars


The Company's available for sale marketable securities and held-to-maturity
securities include investments in debentures of U.S. and Israeli corporations
and state and local governments. Management believes that those corporations and
states are institutions that are financially sound, that the portfolio is well
diversified, and accordingly, that minimal credit risk exists with respect to
these marketable securities.

The Company and its subsidiaries had no off-balance-sheet concentration of
credit risk such as foreign exchange contracts, option contracts or other
foreign hedging arrangements.

p. Basic and diluted net loss per share:

Basic net loss per share is computed based on the weighted average number of
shares of common stock outstanding during each year. Diluted net loss per share
is computed based on the weighted average number of shares of common stock
outstanding during each year, plus dilutive potential shares of common stock
considered outstanding during the year, in accordance with Statement of
Financial Standards No. 128, "Earnings Per Share."

All outstanding stock options and warrants have been excluded from the
calculation of the diluted net loss per common share because all such securities
are anti-dilutive for all periods presented. The total weighted average number
of shares related to the outstanding options and warrants excluded from the
calculations of diluted net loss per share was 31,502,158, 22,194,211 and
4,394,803 for the years ended December 31, 2004, 2003 and 2002, respectively.

q. Accounting for stock-based compensation:

The Company has elected to follow Accounting Principles Board Opinion No. 25
"Accounting for Stock Issued to Employees" ("APB No. 25") and Interpretation No.
44 "Accounting for Certain Transactions Involving Stock Compensation" in
accounting for its employee stock option plans. Under APB No. 25, when the
exercise price of the Company's share options is less than the market price of
the underlying shares on the date of grant, compensation expense is recognized.
Under Statement of Financial Accounting Standard No. 123, "Accounting for
Stock-Based Compensation" ("SFAS No. 123"), pro-forma information regarding net
income and net income per share is required, and has been determined as if the
Company had accounted for its employee stock options under the fair value method
of SFAS No. 123.

The Company applies SFAS No. 123 and Emerging Issue Task Force No. 96-18
"Accounting for Equity Instruments that are Issued to Other than Employees for
Acquiring, or in Conjunction with Selling, Goods or Services" ("EITF 96-18")
with respect to options issued to non-employees. SFAS No. 123 requires use of an
option valuation model to measure the fair value of the options at the grant
date.

The fair value for the options to employees was estimated at the date of grant,
using the Black-Scholes Option Valuation Model, with the following
weighted-average assumptions: risk-free interest rates of 3.63%, 2.54% and 3.5%
for 2004, 2003 and 2002, respectively; a dividend yield of 0.0% for each of
those years; a volatility factor of the expected market price of the common
stock of 0.81 for 2004, 0.67 for 2003 and 0.64 for 2002; and a weighted-average
expected life of the option of 5 years for 2004, 2003 and 2002.

                                      F-31
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars


         The following table illustrates the effect on net income and earnings
per share, assuming that the Company had applied the fair value recognition
provision of SFAS No. 123 on its stock-based employee compensation:

<TABLE>
<CAPTION>
                                                                     Year ended December 31,
                                                            2004              2003*          2002
<S>                                                    <C>             <C>             <C>
Net loss as reported                                   $ (9,042,313)   $ (9,237,621)   $(18,504,358)
Add: Stock-based compensation expenses included in
   reported net loss                                        831,626           8,286           6,000
Deduct:  Stock-based compensation expenses
   determined under fair value method for all awards     (2,741,463)     (1,237,558)     (2,072,903)
                                                       $(10,952,150)   $(10,466,893)   $(20,571,261)
Loss per share:
   Basic and diluted, as reported                      $      (0.18)   $      (0.25)   $      (0.57)
   Diluted, pro forma                                  $      (0.16)   $      (0.27)   $      (0.64)
</TABLE>

-----------------------
       *  Restated (see Note 1.b.).

r. Fair value of financial instruments:

The following methods and assumptions were used by the Company and its
subsidiaries in estimating their fair value disclosures for financial
instruments:

The carrying amounts of cash and cash equivalents, restricted collateral deposit
and restricted held-to-maturity securities, trade receivables, short-term bank
credit, and trade payables approximate their fair value due to the short-term
maturity of such instruments.

The fair value of available for sale marketable securities is based on the
quoted market price.

Long-terms promissory notes are estimated by discounting the future cash flows
using current interest rates for loans or similar terms and maturities. The
carrying amount of the long-term liabilities approximates their fair value.

s. Severance pay:

The Company's liability for severance pay is calculated pursuant to Israeli
severance pay law based on the most recent salary of the employees multiplied by
the number of years of employment as of the balance sheet date. Israeli
employees are entitled to one month's salary for each year of employment, or a
portion thereof. The Company's liability for all of its employees is fully
provided by monthly deposits with severance pay funds, insurance policies and by
an accrual. The value of these policies is recorded as an asset in the Company's
balance sheet.

In addition and according to certain employment agreements, the Company is
obligated to provide for a special severance pay in addition to amounts due to
certain employees pursuant to Israeli severance pay law. The Company has made a
provision for this special severance pay in accordance with Statement of
Financial Accounting Standard No. 106, "Employer's Accounting for Post
Retirement Benefits Other than Pensions." As of December 31, 2004 and 2003, the
accumulated severance pay in that regard amounted to $1,642,801 and $1,699,260,
respectively.

                                      F-32
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars


The deposited funds include profits accumulated up to the balance sheet date.
The deposited funds may be withdrawn only upon the fulfillment of the obligation
pursuant to Israeli severance pay law or labor agreements. The value of the
deposited funds is based on the cash surrendered value of these policies and
includes immaterial profits.

Severance expenses for the years ended December 31, 2004, 2003 and 2002 amounted
to $460,178, $219,857 and ($338,574) respectively.

t. Advertising costs:

The Company and its subsidiaries expense advertising costs as incurred.
Advertising expense for the years ended December 31, 2004, 2003 and 2002 was
approximately $13,271, $34,732 and $294,599, respectively.

u. New accounting pronouncements:

On December 16, 2004, the Financial Accounting Standards Board (FASB) issued
FASB Statement No. 123 (revised 2004), "Share-Based Payment," which is a
revision of FASB Statement No. 123, "Accounting for Stock-Based Compensation."
Statement 123(R) supersedes APB Opinion No. 25, "Accounting for Stock Issued to
Employees," and amends FASB Statement No. 95, "Statement of Cash Flows."
Generally, the approach in Statement 123(R) is similar to the approach described
in Statement 123. However, Statement 123(R) requires all share-based payments to
employees, including grants of employee stock options, to be recognized in the
income statement based on their fair values. Pro forma disclosure is no longer
an alternative.

Statement 123(R) must be adopted no later than July 1, 2005. Early adoption will
be permitted in periods in which financial statements have not yet been issued.
The Company expects to adopt Statement 123(R) on the first interim period
beginning after July 1, 2005.

Statement 123(R) permits public companies to adopt its requirements using one of
two methods:

1. A "modified prospective" method in which compensation cost is recognized
beginning with the effective date (a) based on the requirements of Statement
123(R) for all share-based payments granted after the effective date and (b)
based on the requirements of Statement 123 for all awards granted to employees
prior to the effective date of Statement 123(R) that remain unvested on the
effective date.

2. A "modified retrospective" method which includes the requirements of the
modified prospective method described above, but also permits entities to
restate based on the amounts previously recognized under Statement 123 for
purposes of pro forma disclosures either (a) all prior periods presented or (b)
prior interim periods of the year of adoption.

The Company is still in the process of evaluating the method it will use.

                                      F-33
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars


As permitted by Statement 123, the Company currently accounts for share-based
payments to employees using Opinion 25's intrinsic value method and, as such,
generally recognizes no compensation cost for employee stock options.
Accordingly, the adoption of Statement 123(R)'s fair value method will have a
significant impact on our result of operations, although it will have no impact
on our overall financial position. The impact of adoption of Statement 123(R)
cannot be predicted at this time because it will depend on levels of share-based
payments granted in the future. However, had the Company adopted Statement
123(R) in prior periods, the impact of that standard would have approximated the
impact of Statement 123 as described in the disclosure of pro forma net income
and earnings per share in Note 2r above to the Company's consolidated financial
statements. Statement 123(R) also requires the benefits of tax deductions in
excess of recognized compensation cost to be reported as a financing cash flow,
rather than as an operating cash flow as required under current literature.

In November 2004, the FASB issued Statement of Financial Accounting Standard No.
151, "Inventory Costs, an Amendment of ARB No. 43, Chapter 4.." SFAS 151 amends
Accounting Research Bulletin ("ARB") No. 43, Chapter 4, to clarify that abnormal
amounts of idle facility expense, freight handling costs and wasted materials
(spoilage) should be recognized as current-period charges. In addition, SFAS 151
requires that allocation of fixed production overheads to the costs of
conversion be based on normal capacity of the production facilities. SAFS 151 is
effective for inventory costs incurred during fiscal years beginning after June
15, 2005. The Company is still in the process of the evaluating the impact of
the adoption of SFAS 151 on its financial position or results of operations.

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

--------------------------------------------------------------------------------
In U.S. dollars
NOTE 3:-      RESTRICTED COLLATERAL DEPOSIT AND OTHER RESTRICTED CASH (Cont.)


                                                           December 31,
                                                   -------------------------
                                                      2004          2003
                                                   -----------   -----------
             Short-term:
             Restricted, held to maturity, bonds
               in connection with FAAC earn out
               (Note 1.d.)(1)                      $ 5,969,413   $        --
             IES deposit in connection to the
               Company's litigation with IES
               Electronics Industries Ltd.                  --       450,000
             Deposits in connection with FAAC
               projects                                650,989            --
             Forward Deal                                   --       205,489
             Property lease                                 --        41,412
             Other                                     341,708         9,279
                                                   -----------   -----------
             Total short-term                        6,962,110       706,810
                                                   -----------   -----------
Long-term:
Restricted cash in connection with
AoA earn out (Note 1.e.)                             3,000,000            --
Restricted deposit in connection with
Epsilor acquisition (Note 1.c.)                      1,000,000            --
                                                   -----------   -----------
Total long-term                                      4,000,000            --
                                                   -----------   -----------
                                                   $10,962,110   $   706,180
                                                   ===========   ===========


                                      F-34
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars


(1) The following is a summary of held-to-maturity securities at December 31,
2004 and 2003:

<TABLE>
<CAPTION>
                            Amortized cost             Unrealized losses       Estimated fair value
                        ----------   ----------    ----------    ----------   ----------   ----------
                          2004          2003          2004           2003          2004          2003
                        ----------   ----------    ----------    ----------   ----------   ----------
<S>                     <C>          <C>           <C>           <C>          <C>          <C>
Obligations of States   $1,012,787   $       --    $   (1,870)   $       --   $1,010,917   $       --
   and political
   subdivisions
Corporate obligations    4,956,626           --       (11,966)           --    4,944,660           --
                        ----------   ----------    ----------    ----------   ----------   ----------

                        $5,969,413   $       --    $  (13,836)   $       --   $5,955,577   $       --
                        ==========   ==========    ==========    ==========   ==========   ==========
</TABLE>

The amortized cost of held-to-maturity debt securities at December 31, 2004, by
contractual maturities, is shown below:

<TABLE>
<CAPTION>
                                                          Amortized     Unrealized     Estimated
                                                                cost losses fair value
                                                        ------------- -------------- -------------
<S>                                                       <C>           <C>          <C>
              Due in one year or less                     $5,969,413    $ (13,836)   $ 5,955,577
                                                        ============= ============== =============
</TABLE>

The unrealized losses in the Company's investments were caused by interest rate
increases. It is expected that the securities would not be settled at a price
less than the amortized cost of the Company's investment. Based on the
immaterial severity of the impairments and the obligation of the Company to hold
these investments until maturity, the bonds were not considered to be other than
temporarily impaired at December 31, 2004.

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

In U.S. dollars

NOTE 4: -     AVAILABLE FOR SALE MARKETABLE SECURITIES

The following is a summary of investments in marketable securities as of
December 31, 2004 and 2003:

<TABLE>
<CAPTION>
                                               Cost                  Unrealized gains         Estimated fair value
                                     -------------------------- --------------------------- --------------------------
                                        2004          2003          2004          2003         2004          2003
                                     ------------  ------------ ------------- ------------- ------------  ------------
<S>                                   <C>           <C>          <C>           <C>           <C>           <C>

        Available for sale
        marketable securities         $  130,061    $        -   $     5,507   $         -   $  135,568    $        -
</TABLE>

NOTE 5:-      OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES

                                                              December 31,
                                                   -----------------------------
                                                       2004                2003
                                                   ----------         ----------

Government authorities                             $  433,427         $   65,402
Employees                                             217,948            246,004
Prepaid expenses                                      490,357            551,010
Deferred taxes                                        135,482                 --
Other                                                  62,179            324,955
                                                   ----------         ----------

                                                   $1,339,393         $1,187,371
                                                   ==========         ==========


                                      F-35
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars



NOTE 6:-          INVENTORIES

                                              December 31,
                                  --------------------------------------
                                        2004                 2003
                                  -----------------    -----------------

Raw and packaging materials        $    3,969,400       $      657,677
Work in progress                        1,996,139              634,221
Finished products                       1,311,762              622,850
                                  -----------------    -----------------
                                   $    7,277,301       $    1,914,748
                                  =================    =================


NOTE 7:-          PROPERTY AND EQUIPMENT, NET

a. Composition of property and equipment is as follows:

<TABLE>
<CAPTION>
                                                                           December 31,
                                                               -------------------------------------
                                                                     2004                2003
                                                               -----------------   -----------------
<S>                                                              <C>                 <C>
              Cost:
                   Computers and related equipment               $   3,374,695       $   1,015,836
                   Motor vehicles                                      653,255             288,852
                   Office furniture and equipment                      872,804             402,726
                   Machinery, equipment and  installations           7,464,470           4,866,904
                   Leasehold improvements                            1,321,025             882,047
                   Demo inventory                                      141,961             150,996
                                                                ----------------    ----------------

                                                                    13,828,210           7,607,361
                                                                ----------------    ----------------
              Accumulated depreciation:
                   Computers and related equipment                   2,581,689             753,593
                   Motor vehicles                                      197,071              95,434
                   Office furniture and equipment                      494,181             173,301
                   Machinery, equipment and installations            5,143,186           3,637,111
                   Leasehold improvements                              811,392             655,181
                                                                ----------------    ----------------

                                                                     9,227,519           5,314,620
                                                                ----------------    ----------------

              Depreciated cost                                   $   4,600,691       $   2,292,741
                                                                ================    ================
</TABLE>

b. Depreciation expense amounted to $1,199,465, $730,159 and $473,739, for the
years ended December 31, 2004, 2003 and 2002, respectively.

As for liens, see Note 12.d.


                                      F-36
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars

NOTE 8:-          OTHER INTANGIBLE ASSETS, NET

a.
                                                      Year ended December 31,
                                                --------------------------------
                                                   2004               2003
                                                ------------       ------------
Cost:
  Technology                                    $  6,841,746       $  2,231,746
  Capitalized software costs                         574,967            209,615
  Backlog                                          2,194,000             46,000
  Covenants not to compete                           359,000             99,000
  Customer list                                    7,548,645            827,250
  Certification                                      246,969                 --
                                                ------------       ------------

                                                  17,765,327          3,413,611
Exchange differences                                 125,455             25,438
Less - accumulated amortization                   (4,391,081)        (1,502,854)
                                                ------------       ------------

Amortized cost                                    13,499,701          1,936,195
Trademarks                                           869,000            439,000
                                                ------------       ------------

                                                $ 14,368,701       $  2,375,195
                                                ============       ============


b.    Amortization expenses amounted to $2,888,226, $879,311 and $623,543 for
      the years ended December 31, 2004, 2003 and 2002.

c.    Estimated amortization expenses, except capitalized software costs, for
      the years ended

       Year ended December 31,
--------------------------------------
2005                  $    3,280,815
2006                       2,073,209
2007                       1,381,883
2008                       1,276,075
2009 and forward           5,000,546
                     -----------------
                         $13,012,528
                     =================

NOTE 9:-          SHORT-TERM BANK CREDIT AND LOANS

The Company has a $ 3.2 million authorized credit line from certain banks, of
which $ 209,000 is denominated in NIS and carries an interest rate of
approximately prime + 2.5% and $ 3.0 million of which is denominated in dollars
and carries an interest rate of prime + 0.25%. As of December 31, 2004, $ 2.1
million was utilized, out of which $2.0 million is related to letter of credit
issued to one of the customers of one of the Company's subsidiaries.

This line of credit is secured by the accounts receivable, inventory and
marketable securities of the relevant subsidiary of the Company.

In addition the Company has two automobile purchase loans, of which the later
one will be repaid in June 2006. Those loans are denominated in NIS and carry an
interest rate of 5.2%-6.2%. Each loan is secured by the automobile purchased
with the proceeds of the loan.


                                      F-37
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars

NOTE 10:-     PROMISSORY NOTES

In connection with the acquisition of IES, the Company issued promissory notes
in the face amount of an aggregate of $1,800,000, one of which was a note for
$400,000 that was convertible into an aggregate of 200,000 shares of the
Company's common stock. The Company has accounted for these notes in accordance
with Accounting Principles Board Opinion No. 21, "Interest on Receivables and
Payables," and recorded the notes at their present value in the amount of
$1,686,964. In December 2002, the terms of these promissory notes were amended
to (i) extinguish the $1,000,000 note due at the end of June 2003 in exchange
for prepayment of $750,000, (ii) amend the $400,000 note due at the end of
December 2003 to be a $450,000 note, and (iii) amend the convertible $400,000
note due at the end of June 2004 to be a $450,000 note convertible at $0.75 as
to $150,000, at $0.80 as to $150,000, and at $0.85 as to $150,000. In accordance
with EITF 96-19, "Debtor's Accounting for a Modification or Exchange of Debt
Instruments," the terms of promissory notes were not treated as changed or
modified as the cash flow effect on a present value basis was less than 10%. The
$450,000 note due at the end of June 2004 was converted into an aggregate of
563,971 shares of common stock in August 2003. With reference to the $450,000
note due at the end of December 2003, see Note 14.f.6.

NOTE 11:-     OTHER ACCOUNTS PAYABLE AND ACCRUED EXPENSES

<TABLE>
<CAPTION>
                                                                                 December 31,
                                                                      ------------------------------------
                                                                           2004                2003*
                                                                      ---------------    -----------------
<S>                                                                    <C>                <C>
                                Employees and payroll accruals         $   1,534,295      $   1,232,608
                                Accrued vacation pay                         469,527            216,768
                                Accrued expenses                           1,770,348            842,760
                                Minority balance                             243,116            149,441
                                Government authorities                     1,036,669            357,095
                                Litigation settlement accrual(1)                   -          1,163,642
                                Advances from customers                      746,819                  -
                                Other                                         17,414             68,097
                                                                      ---------------    -----------------

                                                                       $   5,818,188   $  $4,174,030,411
                                                                      ===============    =================
</TABLE>

                          *   Restated (see Note 1.b.).
                          (1) See Note 14.f.6.


                                      F-38
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars

NOTE 12:-     COMMITMENTS AND CONTINGENT LIABILITIES

a. Royalty commitments:

1. Under EFL's research and development agreements with the Office of the Chief
Scientist ("OCS"), and pursuant to applicable laws, EFL is required to pay
royalties at the rate of 3%-3.5% of net sales of products developed with funds
provided by the OCS, up to an amount equal to 100% of research and development
grants received from the OCS (linked to the U.S. dollars. Amounts due in respect
of projects approved after year 1999 also bear interest at the Libor rate). EFL
is obligated to pay royalties only on sales of products in respect of which OCS
participated in their development. Should the project fail, EFL will not be
obligated to pay any royalties.

Royalties paid or accrued for the years ended December 31, 2004, 2003 and 2002,
to the OCS amounted to $17,406, $435 and $32,801, respectively.

As of December 31, 2004, the total contingent liability to the OCS was
approximately $10,158,000. The Company regards the probability of this
contingency coming to pass in any material amount to be low.

2. EFL, in cooperation with a U.S. participant, has received approval from the
Israel-U.S. Bi-national Industrial Research and Development Foundation
("BIRD-F") for 50% funding of a project for the development of a hybrid
propulsion system for transit buses. The maximum approved cost of the project is
approximately $1.8 million, and the EFL's share in the project costs is
anticipated to amount to approximately $1.1 million, which will be reimbursed by
BIRD-F at the aforementioned rate of 50%. Royalties at rates of 2.5%-5% of sales
are payable up to a maximum of 150% of the grant received, linked to the U.S.
Consumer Price Index. Accelerated royalties are due under certain circumstances.

EFL is obligated to pay royalties only on sales of products in respect of which
BIRD-F participated in their development. Should the project fail, EFL will not
be obligated to pay any royalties.

No royalties were paid or accrued to the BIRD-F in each of the three years in
the period ended December 31, 2004.

As of December 31, 2004, the total contingent liability to pay BIRD-F (150%) was
approximately $772,000. The Company regards the probability of this contingency
coming to pass in any material amount to be low.

b. Lease commitments:

The Company and its subsidiaries rent their facilities under various operating
lease agreements, which expire on various dates, the latest of which is in 2009.
The minimum rental payments under non-cancelable operating leases are as
follows:

          Year ended December 31
          ----------------------
2005            $    762,636
2006            $    305,109
2007            $    269,220
2008            $     66,688
2009            $     24,312

Total rent expenses for the years ended December 31, 2004, 2003 and 2002 were
approximately $868,900, $484,361 and $629,101, respectively.

                                      F-39
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars

c. Guarantees:

The Company obtained bank guarantees in the amount of $1,199,096 in connection
with (i) the purchase agreement of one of the Company's subsidiaries (ii)
obligations of two of the Company's subsidiaries to the Israeli customs
authorities and (iii) obligation of one of the Company's subsidiaries to secure
inventory received from one of its customers. In addition, the Company issued
letters of credit in amounts of $143,895 and $2,000,000 to one of its
subsidiary's suppliers and to one of its subsidiary's customers respectively.

d. Liens:

As security for compliance with the terms related to the investment grants from
the state of Israel, EFL and Epsilor have registered floating liens on all of
its assets, in favor of the State of Israel.

The Company has granted to the holders of its 8% secured convertible debentures
a first position security interest in (i) the shares of MDT Armor Corporation,
(ii) the assets of its IES Interactive Training, Inc. subsidiary, (iii) the
shares of all of its subsidiaries, and (iv) any shares that the Company acquires
in future Acquisitions (as defined in the securities purchase agreement).

EFL has granted to its former CEO a security interest in certain of its property
located in Beit Shemesh, Israel, to secure sums due to him pursuant to the terms
of the settlement agreement with him.

FAAC has a $3 million line of credit secured by all of its accounts receivable,
unbilled revenues and inventory.

Epsilor has recorded a lien on all of its assets in favor of its banks to secure
lines of credit and loans received. In addition the company has a specific
pledge on assets in respect of which government guaranteed loan were given.

See also Note 9 regarding automobiles purchased in EFL and Epsilor.

e. Litigation and other claims:

As of December 31, 2004, there were no pending legal proceedings to which the
Company was a party, other than ordinary routine litigation incidental to its
business, except as follows:

a. In December 2004, AoA filed an action against a U.S. government defense
agency, seeking approximately $2.2 million in damages for alleged improper
termination of a contract. In its answer, the government agency counterclaimed,
seeking approximately $2.1 million in reprocurement expenses. AoA is preparing
its answer to the counterclaim. At this stage in the proceedings, the Company
and its legal advisors cannot determine with any certainty whether AoA will have
any liability and, if so, the extent of that liability.

b. In the beginning of 2005 a competitor of FAAC brought an action against FAAC
and a municipal transport agency, alleging, inter alia, that the municipal
transport agency and FAAC have conspired to violate federal and state antitrust
laws and have engaged in unfair competition with respect to this competitor. The
competitor seeks unspecified monetary damages from FAAC and the municipal
transport agency and injunctive relief. FAAC has not yet filed its answer in
this case. At this stage in the proceedings, the Company and its legal advisors
cannot determine with any certainty whether FAAC will have any liability and, if
so, the extent of that liability.

c. There is an action against EFL brought in the matter of the bankruptcy of an
intellectual property law firm, seeking payment of approximately $150,000, plus
interest, fees and costs, in respect of unpaid legal fees and expenses. EFL has
not yet filed its answer in this case. The Company and its legal advisors does
not believe EFL's liability in this matter will exceed $100,000.The Company has
recorded an appropriate provision in respect of this amount.

d. In 2000 and 2001, the Company sold consumer cellphone batteries and chargers
to a major department store chain. Subsequent to these sales, in late 2001, one
of the Company's employees signed an agreement with the department store chain
to price-protect the goods previously sold, with such price protection "to be
debited from current open invoices." The department store chain has recently
claimed to the Company that the Company owes them approximately $517,000,
primarily in respect of this price protection. The Company contends that
employee who signed the price protection had no authority, actual or apparent,
to do so, and that in any event the clear meaning of the language in the price
protection is that the department store chain may deduct the price protection
from sums they owe the Company, not that the Company is obligated to return sums
previously paid. Settlement discussions are currently taking place. At this
early stage, the Company and its legal advisors cannot determine with any
certainty whether it will have any liability and, if so, the extent of that
liability.


                                      F-40
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars

NOTE 13:-     CONVERTIBLE DEBENTURES

a.    9% Secured Convertible Debentures due June 30, 2005

Pursuant to the terms of a Securities Purchase Agreement dated December 31,
2002, the Company issued and sold to a group of institutional investors an
aggregate principal amount of 9% secured convertible debentures in the amount of
$3.5 million due June 30, 2005. These debentures are convertible at any time
prior to June 30, 2005 at a conversion price of $0.75 per share, or a maximum
aggregate of 4,666,667 shares of common stock. The conversion price of these
debentures was adjusted to $0.64 per share in April 2003. In accordance with
EITF 96-19, "Debtor's Accounting for a Modification or Exchange of Debt
Instruments," the terms of convertible debentures were not treated as changed or
modified when the cash flow effect on a present value basis was less than 10%.

As part of the securities purchase agreement on December 31, 2002, the Company
issued to the purchasers of its 9% secured convertible debentures due June 30,
2005, warrants, as follows: (i) Series A Warrants to purchase an aggregate of
1,166,700 shares of common stock at any time prior to December 31, 2007 at a
price of $0.84 per share; (ii) Series B Warrants to purchase an aggregate of
1,166,700 shares of common stock at any time prior to December 31, 2007 at a
price of $0.89 per share; and (iii) Series C Warrants to purchase an aggregate
of 1,166,700 shares of common stock at any time prior to December 31, 2007 at a
price of $0.93 per share. The exercise price of these warrants was adjusted to
$0.64 per share in April 2003.

This transaction was accounted according to APB No. 14 "Accounting for
Convertible debt and Debt Issued with Stock Purchase Warrants" ("APB No. 14")
and Emerging Issue Task Force No. 00-27 "Application of Issue No. 98-5 to
Certain Convertible Instruments" ("EITF 00-27"). The fair value of these
warrants was determined using Black-Scholes pricing model, assuming a risk-free
interest rate of 3.5%, a volatility factor 64%, dividend yields of 0% and a
contractual life of five years.

                                      F-41
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars

In connection with these convertible debentures, the Company recorded a deferred
debt discount of $1,890,000 with respect to the beneficial conversion feature
and the discount arising from fair value allocation of the warrants according to
APB No. 14, which is being amortized from the date of issuance to the stated
redemption date - June 30, 2005 - or to the actual conversion date, if earlier,
as financial expenses.

During 2003, an aggregate principal amount of $2,350,000 in 9% secured
convertible debentures was converted into an aggregate of 3,671,875 shares of
common stock and an aggregate of 1,500,042 shares were issued pursuant to
exercises of the warrants.

During 2004, the remaining principal amount of $1,150,000 of 9% secured
convertible debentures outstanding was converted into an aggregate of 1,796,875
shares of common stock.

During 2003 and 2004, the Company recorded expenses of $1,517,400 and $372,600,
respectively, of which $548,100 and $0, respectively, was attributable to
amortization of the beneficial conversion feature of the convertible debenture
over its term and $969,300 and $372,600, respectively, was attributable to
amortization due to conversion of the convertible debenture into shares.

b.    8% Secured Convertible Debentures due September 30, 2006 and issued in
      September 2003

Pursuant to the terms of a Securities Purchase Agreement dated September 30,
2003, the Company issued and sold to a group of institutional investors an
aggregate principal amount of 8% secured convertible debentures in the amount of
$5.0 million due September 30, 2006. These debentures are convertible at any
time prior to September 30, 2006 at a conversion price of $1.15 per share, or a
maximum aggregate of 4,347,826 shares of common stock.

As part of the securities purchase agreement on September 30, 2003, the Company
issued to the purchasers of its 8% secured convertible debentures due September
30, 2006, warrants to purchase an aggregate of 1,250,000 shares of common stock
at any time prior to September 30, 2006 at a price of $1.4375 per share.

This transaction was accounted according to APB No. 14 "Accounting for
Convertible Debt and Debt Issued with Stock Purchase Warrants" and Emerging
Issue Task Force No. 00-27 "Application of Issue No. 98-5 to Certain Convertible
Instruments." The fair value of these warrants was determined using
Black-Scholes pricing model, assuming a risk-free interest rate of 1.95%, a
volatility factor 98%, dividend yields of 0% and a contractual life of three
years.

In connection with these convertible debentures, the Company recorded a deferred
debt discount of $2,963,043 with respect to the beneficial conversion feature
and the discount arising from fair value allocation of the warrants according to
APB No. 14, which is being amortized from the date of issuance to the stated
redemption date - September 30, 2006 - or to the actual conversion date, if
earlier, as financial expenses.

                                      F-42
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars

During 2003, an aggregate principal amount of $3,775,000 in 8% secured
convertible debentures was converted into an aggregate of 3,282,608 shares of
common stock and an aggregate of 437,500 shares were issued pursuant to
exercises of the warrants.

During 2004, an aggregate of principal amount $1,075,000 in 8% secured
convertible debentures was converted into an aggregate of 934,784 shares. As of
December 31, 2004, principal amount of $150,000 remained outstanding under these
debentures.

During 2003 and 2004, the Company recorded expenses of $2,298,034 and $613,263,
respectively, of which $205,858 and $191,895, respectively, was attributable to
amortization of the beneficial conversion feature of the convertible debenture
over its term and $2,092,176 and $421,368, respectively, was attributable to
amortization due to conversion of the convertible debenture into shares.

c.    8% Secured Convertible Debentures due September 30, 2006 and issued in
      December 2003

Pursuant to the terms of a Securities Purchase Agreement dated September 30,
2003, the Company issued and sold to a group of institutional investors an
aggregate principal amount of 8% secured convertible debentures in the amount of
$6.0 million due September 30, 2006. These debentures are convertible at any
time prior to September 30, 2006 at a conversion price of $1.45 per share, or a
maximum aggregate of 4,137,931 shares of common stock.

As a further part of the securities purchase agreement on September 30, 2003,
the Company issued to the purchasers of its 8% secured convertible debentures
due September 30, 2006, warrants to purchase an aggregate of 1,500,000 shares of
common stock at any time prior to December 18, 2006 at a price of $1.8125 per
share. Additionally, the Company issued to the investors supplemental warrants
to purchase an aggregate of 1,038,000 shares of common stock at any time prior
to December 31, 2006 at a price of $2.20 per share.

This transaction was accounted according to APB No. 14 "Accounting for
Convertible debt and Debt Issued with Stock Purchase Warrants" and Emerging
Issue Task Force No. 00-27 "Application of Issue No. 98-5 to Certain Convertible
Instruments." The fair value of these warrants was determined using
Black-Scholes pricing model, assuming a risk-free interest rate of 2.45%, a
volatility factor 98%, dividend yields of 0% and a contractual life of three
years.

In connection with these convertible debentures, the Company recorded a deferred
debt discount of $6,000,000 with respect to the beneficial conversion feature
and the discount arising from fair value allocation to warrants according to APB
No. 14, which is being amortized from the date of issuance to the stated
redemption date - September 30, 2006 - or to the actual conversion date, if
earlier, as financial expenses.

During 2003 the Company recorded an expense of $132,803, which represents the
amortization of the beneficial conversion feature of the convertible debenture
over its term.

                                      F-43
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars

During 2004 an aggregate of 1,500,000 shares were issued pursuant to exercise of
these warrants. Out of these warrants, the holders of 1,125,000 warrants
exercised their warrants on July 14, 2004 were granted an additional warrants to
purchase 1,125,000 shares of common stock of the Company at an exercise price
per share of $1.38. See also Note 14.f.4.

During 2004 the Company recorded expenses of $3,156,246 of which $1,782,561 was
attributable to amortization of the beneficial conversion feature of the
convertible debenture over its term and $1,373,685 was attributable to
amortization due to conversion of the convertible debenture into shares.

d. The Company's debt agreements contain customary affirmative and negative
operations covenants that limit the discretion of its management with respect to
certain business matters and place restrictions on it, including obligations on
the Company's part to preserve and maintain assets and restrictions on its
ability to incur or guarantee debt, to merge with or sell its assets to another
company, and to make significant capital expenditures without the consent of the
debenture holders, as well as granting to the Company's investors a right of
first refusal on any future financings, except for underwritten public offerings
in excess of $30 million. Management does not believe that this right of first
refusal will materially limit the Company's ability to undertake future
financings.

NOTE 14:-     STOCKHOLDERS' EQUITY

a. Stockholders' rights:

The Company's shares confer upon the holders the right to receive notice to
participate and vote in the general meetings of the Company and right to receive
dividends, if and when declared.

b. Issuance of common stock to investors:

1. On January 18, 2002, the Company issued a total of 441,176 shares of its
common stock at a purchase price of $1.70 per share, or a total purchase price
of $750,000, to an investor (see also Note 14.f.2.).

2. On January 24, 2002, the Company issued a total of 1,600,000 shares of its
common stock at a purchase price of $1.55 per share, or a total purchase price
of $2,480,000, to a group of investors.

3. In September 2003, the company acquired an additional 12% interest in MDT
Armor Corporation and an additional 24.5% interest in MDT Protective Industries,
Ltd. in exchange for the issuance to AGA Means of Protection and Commerce, Ltd.
of 126,000 shares of its common stock.

4. In January 2004, the Company issued an aggregate of 9,840,426 shares of
common stock at a price of $1.88 per share, or a total purchase price of
$18,500,000, to a group of investors (see also Note 14.f.3.). Finance expenses
in connection with this issuance totaled $692,500.

                                      F-44
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars

5. In July 2004, pursuant to a Securities Purchase Agreement dated July 15,
2004, the Company issued an aggregate of 4,258,065 shares of common stock at a
price of $1.55 per share, or a total purchase price of $6,600,000, to a group of
investors (see also Note 14.f.4.).

c. Issuance of common stock to service providers and employees, in settlement of
litigation, and as donations to charities:

1. On February 15, 2002 and September 10, 2002, the Company issued 318,468 and
50,000 shares, respectively, of common stock at par consideration to a
consultant for providing business development and marketing services in the
United Kingdom. At the issuance date, the fair value of these shares was
determined both by the value of the shares issued as reflected by their market
price at the issuance date and by the value of the services provided which
amounted to $394,698 and $63,000, respectively, in accordance with EITF 96-18.
In accordance with EITF 96-18, the Company recorded this compensation expense of
$394,698 and $63,000, respectively, during the year 2002 and included this
amount in marketing expenses.

2. On September 10, 2002, the Company issued an aggregate of 13,000 shares of
common stock at par consideration to two of its employees as stock bonuses. At
the issuance date, the fair value of these shares was determined by the fair
market value of the shares issued as reflected by their market price at the
issuance date in accordance with APB No. 25. In accordance with APB No. 25, the
Company recorded this compensation expense of $13,000 during the year 2002 and
included this amount in general and administrative expenses.

3. In July 2003, the Company issued 215,294 shares of common stock to a
consultant as commissions on battery orders. At the issuance date, the fair
value of these shares was determined both by the value of the shares issued as
reflected by the market price at the issuance date and by the value of the
services provided and amounted to $154,331 in accordance with EITF 96-18. In
accordance with EITF 96-18, the Company recorded this compensation expense of
$154,331 during the year 2003 and included this amount in marketing expenses.

4. In November 2003, the Company issued 8,306 shares of common stock to a
consultant as commissions on battery orders. At the issuance date, the fair
value of these shares was determined by the fair market value of the shares
issued as reflected by their market price at the issuance date and by the value
of the services provided and amounted to $7,616 in accordance with EITF 96-18.
In accordance with EITF 96-18, the Company recorded this compensation expense of
$7,616 during the year 2003 and included this amount in marketing expenses.

5. In February 2004, the Company issued 74,215 shares of common stock to a
consultant as commissions on battery orders. At the issuance date, the fair
value of these shares was determined both by the value of the shares issued as
reflected by their market price at the issuance date and by the value of the
services provided and amounted to $171,680 in accordance with EITF 96-18. In
accordance with EITF 96-18, the Company accrued this compensation expense of
$171,680 during the year 2003 and included this amount in selling and marketing
expenses.

6. Beginning in January 2004, the Company entered into a consulting agreement
with one of its directors pursuant to which the director agreed to aid the
Company in identifying potential acquisition candidates, in exchange for a
commission. The Company also agreed to issue to this director, at par value, a
total of 32,000 shares of its common stock, the value of which was to be
deducted from any transaction fees paid. 16,000 of these shares were earned and
issued prior to termination of this agreement in August 2004. At the issuance
date, the fair value of these shares was determined both by the value of the
shares issued as reflected by their market price at the issuance date and by the
value of the services provided and amounted to $28,160 in accordance with EITF
96-18. In accordance with EITF 96-18, the Company recorded this compensation
expense of $28,160 during the year 2004 and included this amount in general and
administrative expenses

                                      F-45
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars

7. In June 2004 the Company sold 40,000 shares of the Company's common stock at
a price of $1.00 per share to one of its employees. At the issuance date, the
fair value of these shares was determined by the fair market value of the shares
issued as reflected by their market price at the issuance date in accordance
with APB No. 25. In accordance with APB No. 25, the Company recorded this
compensation expense of $53,200 during the year 2004 and included this amount in
general and administrative expenses

8. In December 2004, the Company donated 40,000 shares of its common stock to a
charitable organization recognized by the Internal Revenue Service as tax-exempt
under Section 501(c)(3) of the Internal Revenue Code of 1986, as amended. At the
issuance date, the fair value of these shares was determined by the value of the
shares issued as reflected by their market price at the issuance date and
amounted to $69,200 in accordance with EITF 96-18. This compensation expense
will be amortized over the course of one year due to legal restrictions on
selling these shares for that period of time. In accordance with EITF 96-18, the
Company recorded compensation expense of $4,361 during the year 2004 and
included this amount in general and administrative expenses

9. See Note 14.f.6.

d. Issuance of shares to lenders

As part of the securities purchase agreement on December 31, 2002 (see Note
13.a.), the Company issued 387,301 shares at par as consideration to lenders for
the first nine months of interest expenses. At the issuance date, the fair value
of these shares was determined both by the value of the shares issued as
reflected by their market price at the issuance date and by the value of the
interest and amounted to $236,250 in accordance with APB 14. During 2003 the
Company recorded this amount as financial expenses.

e. Issuance of promissory note:

As part of its purchase of the assets of IES Interactive Training, Inc., the
Company issued a $450,000 convertible promissory note (see Note 10). This note
was converted into an aggregate of 563,971 shares of common stock in August
2003.

f. Warrants:

1. As part of an investment agreement in May 2001, the Company issued to the
investors a total of 2,696,971 warrants (the "May 2001 Warrants") to purchase
shares of common stock at a price of $3.22 per share; these warrants are
exercisable by the holder at any time after November 8, 2001 and will expire on
May 8, 2006.

                                      F-46
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars

In June and July 2003, the Company adjusted the purchase price of 1,357,577 of
the May 2001 Warrants to $0.82 per share in exchange for immediate exercise of
these warrants, and issued to the holders of these exercised warrants new
warrants to purchase a total of 905,052 shares of common stock at a purchase
price of $1.45 per share (the "June 2003 Warrants"). The June 2003 Warrants were
originally exercisable at any time from and after December 31, 2003 to June 30,
2008; however, in September 2003, the exercise period of 638,385 of these June
2003 Warrants was adjusted to make them exercisable at any time from and after
December 31, 2004 to June 30, 2009. As a result the company recorded during 2003
a deemed dividend in the amount of $267,026. See also Note 1.b.

In addition, with respect to an additional 387,879 May 2001 Warrants, in
December 2003 the Company adjusted the purchase price to $1.60 per share in
exchange for immediate exercise of these warrants, and issued to the holders of
these exercised warrants new warrants to purchase a total of 193,940 shares of
common stock at a purchase price of $2.25 per share. As a result the company
recorded during 2003 a deemed dividend in the amount of $82,974. See also Note
1.b.

Additionally, in October 2003 the Company granted to three of these investors
additional new warrants to purchase a total of 150,000 shares of common stock at
a purchase price of $1.20 per share. As a result the company recorded during
2003 an expense of $199,500 and included this amount in general and
administrative expenses. During 2004, 64,557 warrants were exercised.

On July 14, 2004, the Company repriced the exercise price of 242,424 warrants
granted previously in May 2001 to $1.88 in order to induce their holders to
exercise them immediately. In connection with the exercise of the warrants, the
Company additionally granted five-year warrants to purchase up to an aggregate
of 145,454 shares of the Company's common stock at an exercise price per share
of $1.38. The fair value of these warrants was determined using Black Scholes
pricing model, assuming a risk-free interest rate of 3.5%, a volatility factor
of 79%, dividend yields of 0% and a contractual life of five years. For
accounting treatment, please see also Notes 14.b.4. and 14.f.4.

2. As part of the investment agreement in January 2002 (see Note 14.b.1), the
Company, in January 2002, issued to a financial consultant that provided
investment banking services concurrently with this transaction a warrants to
acquire (i) 150,000 shares of common stock at an exercise price of $1.68 per
share, and (ii) 119,000 shares of common stock at an exercise price of $2.25 per
share; these warrants are exercisable by the holder at any time and will expire
on January 4, 2007.

3. In connection with the Securities Purchase Agreement referred to in Note
14.b.4 above, the Company granted three-year warrants to purchase up to an
aggregate of 9,840,426 shares of the Company's common stock at any time
beginning six months after closing at an exercise price per share of $1.88.

                                      F-47
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars

In July 2004 an aggregate of 7,446,811 shares were issued pursuant to exercise
of these warrants. In connection with the exercise of the warrants, the Company
granted to the same investors five-year warrants to purchase up to an aggregate
of 7,446,811 shares of the Company's common stock at an exercise price per share
of $1.38. The fair value of these warrants was determined using Black Scholes
pricing model, assuming a risk-free interest rate of 3.5%, a volatility factor
of 79%, dividend yields of 0% and a contractual life of five years. See also
Note 14.f.4.

4. On July 14, 2004, warrants to purchase 8,814,235 shares of common stock,
having an aggregate exercise price of $16,494,194, net of issuance expenses,
were exercised (see also Notes 14.f.1., 14.f.3. and 13.c.). Out of the shares
issued in conjunction with the exercise of these warrants, 1,125,000 shares were
issued upon exercise of warrants issued in the transaction referred to in Note
13.c above and 7,446,811 shares were issued upon exercise of warrants issued in
the transaction referred to in the Note 14.f.4. above; the remaining 242,424
shares were issued upon exercise of a warrant that the Company issued to an
investor in May 2001 referred to in Note 14.f.1 above. In connection with this
transaction, the Company issued to the holders of those exercising warrants an
aggregate of 8,717,265 new five-year warrants to purchase shares of common stock
at an exercise price of $1.38 per share

As a result of the transactions described in Notes 14 f.1, 14.f.3 and 13.c.,
including the repricing of the warrants to the investors and the issuance of
additional warrants to the investors, the Company recorded a deemed dividend in
the amount of $2,165,952, to reflect the additional benefit created for these
investors. The deemed dividend increased the loss applicable to common
stockholders in the calculation of basic and diluted net loss per share for the
year ended December 31, 2004, without any effect on total shareholder's equity.

As all warrants in the July 14, 2004, securities purchase agreement were subject
to shareholders approval, in accordance with Emerging Issues Task Force
No.00-19, "Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company's Own Stock" their fair value was recorded as
a liability at the closing date. Such fair value was remeasured at each
subsequent cut-off date. Upon obtaining stockholders approval on December 14,
2004, the warrants were remeasured and reclassified to equity. The fair value of
these warrants was determined using the Black-Scholes pricing model, assuming a
risk-free interest rate of 3.5%, a volatility factor 79%, dividend yields of 0%
and a contractual life of approximately five years. The change in the fair value
of the warrants between the date of grant and December 14, 2004 has been
recorded as finance income in the amount of $326,839.

5. In November 2000 and May 2001, the Company issued a total of 916,667 warrants
to an investor, which warrants contained certain antidilution provisions: a
Series A warrant to purchase 666,667 shares of the Company's common stock at a
price of $3.50 per share, and a Series C warrant to purchase 250,000 shares at a
price of $3.08 per share. Operation of the antidilution provisions provided that
the Series A warrant should be adjusted to be a warrant to purchase 888,764
shares at a price of $2.67 per share, and the Series C warrant should be
adjusted to be a warrant to purchase 333,286 shares at a price of $2.35 per
share. After negotiations, the investor agreed in March 2004 to exercise its
warrants immediately, in exchange for an exercise price reduction to $1.45 per
share, and the issuance of a new six-month Series D warrant to purchase
1,222,050 shares at an exercise price of $2.10 per share. The new Series D
warrant does not have similar antidilution provisions. As a result of this
repricing and the issuance of new warrants, the Company recorded a deemed
dividend in the amount of approximately $1,163,000 in 2004.

                                      F-48
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars

6. On February 4, 2004, the Company entered into an agreement settling the
litigation brought against it in the Tel-Aviv, Israel district court by I.E.S.
Electronics Industries, Ltd. ("IES Electronics") and certain of its affiliates
in connection with the Company's purchase of the assets of its IES Interactive
Training, Inc. subsidiary from IES Electronics in August 2002. The litigation
had sought monetary damages in the amount of approximately $3 million. Pursuant
to the terms of the settlement agreement, in addition to agreeing to dismiss
their lawsuit with prejudice, IES Electronics agreed (i) to cancel the Company's
$450,000 debt to them that had been due on December 31, 2003, and (ii) to
transfer to the Company title to certain certificates of deposit in the
approximate principal amount of $112,000. The parties also agreed to exchange
mutual releases. In consideration of the foregoing, the Company issued to IES
Electronics (i) 450,000 shares of common stock, and (ii) five-year warrants to
purchase up to an additional 450,000 shares of common stock at a purchase price
of $1.91 per share. The fair value of the warrants was determined using
Black-Scholes pricing model, assuming a risk-free interest rate of 3.5%, a
volatility factor 79%, dividend yields of 0% and a contractual life of five
years. The fair value of warrants was calculated as $483,828 and fair value of
shares as $765,000.

In respect of the above settlement, the Company recorded in 2003 an expense of
$688,642, representing the fair value of the warrants and shares over the
remaining balance of the Company's debt to IES Electronics as carried in the
Company books at December 31, 2003, less the $112,000 certificate of deposit
that was transferred to the Company's name as noted above. During the year 2004,
200,000 warrants were exercised.

7. As of December 31, 2004, the Company outstanding warrants totaled 16,961,463.

g. Stock option and restricted stock purchase plans:

1. Options and restricted shares to employees and others (except consultants)

a. The Company has adopted the following stock option plans, whereby options and
restricted shares may be granted for purchase of shares of the Company's common
stock. Under the terms of the employee plans, the Board of Directors or the
designated committee grants options and determines the vesting period and the
exercise terms.

1) 1998 Employee Option Plan - as amended, 4,750,000 shares reserved for
issuance, of which no shares were available for future grants to employees and
consultants as of December 31, 2004.

2) 1995 Non-Employee Director Plan - 1,000,000 shares reserved for issuance, of
which 355,000 were available for future grants to directors as of December 31,
2004.

3) 2004 Employee Option Plan - 7,500,000 shares reserved for issuance, of which
5,168,400 were available for future grants to employees and consultants as of
December 31, 2004.

                                      F-49
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars

b. Under these plans, options generally expire no later than 5-10 years from the
date of grant. Each option can be exercised to purchase one share, conferring
the same rights as the other common shares. Options that are cancelled or
forfeited before expiration become available for future grants. The options
generally vest over a three-year period (33.3% per annum) and restricted shares
vest after two years; in the event that employment is terminated for cause
within that period, restricted shares revert back to the Company.

c. A summary of the status of the Company's plans and other share options and
restricted shares (except for options granted to consultants) granted as of
December 31, 2004, 2003 and 2002, and changes during the years ended on those
dates, is presented below:

<TABLE>
<CAPTION>
                                              2004                        2003                        2002
                                    --------------------------  --------------------------  -------------------------
                                      Amount       Weighted       Amount       Weighted        Amount      Weighted
                                                    average                     average                    average
                                                   exercise                    exercise                    exercise
                                                     price                       price                       price
                                    ------------                ------------                -------------
                                                  ------------                ------------                 ----------
                                                       $                           $                           $
                                                  ------------                ------------                 ----------
<S>                                   <C>          <C>            <C>          <C>            <C>          <C>
Options outstanding at beginning      9,018,311    $     1.37     5,260,366    $     2.26     4,240,228    $     2.74
  of year
Changes during year:
Granted (1) (2)                       2,248,490    $     1.06     5,264,260    $     0.71     1,634,567    $     0.87
Exercised (3)                          (191,542)
                                       (897,248)   $     1.24      (689,640)   $     0.64      (191,542)   $     1.29
Forfeited                              (514,793)   $     3.77      (816,675)   $     3.51      (422,887)   $     1.92
                                     ----------    ----------    ----------    ----------    ----------    ----------

Options outstanding at end of year    9,854,760    $     1.19     9,018,311    $     1.37     5,260,366    $     2.26
                                     ==========    ==========    ==========    ==========    ==========    ==========

Options exercisable at end of year    6,465,316    $     1.32     5,826,539    $     1.70     4,675,443    $     2.26
                                     ==========    ==========    ==========    ==========    ==========    ==========
</TABLE>

     (1) Includes 936,250, 2,035,000 and 481,435 options and restricted shares
     granted to related parties in 2004, 2003 and 2002, respectively.

     (2) The Company recorded deferred stock compensation for options and
     restricted shares issued with an exercise price below the fair value of the
     common stock in the amount of $2,081,457, $4,750 and $0 as of December 31,
     2004, 2003 and 2002, respectively. Deferred stock compensation is amortized
     and recorded as compensation expenses ratably over the vesting period of
     the option or the restriction period of the restricted shares. The stock
     compensation expense that has been charged in the consolidated statements
     of operations in respect of options and restricted shares to employees and
     directors in 2004, 2003 and 2002, was $831,626, $8,286 and $6,000,
     respectively.

     (3) In June 2002, the employees exercised 100,000 options for which the
     exercise price was not paid at the exercise date. The Company recorded the
     owed amount of $73,000 as "Note receivable from stockholders" in the
     Statement of Changes in Stockholders' Equity. In accordance with EITF
     95-16, since the original option grant did not permit the exercise of the
     options through loans, and due to the Company's history of granting
     non-recourse loans, this postponement in payments of the exercise price
     resulted in a variable plan accounting. However, the Company did not record
     any compensation due to the decrease in the market value of the Company's
     shares during 2002. During 2002 the note in the amount of $36,500 was
     forgiven and appropriate compensation was recorded. During 2003 and 2004,
     the Company recorded compensation expenses and (income) in amounts of
     $38,500 and ($10,000), respectively, due to increase and decrease in the
     market value of the Company's shares.

                                      F-50
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In U.S. dollars

d. The options and restricted shares outstanding as of December 31, 2004 have
been separated into ranges of exercise price, as follows:

<TABLE>
<CAPTION>
                          Total options outstanding                Exercisable options outstanding
              --------------------------------------------------- ----------------------------------
 Range of         Amount          Weighted          Weighted          Amount           Weighted
                                   average
              outstanding at      remaining                       exercisable at
 exercise      December 31,      contractual         average       December 31,         average
  prices           2004             life         exercise price        2004         exercise price
              ----------------                                    ----------------
------------                   ----------------  ----------------                   ----------------
     $                              Years               $                                  $
------------                   ----------------  ----------------                   ----------------

<S>         <C>                 <C>               <C>           <C>                  <C>
0.01-2.00         8,944,827           6.44              0.87          5,730,382            0.88
2.01-4.00           270,933           3.79              2.46             95,934            2.56
4.01-6.00           594,000           1.97              4.80            594,000            4.80
6.01-8.00            35,000           1.05              7.73             35,000            7.73
8.01                 10,000           2.75              9.06             10,000            9.06
              ---------------- ----------------  ---------------- ----------------  ----------------
                  9,854,760           6.07              1.19          6,465,316            1.32
              ================ ================  ================ ================  ================
</TABLE>

Weighted-average fair values and exercise prices of options and restricted
shares on dates of grant are as follows:

<TABLE>
<CAPTION>
                             Equals market price              Less than market price
                         -----------------------------     ------------------------------
                           Year ended December 31,            Year ended December 31,
                         -----------------------------     ------------------------------
                          2004       2003      2002         2004      2003        2002
                         --------   --------  --------     -------   --------   ---------
<S>                      <C>         <C>       <C>          <C>       <C>        <C>
 Weighted average        $1.494      $ 0.950   $ 1.265      $1.672    $  -       $ 0.755
   exercise prices
 Weighted average fair
   value on grant date   $1.002      $ 0.730   $ 0.560      $1.729    $  -       $ 0.250
</TABLE>


2. Options issued to consultants:

a.    The Company's outstanding options to consultants as of December 31, 2004,
      are as follows:

<TABLE>
<CAPTION>
                                         2004                         2003                         2002
                              ---------------------------  ---------------------------  ---------------------------
                                 Amount       Weighted        Amount       Weighted        Amount       Weighted
                                               average                      average                      average
                                              exercise                     exercise                     exercise
                                                price                        price                        price
                              ------------                 ------------                 -------------
                                            -------------                -------------                -------------
                                                  $                            $                            $
                                            -------------                -------------                -------------
<S>                               <C>          <C>             <C>          <C>              <C>         <C>
 Options outstanding at           313,901      $   4.59        245,786      $   5.55         245,786     $   5.55
   beginning of year
 Changes during year:
   Granted                         10,000      $         -      83,115      $   0.99               -     $     -
   Exercised                      (37,615)     $   1.03        (15,000)     $   0.49               -     $     -

   Forfeited or cancelled        (120,000)     $   6.40      -              $         -            -     $     -
                              ------------                 ------------                 -------------

 Options outstanding at
   end of year                    166,286      $   3.80        313,901      $   4.59         245,786     $   5.55
                              ============  =============  ============  =============  ============= =============

 Options exercisable at
   end of year                    166,286      $   3.80        193,901      $   3.46         125,786     $   6.42
                              ============  =============  ============  =============  ============= =============
</TABLE>


b. The Company accounted for its options to consultants under the fair value
method of SFAS No. 123 and EITF 96-18. The fair value for these options was
estimated using a Black-Scholes option-pricing model with the following
weighted-average assumptions:

                                      F-51
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------


                                    2004              2003             2002
                               ----------------  ---------------  --------------
Dividend yield                          0%               0%                -
Expected volatility                    81%              78%                -
Risk-free interest                    3.4%             2.3%                -
Contractual life of up to          5 years         10 years                -


c. In connection with the grant of stock options to consultants, the Company
recorded stock compensation expenses totaling $0, $29,759 and $0 for the years
ended December 31, 2004, 2003 and 2002, respectively, and included these amounts
in marketing and general and administrative expenses.

3. Dividends:

In the event that cash dividends are declared in the future, such dividends will
be paid in U.S. dollars. The Company does not intend to pay cash dividends in
the foreseeable future.

4. Treasury Stock:

Treasury stock is the Company's common stock that has been issued and
subsequently reacquired. The acquisition of common stock is accounted for under
the cost method, and presented as reduction of stockholders' equity.

NOTE 15:-     INCOME TAXES

a. Taxation of U.S. parent company (Arotech) and other U.S. subsidiaries:

As of December 31, 2004, Arotech has operating loss carryforwards for U.S.
federal income tax purposes of approximately $23 million, which are available to
offset future taxable income, if any, expiring in 2009 through 2024. Utilization
of U.S net operating losses may be subject to substantial annual limitations due
to the "change in ownership" provisions of the Internal Revenue Code of 1986 and
similar state provisions. The annual limitation may result in the expiration of
net operating loses before utilization.

The Company files consolidated tax returns with its US subsidiaries.

b. Israeli subsidiary (Epsilor):

Tax benefits under the Law for the Encouragement of Capital Investments, 1959
(the "Investments Law"):

Currently, Epsilor is operating under three programs as follows:

1. Program one:

Epsilor's expansion program of its existing enterprise in Dimona was granted the
status of an "approved enterprise" under the Investments Law and was entitled to
investments grants from the state of Israel in the amount of 24% on property and
equipment located at its Dimona plant.

The approved expansion program was in the amount of approximately $350,000.
Epsilor effectively operated the program during 1999 and is entitled to the tax
benefits available under the Investments Law.

                                      F-52
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

Taxable income derived from the approved enterprise is subject to a reduced tax
rate during seven years beginning from the year in which taxable income is first
earned (tax exemption for the first two-year period and 25% tax rate for the
five remaining years).

Those benefits are limited to 12 years from the year that the enterprise began
operations, or 14 years from the year in which the approval was granted,
whichever is earlier. Hence, this approved program will expire in 2005.

2. Program two:

Epsilor's expansion program of its existing enterprise in Dimona was granted the
status of an "approved enterprise" under the Investments Law and was entitled to
investments grants from the State of Israel in the amount of 24% on property and
equipment located at its Dimona plant.

The approved expansion program is in the amount of approximately $600,000.
Epsilor effectively operated the program during 2002, and is entitled to the tax
benefits available under the Investments Law (commencing from 2003).

Taxable income derived from the approved enterprise is subject to a reduced tax
rate during seven years beginning from the year in which taxable income is first
earned (tax exemption for the first two-year period and 25% tax rate for the
five remaining years).

Those benefits are limited to 12 years from the year that the enterprise began
operations, or 14 years from the year in which the approval was granted,
whichever is earlier. Hence, this approved program will expire in 2009.

3. Program three:

Epsilor's expansion program of its existing enterprise in Dimona was granted the
status of an "approved enterprise" under the Investments Law, and is entitled to
investments grants from the State of Israel in the amount of 32% on property and
equipment located at its Dimona plant.

The approved expansion program is in the amount of approximately $945,000. This
program has not yet received final approval.

Taxable income derived from the approved enterprise is subject to a reduced tax
rate during seven years beginning from the year in which taxable income is first
earned (tax exemption for the first two-year period and 25% tax rate for the
five remaining years).

Those benefits are limited to 12 years from the year that the enterprise began
operations, or 14 years from the year in which the approval was granted,
whichever is earlier.

The main tax benefits available to Epsilor are:

a) Reduced tax rates:

As stated above for each specific program

b) Accelerated depreciation:

Epsilor is entitled to claim accelerated depreciation in respect of machinery
and equipment used by the "Approved Enterprise" for the first five years of
operation of these assets.

                                      F-53
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

Income from sources other than the "Approved Enterprise" during the benefit
period will be subject to tax at the regular corporate tax rate of 35%.

.. If retained tax-exempt profits attributable to the "approved enterprise" are
distributed, they would be taxed at the corporate tax rate applicable to such
profits as if Epsilor had not elected the alternative system of benefits,
currently 25% for an "approved enterprise."

Dividends paid from the profits of an approved enterprise are subject to tax at
the rate of 15% in the hands of their recipient.

As of December 31, 2004 approximately $370,000 were derived from tax exempt
profits earned by Epsilor's "approved enterprises"; by Israeli law, the Company
can distribute only $197,000 of this amount. The Company has determined that
such tax exempt income in the amount of $180,000 will not be distributed as
dividends.

Tax liability on what can be distributed as dividends from these tax exempt
profits and other Epsilor profits in 2004 in the hand of the recipient and on
the company level as stated in previous section is $51,000 and accordingly
deferred tax liability was recorded as of December 31, 2004.

c. Israeli subsidiary (EFL):

1. Tax benefits under the Investments Law:

A small part of EFL's manufacturing facility has been granted "Approved
Enterprise" status under the Investments Law, and was entitled to investment
grants from the State of Israel of 38% on property and equipment located in
Jerusalem, and 10% on property and equipment located in its plant in Beit
Shemesh, and to reduced tax rates on income arising from the "Approved
Enterprise," as detailed below.

The period of tax benefits granted by "Approved enterprise" is subject to limits
of 12 years from the commencement of production, or 14 years from the approval
date, whichever is earlier. The approved program expired in 2004. The benefits
were not utilized since the Company had no taxable income, since its
incorporation.

d. Other tax information about the Israeli subsidiaries:

1. Measurement of results for tax purposes under the Income Tax Law
(Inflationary Adjustments), 1985

Results for tax purposes are measured in real terms of earnings in NIS after
certain adjustments for increases in the Consumer Price Index. As explained in
Note 2.b., the financial statements are presented in U.S. dollars. The
difference between the annual change in the Israeli consumer price index and in
the NIS/dollar exchange rate causes a difference between taxable income and the
income before taxes shown in the financial statements. In accordance with
paragraph 9(f) of SFAS No. 109, EFL, Epsilor and MDT have not provided deferred
income taxes on this difference between the reporting currency and the tax bases
of assets and liabilities.

                                      F-54
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

2. Tax benefits under the Law for the Encouragement of Industry (Taxation),
1969:

EFL and Epsilor are "industrial companies," as defined by this law and, as such,
are entitled to certain tax benefits, mainly accelerated depreciation, as
prescribed by regulations published under the inflationary adjustments law, the
right to claim amortization of know-how, patents and certain other intangible
property rights as deductions for tax purposes.

3. Tax rates applicable to income from other sources:

Income from sources other than the "Approved Enterprise," is taxed at the
regular rate of 35%. See also Note 15.e

4. Tax loss carryforwards:

As of December 31, 2004, EFL has operating and capital loss carryforwards for
Israeli tax purposes of approximately $87.0 million, which are available,
indefinitely, to offset future taxable income.

e. Reduction in corporate tax rate

In June 2004, the Israeli Parliament approved an amendment to the Income Tax
Ordinance (No. 140 and Temporary Provision) (the "Amendment"), which
progressively reduces the corporate tax rate from 36% to 35% in 2004 and to a
rate of 30% in 2007. The amendment was signed and published in July 2004 and is,
therefore, considered enacted in July 2004. As the Company currently has no
taxable income, and no deferred taxes were recorded, the amendment does not have
an impact on the Company's results of operation or financial position.

f. Deferred income taxes:

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and amounts used for income tax purposes. Significant components of the
Company's deferred tax assets resulting from tax loss carryforward are as
follows:
                                                              December 31,
                                                    ------------    ------------
                                                       2004            2003
                                                    ------------    ------------

Operating loss carryforward                        $ 32,532,998    $ 33,958,434
Reserve and allowance                                 1,328,479         843,453
                                                   ------------    ------------

Net deferred tax asset before valuation allowance    33,861,477      34,801,887
Valuation allowance                                 (33,725,995)    (34,801,887)
                                                   ------------    ------------

Total deferred tax asset                           $    135,482    $         --
                                                   ============    ============
Deferred tax liability                             $     51,366    $         --
                                                   ============    ============

The Company and its subsidiaries provided valuation allowances in respect of
deferred tax assets resulting from tax loss carryforwards and other temporary
differences. Management currently believes that it is more likely than not that
the deferred tax assets related to the loss carryforwards and other temporary
differences will not be realized. The change in the valuation allowance as of
December 31, 2004 was $1,075,892

                                      F-55
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

g. Loss from continuing operations before taxes on income and minorities
interests in loss (earnings) of a subsidiary:

<TABLE>
<CAPTION>
                                                         Year ended December 31
                                     ---------------------------------------------------------------
                                            2004                 2003*                 2002**
                                     -------------------   -------------------   -------------------
<S>                                   <C>                   <C>                   <C>
         Domestic                     $     8,006,205       $     7,411,121       $     5,250,633
         Foreign                              405,305             1,697,617            13,253,725
                                     -------------------   -------------------   -------------------
                                      $     8,411,510       $     9,108,738        $   18,504,358
                                     ===================   ===================   ===================
</TABLE>

-------------------------
             *   Restated (see Note 1.b.).
             ** Includes loss from discontinued operations and minority interest
             in loss (earnings) of a subsidiary


h. Taxes on income were comprised of the following:

                                            Year ended December 31
                            ----------------------------------------------------
                                 2004               2003              2002
                            ---------------    ---------------   ---------------

Current state and local
  taxes                     $       539,674    $        44,102   $            --
Deferred taxes                      (37,857)                --                --
Taxes in respect of prior
  years                              84,292            352,091                --
                            ---------------    ---------------   ---------------
                            $       586,109    $       396,193   $            --
                            ===============    ===============   ===============

Domestic                    $       163,087    $        33,020   $            --
Foreign                             423,022            363,173                --
                            ---------------    ---------------   ---------------

                            $       586,109    $       396,193   $            --
                            ===============    ===============   ===============

i. The cumulative amount of undistributed earnings of foreign subsidiaries,
which is intended to be permanently reinvested and for which U.S. income taxes
have not been provided, totaled approximately $180,000 and $0 on December 31,
2004 and 2003 respectively.

j. A reconciliation between the theoretical tax expense, assuming all income is
taxed at the statutory tax rate applicable to income of the Company and the
actual tax expense as reported in the Statement of Operations is as follows:

                                      F-56
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                                   Year ended December 31,
                                                       -------------------------------------------
                                                           2004            2003*           2002
                                                       -----------     -----------     -----------
<S>                                                    <C>             <C>             <C>
Loss from continuing operations before taxes, as       $(8,411,510)    $(9,108,738)    $(4,582,792)
  reported in the consolidated statements of income
                                                       ===========     ===========     ===========
Statutory tax rate                                              34%             34%             34%
                                                       ===========     ===========     ===========
Theoretical income tax on the above amount at the      $(2,859,914)    $(3,096,971)    $(1,558,149)
  U.S. statutory tax rate
Deferred taxes on losses for which valuation
  allowance was provided                                   556,692       1,146,754       1,558,149
Non-deductible expenses                                  1,629,874       1,873,129              --
State taxes                                                168,081          33,020              --
Accrual for deferred taxes on undistributed earnings        49,416              --              --
Foreign income in tax rates other then U.S rate
                                                           919,895          86,954              --
Taxes in respect of prior years                             84,292         352,091              --
Others                                                      37,773           1,216              --
                                                       -----------     -----------     -----------

Actual tax expense                                     $   586,109     $   396,193     $        --
                                                       ===========     ===========     ===========
</TABLE>

-----------------------
    * Restated (see Note 1.b.).


NOTE 16:-     SELECTED STATEMENTS OF OPERATIONS DATA

Financial income (expenses), net:

<TABLE>
<CAPTION>
                                                                Year ended December 31,
                                                      ------------------------------------------
                                                          2004            2003*          2002
                                                      -----------     -----------    -----------
<S>                                                   <C>             <C>            <C>
Financial expenses:
Interest, bank charges and fees                       $  (622,638)    $  (355,111)   $   (89,271)
Amortization of compensation related to warrants
issued to the holders of convertible debentures and
beneficial conversion feature                          (4,142,109)     (3,928,237)            --
Bonds premium amortization                               (202,467)             --             --
Foreign currency translation differences                  (71,891)        115,538         15,202
                                                      -----------     -----------    -----------

                                                       (5,039,105)     (4,167,810)       (74,069)
                                                      -----------     -----------    -----------
Financial income:
   Interest                                               443,182         129,101        174,520
   Realized gain from marketable securities sale           40,119              --             --
   Financial income in connection with warrants
   granted (note 14.f.4)                                  326,839              --             --
                                                      -----------     -----------    -----------

Total                                                 $(4,228,965)    $(4,038,709)   $   100,451
                                                      ===========     ===========    ===========
</TABLE>

----------
*  Restated (see Note 1.b.).


                                      F-57
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------


NOTE 17:-         RELATED PARTY DISCLOSURES

<TABLE>
<CAPTION>
                                                                            Year ended December 31,
                                                           ----------------------------------------------------------
                                                                 2004                2003                 2002
                                                           -----------------   -----------------    -----------------
<S>                                                         <C>                   <C>                     <C>
Transactions:
Reimbursement of general and administrative expenses              -                   -              $     36,000
                                                           =================   =================    =================
Financial income (expenses), net from notes receivable
  and loan holders                                          $     18,251              -              $     (7,309)
                                                           =================   =================    =================
</TABLE>

NOTE 18:-         SEGMENT INFORMATION

a. General:

The Company and its subsidiaries operate primarily in three business segments
(see Note 1.a. for a brief description of the Company's business) and follow the
requirements of SFAS No. 131.

Prior to its purchase of FAAC, Epsilor and AoA, the Company had managed its
business in two reportable segments organized on the basis of differences in its
related products and services. With the acquisition of FAAC and Epsilor early in
2004 and AoA in August of 2004, the Company reorganized into three segments:
Simulation and Security; Armor; and Battery and Power Systems. As a result the
Company restated information previously reported in order to comply with new
segment reporting.

The Company's reportable operating segments have been determined in accordance
with the Company's internal management structure, which is organized based on
operating activities. The accounting policies of the operating segments are the
same as those described in the summary of significant accounting policies. The
Company evaluates performance based upon two primary factors, one is the
segment's operating income and the other is based on the segment's contribution
to the Company's future strategic growth.

b. The following is information about reported segment gains, losses and assets:

<TABLE>
<CAPTION>
                                               Simulation          Armor           Battery and      All Others(4)          Total
                                              and Security                        Power Systems
                                             -------------    ---------------    ---------------    ---------------    -------------
<S>                                           <C>              <C>                <C>                <C>                <C>
2004
Revenues from outside customers               $21,464,406      $ 17,988,687       $ 10,500,753       $          -       $49,953,846
Depreciation expenses and amortization (1)     (1,983,822)       (1,755,847)        (1,132,953)          (135,613)       (5,008,235)
Direct expenses (2)                           (17,910,967)      (16,444,476)        (9,974,544)        (5,431,627)      (49,761,614)
                                             -------------    ---------------    ---------------    ---------------    -------------
Segment net income (loss)                     $ 1,569,617      $   (211,636)      $   (606,744)      $ (5,567,240)       (4,816,003)
                                             =============    ===============    ===============    ===============
Financial expenses (after deduction of
minority interest)                                                                                                       (4,226,310)

Net loss from continuing operations                                                                                     $(9,042,313)
                                                                                                                       =============
Segment assets (3)                            $ 1,872,943      $  5,819,266       $  3,455,188       $    730,595       $11,877,992
                                             =============    ===============    ===============    ===============    =============
</TABLE>

                                      F-58

<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------


<TABLE>
<CAPTION>
                                               Simulation          Armor           Battery and      All Others(4)          Total
                                              and Security                        Power Systems
                                             -------------    ---------------    ---------------    ---------------    -------------
<S>                                           <C>              <C>                <C>                <C>                <C>
2004
2003*
Revenues from outside customers               $ 8,022,026      $  3,435,716       $  5,868,899       $          -       $17,326,641
Depreciation expenses and amortization           (757,997)         (169,668)          (527,775)          (139,630)       (1,595,070)
Direct expenses (2)                            (7,308,649)       (3,584,284)        (5,945,948)        (4,200,770)      (21,039,651)
                                             -------------    ---------------    ---------------    ---------------    -------------
Segment net income (loss)                     $   (44,620)     $   (318,236)      $   (604,824)      $ (4,340,400)       (5,308,080)
                                             =============    ===============    ===============    ===============
Financial expenses (after deduction of                                                                                   (4,039,951)
minority interest)
                                                                                                                       -------------
Net loss from continuing operations                                                                                     $(9,348,031)
                                                                                                                       =============
Segment assets (3)                            $   898,271      $    730,291       $  2,128,062       $    450,864       $ 4,207,488
                                             =============    ===============    ===============    ===============    =============

2002
Revenues from outside customers               $ 1,980,061      $  2,744,382       $  1,682,296       $          -       $ 6,406,739
Depreciation expenses and amortization (1)       (569,832)         (106,921)          (252,514)          (194,014)       (1,123,281)
Direct expenses (1)                            (2,037,775)       (2,315,995)        (3,062,548)        (2,905,743)      (10,322,061)
                                             -------------    ---------------    ---------------    ---------------    -------------
Segment net income (loss)                     $  (627,546)     $    321,466       $ (1,632,766)      $ (3,099,757)       (5,038,603)
                                             =============    ===============    ===============    ===============
Financial income (after deduction of                                                                                        100,451
minority interest)
                                                                                                                       -------------
Net income from continuing operations                                                                                   $(4,938,152)
                                                                                                                       =============
Segment assets (3)                            $   655,143      $  1,028,682       $  2,007,291       $    575,612       $ 4,266,728

                                             =============    ===============    ===============    ===============    =============
</TABLE>

-----------------------------
*  Restated (see Note 1.b.).
(1) Including property and equipment depreciation, intangible assets
amortization and amortization of adjustment of one of the Company's
subsidiaries' inventory to market values as of the purchase date. (2) Including
sales and marketing, general and administrative expenses.

(3) Including property and equipment and inventory. (4) Including unallocated
costs.

c. Summary information about geographic areas:

The following presents total revenues according to end customers location for
the years ended December 31, 2004, 2003 and 2002, and long-lived assets as of
December 31, 2004, 2003 and 2002:

<TABLE>
<CAPTION>
                               2004                            2003                            2002
                   ------------------------------  ------------------------------  ------------------------------
                       Total        Long-lived         Total        Long-lived         Total        Long-lived
                     revenues         assets         revenues         assets         revenues         assets
                   --------------  --------------  --------------  --------------  -------------- ---------------
                                                           U.S. dollars
                   ----------------------------------------------------------------------------------------------
<S>                 <C>             <C>             <C>             <C>             <C>            <C>
U.S.A.             $40,656,729     $ 45,154,086    $10,099,652     $  6,778,050    $  2,787,250   $  6,710,367
Germany                319,110              -        2,836,725              -             38,160              -
England                344,261              -           29,095              -             47,696              -
Thailand                     -              -           95,434              -            291,200              -
India                3,061,705              -                -              -                  -              -
Israel               4,212,408      13,560,822       3,576,139      2,954,441          2,799,365      3,367,320
Other                1,359,633              -          689,596              -            443,068              -
                   --------------  --------------  --------------  --------------  -------------- ---------------
                    $49,953,846     $ 58,714,908    $17,326,641     $  9,732,491    $  6,406,739   $ 10,077,687
                   ==============  ==============  ==============  ==============  ============== ===============
</TABLE>


                                      F-59
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------


d. Revenues from major customers:

<TABLE>
<CAPTION>
                                                            Year ended December 31,
                                              ----------------------------------------------------
                                                  2004               2003               2002
                                                                       %
                                              -------------- --- -------------- --- --------------
<S>                                                   <C>               <C>                 <C>
     Batteries and power systems:
              Customer A                              8%                27%                 8%
     Armor:
              Customer B                              4%                17%                43%
              Customer C                             24%                 -                  -
     Simulation and security:
              Customer D                             13%                 -                  -
              Customer E                              1%                16%                 -

<CAPTION>

e. Revenues from major products:

                                                            Year ended December 31,
                                              ----------------------------------------------------
                                                  2004               2003               2002
                                              --------------     --------------     --------------
<S>                                                   <C>               <C>                 <C>

     Electric - vehicle                        $   232,394        $    408,161       $   460,562
     Water activated batteries                     921,533             703,084           647,896
     Military batteries                          9,324,247           4,757,116           573,839
     Car armoring                               17,988,686           3,435,715         2,744,382
     Simulators                                 21,414,968           7,961,302         1,980,060
     Other                                          72,018              61,263                 -
                                              --------------     --------------     --------------
     Total                                     $49,953,846        $ 17,326,641       $ 6,406,739
                                              ==============     ==============     ==============
</TABLE>


                                      F-60
<PAGE>


                          SUPPLEMENTARY FINANCIAL DATA

 Quarterly Financial Data (unaudited) for the two years ended December 31, 2004


<TABLE>
<CAPTION>
                                                                       Quarter Ended*
                                            --------------------------------------------------------------------
                    2004                        March 31         June 30        September 30     December 31
        ------------------------------      --------------------------------------------------------------------
<S>                                          <C>              <C>              <C>              <C>
Net revenue................................. $    7,182,254   $    9,928,248   $   16,272,521   $   16,570,823
Gross profit................................ $    2,625,034   $    3,353,501   $    4,723,573   $    5,240,644
Net profit (loss) from continuing operations $   (2,517,889)  $   (4,396,123)  $    1,126,845   $   (3,255,146)
Net loss from discontinued operations....... $            -   $            -   $            -   $            -
Net profit (loss) for the period............ $   (2,517,889)  $   (4,396,123)  $    1,126,845   $   (3,255,146)
Deemed dividend to certain stockholders of
common stock                                 $   (1,163,000)  $        -       $   (2,165,952)  $        -
Net loss attributable to common stockholders $   (3,680,889)  $    (4,396,123) $   (1,039,107)  $   (3,255,146)
Net profit (loss) per share - basic and
diluted..................................... $       (0.06)   $       (0.07)   $       (0.01)   $       (0.04)
Shares used in per share calculation........     59,406,466       64,499,090       76,744,251       79,075,181

<CAPTION>

                                                                       Quarter Ended
                                            --------------------------------------------------------------------
                    2003*                       March 31         June 30        September 30     December 31
        ------------------------------      --------------------------------------------------------------------
<S>                                          <C>              <C>              <C>              <C>
Net revenue................................. $    4,033,453   $    3,493,135   $    5,705,898   $    4,094,155
Gross profit................................ $    1,399,734   $    1,013,965   $    2,453,575   $    1,371,527
Net loss from continuing operations......... $   (1,291,122)  $   (2,788,348)  $      218,606   $   (5,487,167)
Net income (loss) from discontinued
operations.................................. $      (95,962)  $      179,127   $       (2,285)  $       29,529
Net income (loss) for the period............ $   (1,387,083)  $   (2,609,221)  $      216,321   $   (5,457,638)
Deemed dividend to certain stockholders of
common stock................................ $        -       $      (172,350) $       (94,676) $      (82,974)
Net income (loss) attributable to common
stockholders................................ $   (1,387,083)  $   (2,781,571)  $       121,645  $    (5,540,612)
Net loss per share - basic and diluted...... $       (0.04)   $       (0.08)   $          0.00  $       (0.13)
Shares used in per share calculation........     34,758,960       36,209,872        40,371,940       43,604,830
</TABLE>

-----------------------
   * Restated (see Note 1.b. of Notes to Consolidated Financial Statements).


                                      F-61
<PAGE>

                          FINANCIAL STATEMENT SCHEDULE

                      Arotech Corporation and Subsidiaries

                 Schedule II - Valuation and Qualifying Accounts

              For the Years Ended December 31, 2004, 2003 and 2002

<TABLE>
<CAPTION>
                                                  Additions
                                                 Balance at       charged to      Balance at
                                                 beginning        costs and         end of
  Description                                    of period         expenses         period
---------------------------------------------  ---------------  --------------- ----------------
<S>                                             <C>              <C>             <C>
Year ended December 31, 2004
  Allowance for doubtful accounts...........    $      61,282    $      (5,888)  $       55,394

  Allowance for slow moving inventory                  96,350           121,322         217,672
  Valuation allowance for deferred taxes....       34,801,887       (1,075,892)      33,725,995
                                               ---------------  --------------- ----------------
  Totals....................................    $  34,959,519    $    (960,458)  $   33,999,061
                                               ===============  =============== ================
Year ended December 31, 2003
  Allowance for doubtful accounts...........    $      40,636    $      20,646   $       61,282

  Allowance for slow moving inventory                       -           96,350           96,350
  Valuation allowance for deferred taxes....       29,560,322        5,241,565       34,801,887
                                               ---------------  --------------- ----------------
  Totals....................................    $  29,600,958    $   5,358,561   $   34,959,519
                                               ===============  =============== ================
Year ended December 31, 2002
  Allowance for doubtful accounts...........    $      39,153    $       1,483   $       40,636
  Valuation allowance for deferred taxes....       12,640,103       16,920,219       29,560,322
                                               ---------------  --------------- ----------------
  Totals....................................    $  12,679,256    $  16,921,702   $   29,600,958
                                               ===============  =============== ================
</TABLE>

<PAGE>

<TABLE>
<CAPTION>

                                  EXHIBIT INDEX

    Exhibit
    Number                                            Description
    ------                                            -----------
<S>                                                          <C>
   4.1......Specimen certificate for shares of common stock, $.01 par value
   10.91....Consulting Agreement, effective as of January 1, 2005, between us and Sampen Corporation
   21.1.....List of Subsidiaries of the Registrant
   23.1.....Consent of Kost, Forer, Gabbay & Kassierer, a member of Ernst & Young Global
   23.2.....Consent of Stark Winter Schenkein & Co., LLP
   31.1.....Certification of Chief Executive  Officer pursuant to Section 302 of the  Sarbanes-Oxley  Act of
            2002
   31.2.....Certification of Chief Financial  Officer pursuant to Section 302 of the  Sarbanes-Oxley  Act of
            2002
   32.1.....Written Statement of Chief Executive Officer pursuant to Section 906 of the  Sarbanes-Oxley  Act
            of 2002
   32.2.....Written Statement of Chief Financial Officer pursuant to Section 906 of the  Sarbanes-Oxley  Act
            of 2002

</TABLE>

                                      100