================================================================================

                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                   FORM 10-K/A

                |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003.

                                       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
 -----------------------------------------------------------------------------
             (Exact name of registrant as specified in its charter)

          Delaware                                           95-4302784
---------------------------------                    ---------------------------
(State or other jurisdiction                              (I.R.S. Employer
of incorporation or organization)                        Identification No.)

250 West 57th Street, New York, New York                       10107
----------------------------------------             ---------------------------
(Address of principal executive offices)                     (Zip Code)

                                 (212) 258-3222
   -------------------------------------------------------------------------
              (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

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 |_| No |X|

The aggregate market value of the registrant's voting stock held by
non-affiliates of the registrant as of June 30, 2003 was approximately
$31,017,725 (based on the last sale price of such stock on such date as reported
by The Nasdaq National Market).

(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: 62,312,796 as of 3/23/04

Documents incorporated by reference:  None

================================================================================

<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 II

ITEM 6. SELECTED FINANCIAL DATA

      The selected financial information set forth below with respect to the
consolidated financial statements for each of the five fiscal years in the
period ended December 31, 2003, and with respect to the balance sheets at the
end of each such fiscal year has been derived from our consolidated financial
statements audited by Kost, Forer, Gabbay & Kassierer, independent registered
public accounting firm and a member firm of Ernst & Young Global.

      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, 2000 and 1999 have been reclassified in the accompanying
statements of operations as discontinued operations. Our balance sheets at
December 31, 2003, 2002, 2001, 2000 and 1999 give effect 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.

<PAGE>

<TABLE>
<CAPTION>
                                                                  Year Ended December 31,
                                                  --------------------------------------------------------
                                                    1999        2000        2001        2002        2003**
                                                  --------    --------    --------    --------    --------
                                                        (dollars in thousands, except per share data)
<S>                                               <C>         <C>         <C>         <C>         <C>
Statement of Operations Data:
Revenues ......................................   $  2,422    $  1,490    $  2,094    $  6,407    $ 17,326
                                                  --------    --------    --------    --------    --------
Research and development expenses and costs of
  revenues ....................................      3,867       1,985       2,448       5,108      12,141
Selling, general and administrative expenses
  and amortization of intangible assets .......      2,754       3,434       3,934       5,982      10,255
                                                  --------    --------    --------    --------    --------
Operating loss ................................     (4,198)     (3,929)     (4,288)     (4,683)     (5,070)
Financial income (expenses), net ..............        190         544         263         100       4,039
                                                  --------    --------    --------    --------    --------
Loss before minority interest in (loss)
  earnings of subsidiary and tax expenses .....     (4,008)     (3,385)     (4,026)     (4,583)     (9,109)
Taxes on income ...............................         (6)         --          --          --        (396)
Minority interest in (loss) earnings of
  subsidiary ..................................         --          --          --        (355)        157
                                                  --------    --------    --------    --------    --------
Loss from continuing operations ...............     (4,014)     (3,385)     (4,026)     (4,938)     (9,348)
Income (loss) from discontinued operations ....     (2,902)     (8,596)    (13,261)    (13,566)        110
                                                  --------    --------    --------    --------    --------
Net loss for the period .......................     (6,916)    (11,981)    (17,287)    (18,504)     (9,238)
Deemed dividend to certain shareholders of
  common stock ................................         --          --      (1,197)         --        (350)
                                                  --------    --------    --------    --------    --------
Net loss attributable to shareholders of common
  stock .......................................   $ (6,916)   $(11,981)   $(18,483)   $(18,504)   $ (9,588)
                                                  ========    ========    ========    ========    ========
Basic and diluted net loss per share from
  continuing operations .......................   $  (0.28)   $  (0.18)   $  (0.21)   $  (0.15)   $  (0.24)
                                                  ========    ========    ========    ========    ========
Loss per share for combined operations ........   $  (0.48)   $  (0.62)   $  (0.76)   $  (0.57)   $  (0.25)
                                                  ========    ========    ========    ========    ========
Weighted average number of common shares used
  in computing basic and diluted net loss per
  share (in thousands) ........................     14,334      19,243      24,200      32,382      38,890
<CAPTION>
                                                                  Year Ended December 31,
                                                  --------------------------------------------------------
                                                    1999        2000        2001        2002        2003**
                                                  --------    --------    --------    --------    --------
<S>                                               <C>         <C>         <C>         <C>         <C>
Balance Sheet Data:
Cash, cash equivalents, investments in
  marketable debt securities and restricted
  collateral deposits .........................   $  2,556    $ 11,596    $ 12,672    $  2,091    $ 14,391
Receivables and other assets* .................      5,215      13,771      11,515       7,895       8,898
Property and equipment, net of depreciation ...      2,258       2,289       2,221       2,555       2,293
Goodwill and other intangible assets, net .....         --          --          --       7,522       7,440
                                                  --------    --------    --------    --------    --------
Total assets ..................................   $ 10,029    $ 27,656    $ 26,408    $ 20,063    $ 33,022
                                                  ========    ========    ========    ========    ========
Current liabilities* ..........................   $  3,427    $  4,787    $  3,874    $  7,272    $  6,710
Long-term liabilities .........................      2,360       2,791       3,126       3,753       4,635
Stockholders' equity ..........................      4,242      20,078      19,408       9,038      21,626
                                                  --------    --------    --------    --------    --------
Total liabilities and stockholders equity* ....   $ 10,029    $ 27,656    $ 26,408    $ 20,063    $ 33,022
                                                  ========    ========    ========    ========    ========
</TABLE>

----------
  *Includes assets and liabilities, as applicable, from discontinued operations.
 **Restated (see Note 1.b. of Notes to Consolidated Financial Statements).


                                     - 2 -
<PAGE>

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

      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.

      We make available through our internet website free of charge our annual
report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K, amendments to such reports and other filings made by us with the SEC, as
soon as practicable after we electronically files such reports and filings with
the SEC. Our website address is www.arotech.com. The information contained in
this website is not incorporated by reference in this report.

      The following discussion and analysis should be read in conjunction with
the 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 and security personnel, as well as
            offering security consulting and other services (our Simulation,
            Training and Consulting Division);

      >>    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); and

      >>    we utilize sophisticated lightweight materials and advanced
            engineering processes to armor vehicles (our Armored Vehicle
            Division).


                                     - 3 -
<PAGE>

      Early in 2004, we acquired two 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, Training and Consulting Division), and
Epsilor Electronic Industries, Ltd., located in Dimona, Israel, 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 (which we
have placed in our Battery and Power Systems Division). Prior to the acquisition
of FAAC and Epsilor, we were organized into two divisions: Defense and Security
Products (consisting of IES, MDT, MDT Armor and Arocon), and Electric Fuel
Batteries (consisting of EFL and EFB). We have reported our results of
operations for 2003 and 2002 in accordance with these earlier divisions, and our
financial results for 2003 and 2002 do not include the activities of FAAC or
Epsilor.

      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 do 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 17.g. of the Notes to Consolidated Financial
Statements for the year ended December 31, 2003.

      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 their
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:


                                     - 4 -
<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
                                                 ==========     ==========      ==========
</TABLE>

Balance sheet data:

<TABLE>
<CAPTION>
                                                     As of December 31, 2003
                                    -------------------------------------------------------
                                    Previously Reported     Adjustment         As Restated
                                    -------------------   ---------------    --------------
<S>                                    <C>                <C>                <C>
Other accounts payable
 and accrued expenses ........... .    $   4,321,347      $    (150,000)     $   4,171,347

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
</TABLE>

Cash flow data:

<TABLE>
<CAPTION>
                                                       For the Year ended December 31, 2003
                                                    -------------------------------------------
                                                     Previously
                                                      Reported       Adjustment     As Restated
                                                    ------------    -------------   -----------
<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
  beneficial conversion feature and warrants
  issued to holders of convertible debentures ..      3,359,987        568,250       3,928,237
</TABLE>


                                     - 5 -
<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, 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, among others,
affect our more significant judgments and estimates used in the preparation of
our consolidated financial statements.

      Revenue Recognition and Bad Debt

      We generate revenues primarily from sales of multimedia and interactive
digital training systems and use-of-force simulators specifically targeted for
law enforcement and firearms training and from service contracts related to such
sales; from providing lightweight armoring services of vehicles; from sale of
zinc-air battery products for defense applications; and, to a lesser extent,
from development services and long-term arrangements subcontracted by the U.S
government. We recognize revenues in respect of products when, among other
things, we have delivered the goods being purchased and we believe
collectibility to be reasonably assured. We do not grant a right of return to
our customers. We perform ongoing credit evaluations of our customers' financial
condition and we require collateral as deemed necessary. We make judgments as to
our ability to collect outstanding receivables and provide allowances for a
portion of such receivables when and if 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. If the historical data we use to
calculate the allowance provided for doubtful accounts does not reflect the
future ability to collect outstanding receivables, additional provisions for
doubtful accounts may be needed and the future results of operations could be
materially affected.

      Revenues from development services are recognized using contract
accounting on a percentage of completion method, based on completion of
agreed-upon milestones and in accordance with the "Output Method" or based on
the time and material basis. Provisions for estimated losses on uncompleted
contracts are recognized in the period in which the likelihood of such losses is
determined.

      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.


                                     - 6 -
<PAGE>

      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 2003, no
significant changes were made to the underlying assumptions related to estimates
of inventory valuation or the methodology applied.

      Goodwill

      Our business acquisitions typically result in the recognition of goodwill
and other intangible assets, which affect the amount of current and future
period charges and amortization expenses. The determination of value of these
components of a business combination, as well as associated asset useful lives,
requires our management to make various estimates and assumptions. Estimates
using different, but each reasonable, assumptions could produce significantly
different results. We test goodwill for possible impairment on an annual basis
and at any other time if an event occurs or circumstances change that would more
likely than not reduce the fair value of a reporting unit below its carrying
amount. Such impairment loss is measured by comparing the recoverable amount of
an asset with its carrying value. The determination of the value of goodwill
requires our management to make assumptions regarding estimated future cash
flows and other factors to determine the fair value of a respective asset. If
these estimates or the related assumptions change in the future, we could be
required to record impairment charges. Any material change in our valuation of
assets in the future and any consequent adjustment for impairment could have a
material adverse impact on our future reported financial results.

      Impairment of long-lived assets and intangibles

      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" 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 an asset 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. Assets to be disposed of are reported at the lower of
the carrying amount or fair value less selling costs. As of December 31, 2003,
no impairment losses have been identified.

      The determination of the value of such long-lived and intangible assets
requires management to make assumptions regarding estimated future cash flows
and other factors to determine the fair value of the respective assets. These
estimates have been based on our business plans for the entities acquired. If
these estimates or the related assumptions change in the future, we could be
required to record impairment charges. Any material change in our valuation of
assets in the future and any consequent adjustment for impairment could have a
material adverse impact on our future reported financial results.


                                     - 7 -
<PAGE>

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.

Executive Summary

      The following executive summary includes, where appropriate, discussion of
our new subsidiaries, FAAC Incorporated, Epsilor Electronic Industries, Ltd. and
Armour of America Incorporated, that we purchased in 2004. The results of these
subsidiaries are not included in our results of operations for 2003 and 2002,
but are included in this discussion to the extent that they are relevant to our
anticipated financial condition and results of operations going forward.

      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, Training and Consulting Division, consisting of:

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

            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     Arocon Security Corporation, located in New York, New York,
                  which provides security consulting and other services,
                  focusing on protecting life, assets and operations with
                  minimum hindrance to personal freedom and daily activities
                  ("Arocon").


                                     - 8 -
<PAGE>

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

            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");

            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"); 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").

      >>    Our Armored Vehicle Division, consisting of:

            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 cars, and is a leading
                  supplier to the Israeli military, Israeli special forces and
                  special services ("MDT") (75.5% owned);

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

            o     Armour of America, 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 blankest and a
                  unique ballistic/flotation vest (ArmourFloat) that is U.S.
                  Coast Guard-certified ("AoA").

      Prior to the acquisition of FAAC and Epsilor, we were organized into two
divisions: Defense and Security Products (consisting of IES, MDT, MDT Armor and
Arocon), and Electric Fuel Batteries (consisting of EFL and EFB). We have
reported our results of operations for 2003 and 2002 in accordance with these
earlier divisions.


                                     - 9 -
<PAGE>

      Overview of Results of Operations

      We incurred significant operating losses for the years ended December 31,
2003, 2002 and 2001. 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, we substantially increased our revenues and reduced our net
loss, from $18.5 million in 2002 to $9.2 million in 2003. 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 interactive training systems by IES. We believe that our new acquisitions,
FAAC and Epsilor, will contribute to our goal of achieving profitability.

      We regard moving the company to a positive cash flow situation on a
consistent basis to be an important goal, and we are focused on achieving that
goal for the second half of 2004 and beyond. 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 2004 as well.

      A portion of our operating loss during 2003 arose as a result of non-cash
charges. These charges were primarily related to our acquisitions and to our
raising capital. Because we anticipate continuing these activities during 2004,
we expect to continue to incur such non-cash charges in the future.

      Non-cash charges related to acquisitions arise when the purchase price for
an acquired company exceeds the company's book value. In such a circumstance, a
portion of the excess of the purchase price is recorded as goodwill, and a
portion as intangible assets. 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. Intangible assets are amortized in accordance with
their useful life. Accordingly, for a period of time following an acquisition,
we incur a non-cash charge in the amount of a fraction (based on the useful life
of the intangible assets) of the amount recorded as intangible assets. Such
non-cash charges will continue during 2004; additionally, our acquisitions of
FAAC and Epsilor will result in our incurring similar non-cash charges beginning
in 2004.

      As a result of the application of the above accounting rule, we incurred
non-cash charges in the amount of $865,000 during 2003. See "Critical Accounting
Policies - Goodwill," above.

      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.


                                     - 10 -
<PAGE>

      As a result of the application of the above accounting rule, we incurred
non-cash charges in the amount of $3.9 million during 2003.

      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 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.

      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 $350,000 during 2003.

      We also incurred a non-cash charge in the amount of $689,000 during 2003
arising out of the shares and warrants we granted to IES Electronics in
connection with the settlement of our litigation with them. The expense in the
amount above was determined based upon the fair value of these warrants and
shares. This charge is not expected to recur.

      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. Since then,
we have concentrated on eliminating our operating deficit and moving Arotech to
cash-flow positive operations. In order to do this, we have focused on acquiring
businesses with strong revenues and profitable operations.

      In our Defense and Security Products Division, MDT experienced a slowdown
in revenues during 2003 because MDT's primary customer, the Israel Defense
Forces, reduced orders as a result of cuts in that portion of its budget that it
can spend in Israel. We noted this trend in 2003 and began to work on reversing
it by opening production facilities for MDT Armor in Auburn, Alabama. As of
December 31, 2003, our backlog for MDT totaled $931,000, most of which was from
orders from customers other than the Israel Defense Forces.

      IES had record sales in 2003; IES sales have grown from $3.5 million in
2001 (before we owned it) to more than $8.0 million in 2003. We attribute this
to a number of substantial orders, such as orders from the German Police and
from the United States Department of Health and Human Services. Since sales of
new IES simulation systems (as opposed to upgrades and add-ons) have a very long
sales cycle, it is difficult to predict what sales will be like in 2004. As of
December 31, 2003, our backlog for IES totaled $334,000.

      In our Electric Fuel Batteries Division, EFB had its first sales in 2003.
These sales were almost exclusively from the United States Army, which continues
to use our BA-8180 Zinc-Air battery for its CECOM division. We believe the war
in Iraq had a substantial positive effect on our sales in 2003. However, we are
hopeful that since the war came at a time when we were just beginning the
introduction of our batteries to the Army, much of the falloff in use of our
products that would normally be expected to occur at the war's end (which is not
presently anticipated to occur in the immediate future) will be offset by
growing acceptance of our batteries by soldiers in the field and their supply
officers. As of December 31, 2003, our backlog for EFB totaled $5.3 million.


                                     - 11 -
<PAGE>

      We do not anticipate a substantial change in our revenues from EFL, either
from the water-activated battery line or from the electric vehicle. In this
connection, we have begun an effort to find external financing for development
of our electric vehicle in the form of a partnership or joint venture, but there
can be no assurance that we will succeed in this effort, and we do not
anticipate that our electric vehicle program will provide significant revenues
in 2004.

      We anticipate that our acquisitions of Epsilor and FAAC, which occurred in
January 2004, will add to our revenues, our gross profit and our cash flow in
2004.

Results of Operations

      Preliminary Note

      Results for the years ended December 31, 2003 and 2002 include the results
of IES and MDT for such periods as a result of our acquisitions of these
companies early in the third quarter of 2002. However, the results of IES and
MDT were not included in our operating results for the full year ended December
31, 2002. Accordingly, the following year-to-year comparisons should not
necessarily be relied upon as indications of future performance.

      In addition, results are net of the operations of the retail consumer
battery products, which operations were discontinued in the third quarter of
2002.

      Following is a table summarizing our results of operations for the years
ended December 31, 2003 and 2002, after which we present a narrative discussion
and analysis:

                                                      Year Ended December 31,
                                                  ------------------------------
                                                     2003*              2002
                                                  -----------        -----------
Revenues:
     Defense and Security Products ........       $11,457,741        $ 4,724,443
     Electric Fuel Batteries ..............         5,868,899          1,682,296
     All other ............................                --                 --
                                                  -----------        -----------
                                                  $17,326,641        $ 6,406,739
Cost of revenues:
     Defense and Security Products ........       $ 6,566,252        $ 2,380,387
     Electric Fuel Batteries ..............         4,521,588          2,041,361
     All other ............................                --                 --
                                                  -----------        -----------
                                                  $11,087,840        $ 4,421,748
Research and development expenses.:
     Defense and Security Products ........       $   216,800        $   175,796
     Electric Fuel Batteries ..............           836,608            510,123
     All other ............................                --                 --
                                                  -----------        -----------
                                                  $ 1,053,408        $   685,919


                                     - 12 -
<PAGE>

<TABLE>
<CAPTION>
                                                             Year Ended December 31,
                                                        ------------------------------
                                                            2003*              2002
                                                        ------------      ------------
<S>                                                     <C>               <C>
Sales and marketing expenses:
     Defense and Security Products ................     $  2,418,017      $    636,066
     Electric Fuel Batteries ......................          926,872           673,601
     All other ....................................          187,747                --
                                                        ------------      ------------
                                                        $  3,532,636      $  1,309,669
General and administrative expenses:
     Defense and Security Products ................     $  1,519,458      $    833,610
     Electric Fuel Batteries ......................          188,655            89,945
     All other ....................................        4,149,763         3,099,548
                                                        ------------      ------------
                                                        $  5,857,876      $  4,023,103
Financial expense (income):
     Defense and Security Products ................     $   (139,668)     $     (4,556)
     Electric Fuel Batteries ......................            7,936                --
     All other ....................................        4,170,441           (95,895)
                                                        ------------      ------------
                                                        $  4,038,709      $   (100,451)
Tax expenses:
     Defense and Security Products ................     $    393,303      $         --
     Electric Fuel Batteries ......................               --                --
     All other ....................................            2,890                --
                                                        ------------      ------------
                                                        $    396,193      $         --
Amortization of intangible assets:
     Defense and Security Products ................     $    864,910      $    649,543
     Electric Fuel Batteries ......................               --                --
     All other ....................................               --                --
                                                        ------------      ------------
                                                        $    864,910      $    649,543
Minority interest in loss (profit) of subsidiaries:
     Defense and Security Products ................     $    156,900      $   (355,360)
     Electric Fuel Batteries ......................               --                --
     All other ....................................               --                --
                                                        ------------      ------------
                                                        $    156,900      $   (355,360)
Net loss from continuing operations:
     Defense and Security Products ................     $    224,431      $    301,765
     Electric Fuel Batteries ......................          612,760         1,632,734
     All other ....................................        8,510,840         3,003,653
                                                        ------------      ------------
                                                        $  9,348,031      $  4,938,152
Net loss (profit) from discontinued operations:
     Defense and Security Products ................     $         --      $         --
     Electric Fuel Batteries ......................         (110,410)       13,566,206
     All other ....................................               --                --
                                                        ------------      ------------
                                                        $   (110,410)     $ 13,566,206
Net loss:
     Defense and Security Products ................     $    224,431      $    301,765
     Electric Fuel Batteries ......................          502,350        15,198,940
     All other ....................................        8,510,840         3,003,653
                                                        ------------      ------------
                                                        $  9,237,621      $ 18,504,358
                                                        ============      ============
</TABLE>

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

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;

      >>    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 $11.5 million for the Defense and Security Products
Division (compared to $4.7 million in 2002, an increase of $6.7 million, or
143%, due primarily to increased sales on the part of IES, as well as the
inclusion of IES and MDT in our results for the full year of 2003 but only part
of 2002), and $5.9 million for the Electric Fuel Batteries 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).

      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 two divisions during 2003 were $10.9 million for
the Defense and Security Products Division (compared to $4.4 million in 2002, an
increase of $6.5 million, or 150%, due primarily to increased sales attributable
to IES, as well as the inclusion of IES and MDT in our results for the full year
of 2003 but only part of 2002), and $5.9 million for the Electric Fuel Batteries
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).

      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.


                                     - 13 -
<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.

      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.

      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.


                                     - 14 -
<PAGE>

      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."

      Profit from discontinued operations in 2003 was $110,000, compared to a
net 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 profit 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%.

      Fiscal Year 2002 compared to Fiscal Year 2001

      Revenues. Revenues from continuing operations for the year ended December
31, 2002 totaled $6.4 million, compared to $2.1 million for 2001, an increase of
$4.3 million, or 206%. This increase was primarily the result of the inclusion
of IES and MDT in our results in 2002.

      During 2002, we recognized revenues from the sale of interactive
use-of-force training systems (through our IES subsidiary), from payments under
vehicle armoring contracts (through our MDT subsidiary), and from the sale of
lifejacket lights, as well as under contracts with the U.S. Army's CECOM for
deliveries of batteries and for design and procurement of production tooling and
equipment. We also recognized revenues from subcontracting fees received in
connection with Phase II of the United States Department of Transportation (DOT)
program, which began in the fourth quarter of 2001 and was completed in July
2002, and Phase III of the DOT program, which began in October 2002. We
participate in this program as a member of a consortium seeking to demonstrate
the ability of the Electric Fuel battery system to power a full-size,
all-electric transit bus. The total program cost of Phase II was $2.7 million,
50% of which was covered by the DOT subcontracting fees. Subcontracting fees
cover less than all of the expenses and expenditures associated with our
participation in the program. In 2001, we derived revenues principally from the
sale of lifejacket lights, under contracts with the U.S. Army's CECOM for
deliveries of batteries and for design and procurement of production tooling and
equipment and from subcontracting fees received in connection with the DOT
program.


                                     - 15 -
<PAGE>

      In 2002, revenues were $4.7 million for the Defense and Security Products
Division (compared to $0 in 2001), due to the inclusion of IES and MDT in our
2002 results, and $1.7 million for the Electric Fuel Batteries Division
(compared to $2.1 million in the comparable period in 2001, a decrease of
$411,000, or 20%), due primarily to $471,000 in revenues from a German
consortium project relating to our electric vehicle that were included in 2001
but that did not exist in 2002. Of the $4.7 million increase in Defense and
Security Products revenues, $2.0 million was attributable to the inclusion of
IES in our results in 2002 and $2.7 million was attributable to the inclusion of
MDT in our results in 2002.

      Cost of revenues and gross profit. Cost of revenues totaled $4.4 million
during 2002, compared to $2.0 million in 2001, an increase of $2.4 million, or
122%, due to the inclusion of IES and MDT in our 2002 results.

      Direct expenses for our two divisions during 2002 were $4.4 million for
the Defense and Security Products Division (compared to $0 in 2001), due to the
inclusion of IES and MDT in our 2002 results, and $3.1 million for the Electric
Fuel Batteries Division (compared to $2.3 million in the comparable period in
2001, an increase of $767,000, or 33%), due primarily to the following factors:

      >>    We began to ramp up production at our CECOM facility in Alabama in
            anticipation of the CECOM order that we received in December 2002;
            and

      >>    We wrote off certain disqualified CECOM inventory in the amount of
            $116,000.

      Of the $4.4 million increase in Defense and Security Products direct
expenses, $2.1 million was attributable to the inclusion of IES in our results
in 2002 and $2.3 million was attributable to the inclusion of MDT in our results
in 2002.

      Gross profit was $2.0 million during 2002, compared to $101,000 during
2001, an increase of $1.9 million. This increase was the direct result of all
factors presented above, most notably the inclusion of IES and MDT in our 2002
results. In 2002, IES contributed $1.3 million to our gross profit, and MDT
contributed $1.1 million, which was offset by a gross loss of $360,000 in our
other divisions.

      Research and development expenses. Research and development expenses for
2002 were $686,000, compared to $456,000 in 2001, an increase of $230,000, or
50%. This increase was primarily the result of the inclusion of IES, which
accounted for $130,000 of the increase, in our 2002 results.


                                     - 16 -
<PAGE>

      Sales and marketing expenses. Sales and marketing expenses for 2002 were
$1.3 million, compared to $106,000 in 2001, an increase of $1.2 million, or
1,136%. This increase was primarily attributable to the following factors:

      >>    We had sales and marketing expenses in 2002 related to IES of
            $572,000, which we did not have in 2001;

      >>    We had sales and marketing expenses in 2002 related to MDT of
            $63,000, which we did not have in 2001; and

      >>    We incurred expenses for consultants, primarily lobbyists, in the
            amount of $128,000 in connection with our Electric Vehicle program
            and $441,000 in connection with our CECOM battery program with the
            U.S. Army.

      General and administrative expenses. General and administrative expenses
for 2002 were $4.0 million compared to $3.8 million in 2001, an increase of
$196,000, or 5%. This increase was primarily attributable to the inclusion of
IES and MDT in our results beginning with the third quarter, which increased
general and administrative expenses by approximately $839,000. This increase was
offset by a decrease in general and administrative expenses of $643,000,
resulting from:

      >>    the dismissal of our litigation with Electrofuel Inc., which
            resulted in a decrease in litigation-related legal expenses; and

      >>    the settlement of our dispute with a former employee on terms that
            resulted in a savings to us over the amount that we had set aside on
            our books.

      Financial income. Financial income, net of interest expenses and exchange
differentials, totaled approximately $100,000 in 2002 compared to $263,000 in
2001, a decrease of $163,000, or 62%. This decrease was due primarily to lower
interest rates and lower balances of invested funds as a result of our use of
the proceeds of private placements of our securities.

      Income taxes. We and our Israeli subsidiary EFL incurred net operating
losses during 2002 and 2001 and, accordingly, we were not required to make any
provision for income taxes. MDT had taxable income, but we may use EFL's losses
to offset MDT's income, and accordingly MDT has made no provision for income
taxes.

      Amortization of intangible assets. Amortization of intangible assets
totaled $649,000 in 2002, compared to $0 in 2001, due to the inclusion of IES
and MDT in our 2002 results. Of this $649,000 increase, $551,000 was
attributable to the inclusion of IES in our results in 2002 and $98,000 was
attributable to the inclusion of MDT in our results in 2002.


                                     - 17 -
<PAGE>

      Loss from continuing operations. Due to the factors cited above, we
reported a net loss from continuing operations of $4.9 million in 2002, compared
to a net loss of $4.0 million in 2001, an increase of $913,000, or 22%.

      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 year
ended December 31, 2002 in an item entitled "Loss from discontinued operations."

      Loss from discontinued operations in 2002 was $13.6 million, compared to
$13.3 million in 2001, an increase of $306,000, or 2%. This increase was the
result of a write-off of fixed inventory and assets in the amount of $7.1
million in connection with our discontinuation of the operations relating to the
retail sales of our consumer battery products at the end of the third quarter of
2002, which was not entirely offset by the elimination of the losses from these
discontinued operations beginning with the fourth quarter of 2002.

      Net loss. Due to the factors cited above, we reported a net loss of $18.5
million in 2002, compared to a net loss of $17.3 million in 2001, an increase of
$1.2 million, or 7%.

Liquidity and Capital Resources

      As of December 31, 2003, we had cash and cash equivalents of approximately
$13.7 million, compared with $1.5 million as of December 31, 2002, an increase
of $12.2 million, or 839%. The increase in cash was primarily the result of
sales of our securities during 2003. In January 2004, we raised an additional
$17.8 million, net of expenses, through additional sales of our securities. As
of February 29, 2004, our cash totaled approximately $4.2 million, not including
approximately $9.1 million held in restricted deposits to fund future
obligations in connection with such acquisitions, primarily as a result of our
use of cash for the Epsilor and FAAC acquisitions.

      We used available funds in 2003 primarily for working capital needs. We
increased our investment in fixed assets by $585,000 during the year ended
December 31, 2003, primarily in the Electric Fuel Batteries Division. Our fixed
assets amounted to $2.3 million as at year end.

      Net cash used in operating activities from continuing operations for 2003
and 2002 was $3.0 million and $3.5 million, respectively, a decrease of
$465,000, or 13%. This decrease was primarily the result of changes in operating
assets and liabilities, such as accounts payable and inventory.

      Net cash used in investing activities for 2003 and 2002 was $1.8 million
and $5.4 million, respectively, a decrease of $3.6 million, or 66%. This
decrease was primarily the result of our investment in the acquisition of IES
and MDT in 2002.

      Net cash provided by financing activities for 2003 and 2002 was $17.4
million and $3.1 million, respectively, an increase of $14.3 million, or 464%.
This increase was primarily the result of higher amounts of funds raised through
sales of our securities in 2003 compared to 2002.


                                     - 18 -
<PAGE>

      During 2003, certain of our employees exercised options under our
registered employee stock option plan. The proceeds to us from the exercised
options were approximately $434,000.

      On September 30, 2003 we issued and sold to various institutional
investors an aggregate $5,000,000 principal amount of 8% Secured Convertible
Debentures due September 30, 2006, as more fully described in the Current Report
on Form 8-K that we filed with the Securities and Exchange Commission on October
3, 2003.

      On December 18, 2002 we issued and sold to various institutional investors
an aggregate $6,000,000 principal amount of 8% Secured Convertible Debentures
due December 31, 2006, as more fully described under "Item 5. Market For
Registrant's Common Equity and Related Stockholder Matters - Recent Sales of
Unregistered Securities," above.

      We have approximately $10.5 million in long term debt outstanding, of
which $8.4 million was convertible debt, and approximately $6.9 million in
short-term debt.

      We believe that our present cash position and anticipated cash flows from
operations should be sufficient to satisfy our current estimated cash
requirements through the next year. 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.

      Our current debt agreements grant 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 covenant will materially
limit our ability to undertake future financings.

Effective Corporate Tax Rate

      Arotech and EFL have incurred net operating losses or had earnings arising
from tax-exempt income during the years ended December 31, 2001, 2002 and 2003
and accordingly no provision for income taxes was required. Taxes in these
entities paid in 2001, 2002 and 2003 are primarily composed of United States
federal alternative minimum taxes.

      As of December 31, 2003, we had U.S. net operating loss carry forwards of
approximately $17.0 million that are available to offset future taxable income,
expiring primarily in 2015, and foreign net operating and capital loss carry
forwards of approximately $84.0 million, which are available indefinitely to
offset future taxable income.

Contractual Obligations

      The following table lists our contractual obligations and commitments as
of December 31, 2003:


                                     - 19 -
<PAGE>

<TABLE>
<CAPTION>
                                                         Payment Due by Period
                              -------------------------------------------------------------------------------
Contractual Obligations         Total       Less Than 1 Year    1-3 Years     3-5 Years     More than 5 Years
                              ----------    ----------------   ----------     ---------     -----------------
<S>                           <C>             <C>              <C>              <C>            <C>
Long-term debt* ...........   $8,525,000      $       --       $8,525,000       $   --         $       --
Short-term debt ...........   $  190,849      $  190,849       $       --       $   --         $       --
Operating lease obligations   $  590,778      $  393,512       $  197,266       $   --         $       --
Severance obligations .....   $1,749,391      $  183,056       $1,387,738       $   --         $  178,597
</TABLE>

----------
*  Includes convertible debentures in the gross amount of $8,375,000.
   Unamortized financial expenses related to the beneficial conversion feature
   of these convertible debentures amounted to $6,924,806 at year end.

                                  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 operating losses since our inception.
Additionally, as of December 31, 2003, we had an accumulated deficit of
approximately $110.0 million. There can be no assurance that we will ever be
able to maintain profitability consistently or that our business will continue
to exist.

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

      Our indebtedness aggregated approximately $8.7 million as of December 31,
2003. 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.


                                     - 20 -
<PAGE>

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.

      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 or on acceptable terms. 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 a new business.

      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 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 this new business. If we are unable to
successfully operate these new businesses, our business, financial condition and
results of operations could be materially impaired.


                                     - 21 -
<PAGE>

      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 managers,
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 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 new acquisitions.

      In light of our recent 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
newly-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.


                                     - 22 -
<PAGE>

      A significant portion of our business is dependent on government
contracts.

      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 spending or
law enforcement in the U.S. or other countries could 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 in operation.

      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 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.


                                     - 23 -
<PAGE>

      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:

      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.
In 2003, approximately 36% of our revenues were derived from fixed-price
contracts for both defense and non-defense related government contracts. 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.


                                     - 24 -
<PAGE>

      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.

      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, and 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.

      We may face product liability claims.

      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.

      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. Many of our competitors have financial,
technical, marketing, sales, manufacturing, distribution and other resources
significantly greater than ours.


                                     - 25 -
<PAGE>

      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.

      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
technology. Moreover, 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.


                                     - 26 -
<PAGE>

      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. 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 2003, 2002 and 2001, without taking
account of revenues derived from discontinued operations, 42%, 56% and 49%,
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.

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;


                                     - 27 -
<PAGE>

      o     Rumors relating to our competitors or us;

      o     Actual or anticipated fluctuations in our operating results; 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
periodically traded below $1.00 in the recent 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 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.

      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 29, 2004, we had 59,904,449 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.


                                     - 28 -
<PAGE>

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

      As of February 29, 2004, there were outstanding warrants to purchase a
total of 19,302,156 shares of our common stock at a weighted average exercise
price of $1.85 per share, options to purchase a total of 9,627,212 shares of our
common stock at a weighted average exercise price of $1.48 per share, of which
6,477,440 were vested, at a weighted average exercise price of $1.67 per share,
and outstanding debentures convertible into a total of 5,203,149 shares of our
common stock at a weighted average conversion price of $1.39 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.

      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.


                                     - 29 -
<PAGE>

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
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 35%
of our assets are located outside the United States. In addition, two of our
directors and all 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.


                                     - 30 -
<PAGE>

      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 2003, 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 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                          Index to Financial Statements
                                                                           Page
                                                                           ----
    Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm................    F-2
Consolidated Balance Sheets............................................    F-3
Consolidated Statements of Operations..................................    F-5
Statements of Changes in Shareholders' Equity..........................    F-6
Consolidated Statements of Cash Flows..................................    F-9
Notes to Consolidated Financial Statements.............................    F-12
    Supplementary Financial Data
Quarterly Financial Data (unaudited) for the two years ended
    December 31, 2003..................................................    F-52
    Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts........................    F-53


                                     - 31 -
<PAGE>

                                     PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

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

      (1)   Financial Statements - See Index to Financial Statements on page 32
            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:

Exhibit No.                        Description
-----------                        -----------

*23         Consent of Kost, Forer, Gabbay & Kassierer, a member of Ernst &
            Young Global

*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

----------
*     Amended version filed herewith


                                     - 32 -
<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 amended report to be
signed on its behalf by the undersigned, thereunto duly authorized, on November
29 , 2004.

                               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
amended 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>
        /s/ Robert S. Ehrlich              Chairman, President, Chief Executive Officer and     November 29, 2004
 --------------------------------------      Director (Principal Executive Officer)
          Robert S. Ehrlich

           /s/ Avihai Shen                 Vice President - Finance                             November 29, 2004
 -------------------------------------       (Principal Financial Officer)
             Avihai Shen

          /s/ Danny Waldner                Controller                                           November 29, 2004
 -------------------------------------       (Principal Accounting Officer)
            Danny Waldner

          /s/ Steven Esses                 Executive Vice President,                            November 29, 2004
 -------------------------------------       Chief Operating Officer
             Steven Esses                    and Director

         /s/ Jay M. Eastman                Director                                             November 29, 2004
 -------------------------------------
          Dr. Jay M. Eastman

         /s/ Lawrence M. Miller            Director                                             November 29, 2004
 ---------------------------------------
          Lawrence M. Miller

         /s/ Jack E. Rosenfeld             Director                                             November 29, 2004
 --------------------------------------
          Jack E. Rosenfeld

                                           Director                                             November __, 2004
 ---------------------------------------
           Bert W. Wasserman

                                           Director                                             November __, 2004
 ---------------------------------------
            Edward J. Borey
</TABLE>


                                     - 33 -
<PAGE>

                 ELECTRIC FUEL CORPORATION AND ITS SUBSIDIARIES

                    AROTECH CORPORATION AND ITS SUBSIDIARIES

                        CONSOLIDATED FINANCIAL STATEMENTS

                             AS OF DECEMBER 31, 2003

                                 IN U.S. DOLLARS

                                      INDEX

                                                                          Page
                                                                         -------

Report of Independent Registered Public Accounting Firm                        2
Consolidated Balance Sheets                                                3 - 4
Consolidated Statements of Operations                                          5
Statements of Changes in Shareholders' Equity                              6 - 8
Consolidated Statements of Cash Flows                                     9 - 11
Notes to Consolidated Financial Statements                               12 - 50

<PAGE>

[LOGO]
ERNST & YOUNG

             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

                             To the Shareholders of

                               AROTECH CORPORATION

      We have audited the accompanying consolidated balance sheets of Arotech
Corporation (formerly known as Electric Fuel Corporation) (the "Company") and
its subsidiaries as of December 31, 2003 and 2002, and the related consolidated
statements of operations, changes in shareholders' equity and cash flows for
each of the three years in the period ended December 31, 2003. Our audits also
included the financial statement schedule listed in Item 15(a)(2) of the
Company's 10-K/A. 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 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 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, 2003 and 2002, and the
consolidated results of their operations and cash flows for each of the three
years in the period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States. 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 & KASSIERER
November 22, 2004                               A Member of Ernst & Young Global


                                     F - 2
<PAGE>

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

<TABLE>
<CAPTION>
                                                                                  December 31,
                                                                           -------------------------
                                                                              2003          2002
                                                                           -----------   -----------
<S>                                                                        <C>           <C>
         ASSETS

CURRENT ASSETS:
     Cash and cash equivalents                                             $13,685,125   $ 1,457,526
      Restricted collateral deposit and other restricted cash                  706,180       633,339
      Trade receivables (net of allowance for doubtful accounts in the
        amounts of $61,282 and $40,636 as of December 31, 2003 and 2002,
        respectively)                                                        4,706,423     3,776,195
     Other accounts receivable and prepaid expenses                          1,187,371     1,032,311
     Inventories                                                             1,914,748     1,711,479
     Assets of discontinued operations                                          66,068       349,774
                                                                           -----------   -----------

Total current assets                                                        22,265,915     8,960,624
                                                                           -----------   -----------

SEVERANCE PAY FUND                                                           1,023,342     1,025,071

PROPERTY AND EQUIPMENT, NET                                                  2,292,741     2,555,249

GOODWILL                                                                     5,064,555     4,954,981

OTHER Intangible Assets, NET                                                 2,375,195     2,567,457
                                                                           -----------   -----------

                                                                           $33,021,748   $20,063,382
                                                                           ===========   ===========
</TABLE>

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


                                     F - 3
<PAGE>

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

<TABLE>
<CAPTION>
                                                                                          December 31,
                                                                                 -------------------------------
                                                                                      2003*             2002
                                                                                 -------------     -------------
<S>                                                                              <C>               <C>
         LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:
     Short term bank loans                                                       $      40,849     $     108,659
     Trade payables                                                                  1,967,448         2,900,117
     Other accounts payable and accrued expenses                                     4,171,347         2,009,109
     Current portion of promissory note                                                150,000         1,200,000
     Liabilities of discontinued operations                                            380,108         1,053,798
                                                                                 -------------     -------------

Total current liabilities                                                            6,709,752         7,271,683

LONG TERM LIABILITIES
     Accrued severance pay                                                           2,814,492         2,994,233
     Convertible debenture                                                           1,450,194                --
     Deferred warranty revenue                                                         220,143                --
     Promissory note                                                                   150,000           516,793
                                                                                 -------------     -------------

Total long-term liabilities                                                          4,634,829         3,511,026

COMMITMENTS AND CONTINGENT LIABILITIES

MINORITY INTEREST                                                                       51,290           243,172

SHAREHOLDERS' EQUITY:
     Share capital -
     Common stock - $0.01 par value each;
         Authorized: 100,000,000 shares as of December 31, 2002 and 2001;
           Issued: 47,972,407 shares and 35,701,594 shares as of December 31,
           2003 and 2002, respectively; Outstanding - 47,417,074 shares and
           35,146,261 shares as of December 31, 2003 and 2002, respectively            479,726           357,017
     Preferred shares - $0.01 par value each;
         Authorized: 1,000,000 shares as of December 31, 2003 and 2002; No
           shares issued and outstanding as of December 31, 2003 and 2002                   --                --
     Additional paid-in capital                                                    135,702,413       114,082,584
     Accumulated deficit                                                          (109,911,240)     (100,673,619)
     Deferred stock compensation                                                        (8,464)          (12,000)
     Treasury stock, at cost (common stock - 555,333 shares as of December 31,
       2003 and 2002)                                                               (3,537,106)       (3,537,106)
     Notes receivable from shareholders                                             (1,203,881)       (1,177,589)
     Accumulated other comprehensive loss                                              104,429            (1,786)
                                                                                 -------------     -------------

Total shareholders' equity                                                          21,625,877         9,037,501
                                                                                 -------------     -------------

                                                                                 $  33,021,748     $  20,063,382
                                                                                 =============     =============
</TABLE>

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

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


                                     F - 4
<PAGE>

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

<TABLE>
<CAPTION>
                                                                    Year ended December 31,
                                                          ---------------------------------------------
                                                              2003*            2002            2001
                                                          ------------     ------------    ------------
<S>                                                       <C>              <C>             <C>
Revenues:
   Products                                               $ 16,918,480     $  5,944,370    $  1,670,634
   Services                                                    408,161          462,369         422,998
                                                          ------------     ------------    ------------

Total revenues                                              17,326,641        6,406,739       2,093,632

Cost of revenues                                            11,087,840        4,421,748       1,992,636
                                                          ------------     ------------    ------------

Gross profit                                                 6,238,801        1,984,991         100,996
                                                          ------------     ------------    ------------

Operating expenses:
   Research and development, net                             1,053,408          685,919         455,845
   Selling and marketing expenses                            3,532,636        1,309,669         105,977
   General and administrative expenses                       5,857,876        4,023,103       3,827,544
   Amortization of intangible assets                           864,910          623,543              --
   In-process research and development write-off                    --           26,000              --
                                                          ------------     ------------    ------------

Total operating costs and expenses                          11,308,830        6,668,234       4,389,366
                                                          ------------     ------------    ------------

Operating loss                                               5,070,029        4,683,243       4,288,370
Financial income (expenses), net                            (4,038,709)         100,451         262,581
                                                          ------------     ------------    ------------

Loss before minority interest in loss (earnings) of a
   subsidiary and tax expenses                              (9,108,738)      (4,582,792)     (4,025,789)
Tax expenses                                                  (396,193)              --              --
Minority interest in loss (earnings) of a subsidiary           156,900         (355,360)             --
                                                          ------------     ------------    ------------
Loss from continuing operations                             (9,348,031)      (4,938,152)     (4,025,789)

Income (loss) from discontinued operations (including
   loss on disposal of $4,446,684 during 2002)                 110,410      (13,566,206)    (13,260,999)
                                                          ------------     ------------    ------------
Net loss                                                  $ (9,237,621)    $(18,504,358)   $(17,286,788)

Deemed dividend to certain shareholders of common stock   $   (350,000)    $         --    $ (1,196,667)
                                                          ------------     ------------    ------------

Net loss attributable to shareholders of common stock     $ (9,587,621)    $(18,504,358)   $(18,483,455)
                                                          ============     ============    ============

Basic and diluted net loss per share from continuing
  operations                                              $      (0.24)    $      (0.15)   $      (0.21)
                                                          ============     ============    ============
Basic and diluted net loss per share from discontinued    $       0.00     $      (0.42)   $      (0.55)
  operations
                                                          ============     ============    ============
Basic and diluted net loss per share                      $      (0.25)    $      (0.57)   $      (0.76)
                                                          ============     ============    ============

Weighted average number of shares used in computing
  basic and diluted net loss per share                      38,890,174       32,381,502      24,200,184
                                                          ============     ============    ============
</TABLE>

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

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


                                     F - 5
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
STATEMENTS OF CHANGES IN SHAREHOLDERS' 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, 2001        21,422,691   $     214,227   $  89,091,790   $  64,882,473)  $     (17,240)  $    (37,731)

Repurchase of common shares
  from shareholders and
  repayment of the related
  interest and principal of
  notes from shareholders                    --              --         228,674              --              --     (3,499,375)
Issuance of shares to investors,
  net                                 6,740,359          67,405      14,325,941              --              --             --
Retirement of shares                     (3,000)            (30)        (17,970)             --              --             --
Issuance of shares to service
  providers                             346,121           3,461         536,916              --              --             --
Exercise of options                     219,965           2,200         512,089              --              --             --
Exercise of warrants                    333,333           3,333         836,667              --              --             --
Deferred stock compensation                  --              --          18,000              --         (18,000)            --
Amortization of deferred stock
  compensation                               --              --          (6,193)             --          17,240             --
Stock compensation related to
  options issued to
  consultants                                --              --         139,291              --              --             --
Stock compensation related to
  options to consultants
  repriced                                   --              --          21,704              --              --             --
Comprehensive loss:
Net loss                                     --              --              --     (17,286,788)             --             --
                                  -------------   -------------   -------------   -------------   -------------   ------------
Total comprehensive loss
Balance as of December 31, 2001
                                     29,059,469   $     290,596   $ 105,686,909   $ (82,169,261)  $     (18,000)  $ (3,537,106)
                                  =============   =============   =============   =============   =============   ============
<CAPTION>
                                     Total       Notes receivable    Total
                                  comprehensive        from       shareholders'
                                      loss         shareholders      equity
                                  -------------   -------------   -------------
<S>                               <C>            <C>             <C>
Balance as of January 1, 2001                    $  (4,290,204)  $  20,078,369

Repurchase of common shares
  from shareholders and
  repayment of the related
  interest and principal of
  notes from shareholders                            3,470,431         199,730
Issuance of shares to investors,
  net                                                       --      14,393,346
Retirement of shares                                    18,000              --
Issuance of shares to service
  providers                                                 --         540,377
Exercise of options                                    (43,308)        470,981
Exercise of warrants                        --              --         840,000
Deferred stock compensation                                 --              --
Amortization of deferred stock
  compensation                                              --          11,047
Stock compensation related to
  options issued to
  consultants                                               --         139,291
Stock compensation related to
  options to consultants
  repriced                                                  --          21,704
Comprehensive loss:
Net loss                           (17,286,788)             --     (17,286,788)
                                  ------------   -------------   -------------
Total comprehensive loss          $(17,286,788)
Balance as of December 31, 2001
                                                 $    (845,081)  $  19,408,057
                                  ============   =============   =============
</TABLE>

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


                                     F - 6
<PAGE>

AROTECH CORPORATION AND ITS SUBSIDIARIES
STATEMENTS OF CHANGES IN SHAREHOLDERS' 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
    shareholders
  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  shareholders'
                                       loss      shareholders     loss          equity
                                   ------------- ------------ ------------- --------------
<S>                                <C>            <C>
Balance as of January 1, 2002                     $  (845,081)         --   $ 19,408,057
  Adjustment of notes from
    shareholders                                     (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>

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


                                     F - 7
<PAGE>

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

<TABLE>
<CAPTION>

                                         Common stock          Additional                     Deferred                   Total
                                   -------------------------    paid-in       Accumulated      stock       Treasury   comprehensive
                                     Shares        Amount       capital         deficit     compensation    stock         loss
                                    ----------  ------------  ------------   -------------  ------------ ------------ -------------
<S>                                 <C>         <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)  $(1,177,589)
  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
    warrants and options issued
    to consultants and investors                                   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 shareholders                                    16,615                                             (16,615)
  Other comprehensive loss -
    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)  $(1,203,881)
                                    ==========  ============  ============   =============    =========  ===========   ===========
<CAPTION>
                                        Notes      Accumulated
                                     receivable      other            Total
                                        from      comprehensive    shareholders'
                                     shareholders     loss            equity
                                    ------------- -------------   ------------
<S>                                  <C>            <C>           <C>
Balance as of January 1, 2003*       $ (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
    warrants and options issued
    to consultants and investors                                       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 shareholders                                            --
  Other comprehensive loss -
    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    $104,429                     $ 21,625,877
                                     ========                     ============
</TABLE>

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

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


                                     F - 8
<PAGE>

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

<TABLE>
<CAPTION>
                                                                                          Year ended December 31,
                                                                                ------------------------------------------
                                                                                    2003*           2002           2001
                                                                                -----------     -----------    -----------
<S>                                                                              <C>            <C>            <C>
Cash flows from operating activities:
     Net loss                                                                    (9,237,621)    (18,504,358)   (17,286,788)
       Less loss (profit) for the period from discontinued
         operations                                                                (110,410)     13,566,206     13,260,999

     Adjustments required to reconcile net loss to net cash used in operating
       activities:
     Minority interest in earnings (loss) of subsidiary                            (156,900)        355,360             --
     Depreciation                                                                   730,159         473,739        530,013
     Amortization of intangible assets                                              864,910         623,543             --
     In-process research and development write-off                                       --          26,000             --
     Accrued severance pay, net                                                       3,693        (357,808)       530,777
     Amortization of deferred stock compensation                                      8,286           6,000         17,240
     Impairment and write-off of loans to shareholders                              (12,519)        542,317        206,005
     Compensation expenses related to repurchase of treasury
       stock                                                                             --         228,674
     Write-off of inventories                                                        96,350         116,008             --
     Impairment of fixed assets                                                      68,945              --             --
     Amortization of compensation related to beneficial
       conversion feature and warrants issued to holders of
       convertible debentures                                                     3,928,237              --             --
     Amortization of deferred expenses related to convertible
       debenture issuance                                                           483,713              --             --
     Amortization of prepaid financial expenses                                     236,250              --             --
     Amortization of capitalized research and development
       projects                                                                      14,401              --             --
     Stock-based compensation related to grant of new warrants                      199,500              --             --
     Stock-based compensation related to repricing of warrants
       granted to consultants                                                        29,759              --             --
     Stock-based compensation related to shares issued to
       consultants                                                                  161,947              --             --
     Stock-based compensation related to non-recourse note
       granted to stockholder                                                        38,500              --             --
     Compensation expenses related to shares issued to
       employees                                                                         --          13,000             --
     Accrued interest on notes receivable from shareholders                              --              --         36,940
     Interest accrued on promissory notes due to acquisition                        (66,793)         29,829             --
     Interest accrued on restricted collateral deposit                                   --          (3,213)            --
     Capital (gain) loss from sale of property and equipment                        (11,504)         (4,444)           815
     Decrease (increase) in trade receivables                                      (820,137)        389,516       (452,425)
     Decrease in other accounts receivable and prepaid expenses                      40,520         257,218        616,040
     Increase in inventories                                                       (193,222)       (520,408)      (128,897)
     Decrease in trade payables                                                    (986,022)        (62,536)      (301,075)
     Increase (decrease) in other accounts payable and accrued
       expenses                                                                   1,677,668        (423,664)       286,511
                                                                                -----------     -----------    -----------
     Net cash used in operating activities from continuing                       (3,012,290)     (3,477,695)    (2,455,171)
       operations (reconciled from continuing operations)

     Net cash used in operating activities from discontinued
        operations (reconciled from discontinued operations)                       (313,454)     (5,456,912)   (10,894,660)
                                                                                -----------     -----------    -----------

Net cash used in operating activities                                            (3,325,744)     (8,934,607)   (13,349,831)
                                                                                -----------     -----------    -----------
</TABLE>

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

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


                                     F - 9
<PAGE>

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

<TABLE>
<CAPTION>
                                                                                               Year ended December 31,
                                                                                   ---------------------------------------------
                                                                                       2003*            2002            2001
                                                                                   ------------     ------------    ------------
<S>                                                                                <C>              <C>             <C>
Cash flows from investing activities:
     Purchase of property and equipment                                                (580,949)        (275,540)       (513,746)
     Increase in capitalized research and development projects                         (209,616)              --              --
     Payment to suppliers for purchase of property and
       equipment from previous year                                                          --          (39,336)        (43,883)
     Loans granted to shareholders                                                      (13,737)          (4,529)             --
     Repayment of loans granted to shareholders                                           9,280               --              --
     Proceeds from sale of property and equipment                                        16,753            8,199          40,217
     Acquisition of IES (1)                                                                  --       (2,958,083)             --
     Acquisition of MDT (2)                                                                  --       (1,201,843)             --
     Repayment of promissory note related to acquisition of
       subsidiary                                                                      (750,000)              --              --
     Purchase of intangible assets and inventory                                       (196,331)              --              --
     Increase in restricted cash                                                        (72,840)        (595,341)             --
     Net cash used in discontinued operations (purchase of
       property and equipment)                                                               --         (290,650)       (761,555)
                                                                                   ------------     ------------    ------------
Net cash used in investing activities                                                (1,797,440)      (5,357,123)     (1,278,967)
                                                                                   ------------     ------------    ------------
Cash flows from financing activities:
     Proceeds from issuance of shares, net                                               (6,900)       3,230,000      14,393,346
     Proceeds from exercise of options to employees and
       consultants                                                                      440,914          113,350         470,981
     Proceeds from exercise of warrants                                               3,296,254               --         840,000
     Proceeds from the sale of convertible debentures, net                           13,708,662               --              --
     Payment of interest and principal on notes receivable from
       shareholders                                                                          --           43,308              --
     Profit distribution to minority                                                         --         (412,231)             --
     Increase (decrease) in short term bank credit                                      (74,158)         108,659              --
     Payment on capital lease obligation                                                 (4,427)          (5,584)             --
                                                                                   ------------     ------------    ------------
Net cash provided by financing activities                                            17,360,345        3,077,502      15,704,327
                                                                                   ------------     ------------    ------------
Increase (decrease) in cash and cash equivalents                                     12,237,161      (11,214,228)      1,075,529
Cash erosion due to exchange rate differences                                            (9,562)              --              --
Cash and cash equivalents at the beginning of the year                                1,457,526       12,671,754      11,596,225
                                                                                   ------------     ------------    ------------
Cash and cash equivalents at the end of the year                                   $ 13,685,125     $  1,457,526    $ 12,671,754
                                                                                   ============     ============    ============
Supplementary information on non-cash transactions:
Purchase of property and equipment against trade payables                          $         --     $         --    $     39,336
                                                                                   ============     ============    ============
Purchase of treasury stock in respect of notes receivable from
  shareholders                                                                     $         --     $         --    $  3,499,375
                                                                                   ============     ============    ============
Retirement of shares issued under notes receivables                                $         --     $         --    $     18,000
                                                                                   ============     ============    ============
Issuance of shares to consultants in respect of prepaid
   interest expenses                                                               $         --     $    236,250    $         --
                                                                                   ============     ============    ============
Exercise of options against notes receivable                                       $         --     $     36,500    $     43,308
                                                                                   ============     ============    ============
 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                     $  6,125,000     $         --    $         --
                                                                                   ============     ============    ============
 Benefit due to convertible debentures and warrants                                $ 10,853,043     $         --    $         --
                                                                                   ============     ============    ============
Supplemental disclosure of cash flows activities: Cash paid during the year for:
         Interest                                                                  $     39,412     $     10,640    $     19,106
                                                                                   ============     ============    ============
</TABLE>

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

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


                                     F - 10
<PAGE>

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

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


                                     F - 11
<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 Electric Fuel Ltd. ("EFL") a wholly-owned Israeli subsidiary; IES
Interactive Training, Inc. ("IES"), a wholly-owned U.S. subsidiary; Arocon
Security Corporation, a wholly-owned U.S. subsidiary; Electric Fuel Battery
Corporation, a wholly-owned U.S. subsidiary; MDT Protective Industries ("MDT"),
an Israeli subsidiary in which the Company has a 75.5% interest; and MDT Armor
Corporation, a U.S. subsidiary in which the Company has an 88% interest. The
Company's production and research and development operations are primarily
located in Israel and in the United States.

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 shareholders'
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 16.

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.


                                     F - 12
<PAGE>

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

NOTE 1:- GENERAL (Cont.)

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
                                                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
                                               ==========   ==========    ==========
</TABLE>

Balance sheet data:

<TABLE>
<CAPTION>
                                                As of December 31, 2003
                                     -----------------------------------------------
                                     Previously
                                      Reported          Adjustment      As Restated
                                     -------------    -------------    -------------
<S>                                  <C>              <C>              <C>
Other accounts payable
 and accrued expenses                $   4,321,347    $    (150,000)   $   4,171,347

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
</TABLE>


                                     F - 13
<PAGE>

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

NOTE 1:- GENERAL (Cont.)

Cash flow data:

<TABLE>
<CAPTION>
                                                        For the Year ended December 31, 2003
                                                     ------------------------------------------
                                                     Previously
                                                      Reported      Adjustment      As Restated
                                                     -----------    -----------     -----------
<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
  beneficial conversion feature and warrants
  issued to holders of convertible debentures         3,359,987        568,250       3,928,237
</TABLE>

c. 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 9), 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 - 14
<PAGE>

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

NOTE 1:- GENERAL (Cont.)

Based upon a valuation of tangible and intangible assets acquired, Arotech has
allocated the total cost of the acquisition to IES's assets as follows:

Tangible assets acquired                                            $ 2,856,951

Intangible assets
     Technology (four year useful life)                               1,515,000
     Existing contracts (one year useful life)                           46,000
     Covenants not to compete (five year useful
       life)                                                             99,000
     In process research and development                                 26,000
     Customer list (seven year useful life)                             527,000
     Trademarks (indefinite useful life)                                439,000
     Goodwill                                                         4,032,726
Liabilities assumed                                                  (1,186,784)
                                                                    -----------
Total consideration                                                 $ 8,354,893
                                                                    ===========

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 review. 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 the tangible, intangibles assets and liabilities was
determined as follows:

      1.    To determine the value of the Company's net current assets, property
            and equipment, and net liabilities; the Cost Approach was used,
            which requires that the assets and liabilities in question be
            restated to their market values. Per estimation made by the
            independent appraisal the book values for the current assets and
            liabilities were reasonable proxies for their market values.

      2.    The amount of the excess cost attributable to technology of Range
            2000, 3000 and A2Z Systems is $1,515,000 and was determined using
            the Income Approach.

      3.    The value assigned to purchased in-process technology relates to two
            projects "Black Box" and A2Z trainer. The estimated fair value of
            the acquired in-process research and development platforms that had
            not yet reached technological feasibility and had no alternative
            future use amounted to $26,000. Technological feasibility or
            commercial viability of these projects was established at the
            acquisition date. These products were considered to have no
            alternative future use other than the technological indications for
            which they were in development. Accordingly, these amounts were
            immediately expensed in the consolidated statement of operations on
            the acquisition date in accordance with FASB Interpretation No. 4,
            "Applicability of FASB Statement No. 2 to Business Combinations
            Accounted for by the Purchase Method." The estimated fair values of
            these platforms were determined using discounted cash flow models.
            Projects were estimated to be 4% complete; estimated costs to
            completion of these platforms were approximately $200,000 and
            $25,000, respectively, and discount rate of 25% was used.


                                     F - 15
<PAGE>

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

NOTE 1:- GENERAL (Cont.)

      4.    The value assigned to the customer list is amounted to $527,000.
            Management states that its customers have generally been very loyal
            to IES's products; most present customers are expected to purchase
            add-ons or up-grades to their IES simulator systems in the future,
            and some will purchase additional warranties for the systems they
            possess. Independent appraisal has therefore valued the Company's
            customer list using the Income Approach.

      5.    The value assigned to the trademarks amounted to $439,000 and was
            determined based on the Cost Approach. In doing so, it is assumed
            that historical expenditures for advertising are a reasonable proxy
            for the future benefits expected from the Trademarks and Trade
            names.

      6.    Value of IES's Covenant Not to Compete (CNC) was valued at the
            amount of $99,000. One of IES's intangible assets is its covenant
            not to compete. Asset Purchase Agreement precludes the former parent
            company, and its principals and key employees from competing with
            IES for five years from the Valuation Date. According to management,
            among the individuals covered by the CNC are the original developers
            of the Range 2000 and A2Z systems. Estimated CNC's value was
            determined using the Income Approach. The estimated value of the CNC
            is the sum of the present value of the cash flows that would be lost
            if the CNC was not in place. Specifically, the value of the CNC is
            calculated as the difference between the projected cash flows if the
            former parent company or its principals were to start competing
            immediately and the projected cash flows if those parties start
            competing after five years, when the CNC expires.

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:


                                     F - 16
<PAGE>

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

NOTE 1:- GENERAL (Cont.)

                                                                U.S. Dollars
                                                                ------------
      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:

                                                                U.S. Dollars
                                                                ------------
      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.

d. 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 (five year weighted                           280,000
          average useful life)
         Customer base (five year weighted                        285,000
          average useful life)
         Goodwill                                                 886,255
      Liabilities assumed                                      (1,020,426)
                                                              -----------
      Total consideration                                     $ 1,767,877
                                                              ===========


                                     F - 17
<PAGE>

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

NOTE 1:- GENERAL (Cont.)

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 review. 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 the tangible, intangibles assets and liabilities was
determined as follows:

      1.    To determine the value of the Company's net current assets, net
            property, and equipment and net liabilities; the Cost Approach was
            used, which requires that the assets and liabilities in question be
            restated to their market values. Per estimation made by the
            independent appraisal the book values for the current assets and
            liabilities were reasonable proxies for their market values.

      2.    The amount of the excess cost attributable to technology of optimal
            bulletproofing material and power mechanism for bulletproofed
            windows is $280,000 and was determined using the Income Approach.

      3.    The value assigned to the customer base is amounted to $285,000.
            Independent appraisal has valued the Company's customer base using
            the Income Approach. The valuation of the customers' base derives
            mostly from relations with customers with no contracts. Most of the
            customers of MDT are from defense sector and usually have
            longstanding relationships and tend to reorder from the Company.

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.

e. Pro forma results:

The following unaudited proforma information does not purport to represent what
the Company's results of operations would have been had the acquisitions
occurred on January 1, 2001 and 2002, nor does it purport to represent the
results of operations of the Company for any future period.


                                     F - 18
<PAGE>

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

NOTE 1:- GENERAL (Cont.)

<TABLE>
<CAPTION>
                                                              Year ended December 31,
                                                           ----------------------------
                                                              2002             2001
                                                           -----------     ------------
<S>                                                        <C>             <C>
 Revenues                                                  $12,997,289     $ 12,369,749
                                                           ===========     ============

 Net loss from continuing operations                       $(6,103,771)    $ (5,757,675)
                                                           ===========     ============

Basic and diluted net loss per share for
  continuing operations                                    $     (0.18)    $      (0.21)
                                                           ===========     ============

 Weighted average number of shares of common stock in
   computation of basic and diluted net loss per share      34,495,185       27,840,822
                                                           ===========     ============
</TABLE>

The amount of the excess cost attributable to in-process research and
development of IES and MDT in the amount of $26,000 has not been included in the
pro forma information, as it does not represent a continuing expense.

f. 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 entity 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
2002 and 2001 have been reclassified in the accompanying statements of
operations as a discontinued operation. The Company's balance sheets at December
31, 2002 and 2001 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.

At December 31, 2002, the estimated net losses associated with the disposition
of the retail sales of consumer battery products business were approximately
$13,566,206 for 2002. These losses included approximately $6,508,222 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:


                                     F - 19
<PAGE>

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

NOTE 1:- GENERAL (Cont.)

                                                      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, 2003, 2002 and 2001 are as follows:

                                           Year Ended December 31,
                               -----------------------------------------------
                                   2003             2002              2001
                               ------------     ------------      ------------

Revenues                       $    117,267     $  1,100,442      $  1,939,256
Cost of sales (1)                        --       (5,293,120)       (5,060,966)
                               ------------     ------------      ------------

Gross profit (loss)                 117,267       (4,192,678)       (3,121,710)
Operating expenses, net               6,857        4,926,844        10,139,289
Impairment of fixed assets               --        4,446,684                --
                               ------------     ------------      ------------
Operating profit (loss)        $    110,410     $(13,566,206)     $(13,260,999)
                               ============     ============      ============

----------
(1) Including write-off of inventory in the amount of $0, $2,611,000 and
$441,000 for the years ended December 31, 2003, 2002 and 2001.


                                     F - 20
<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 financial transactions of MDT is in New Israel Shekel ("NIS")
and a substantial portion of MDT's costs is incurred in NIS. Management believes
that the NIS is the functional currency of MDT. Accordingly, the financial
statements of MDT 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 shareholders' 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.

e. 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 2003, the Company wrote off $96,350 of obsolete inventory,
which has been included in the cost of revenues.


                                     F - 21
<PAGE>

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

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

Cost is determined as follows:

Raw and packaging materials - by the average cost method.

Work in progress - represents the cost of manufacturing with the addition of
allocable indirect manufacturing cost.

Finished products - on the basis of direct manufacturing costs with the addition
of allocable indirect manufacturing costs.

f. Property and equipment:

Property and equipment are stated at cost net of accumulated depreciation and
investment grants (no investment grants were received during 2003, 2002 and
2001).

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, equipment and installation              10 - 25 (mainly 10)
      Leasehold improvements                         Over the term of the lease

g. 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.

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, market multiples
and market capitalization. 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.

h. Other intangible 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.
Intangible assets are amortized over their useful life (See Note 1b. and c).


                                     F - 22
<PAGE>


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

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

i. Impairment of indefinite-lived intangible asset

The acquired IES trademark is deemed to have an indefinite useful life because
it is expected to contribute to cash flows indefinitely. Therefore, the
trademark will not be amortized until its useful life is no longer indefinite.
The trademark is tested annually for impairment in accordance FAS 142.

j. Impairment of long-lived assets:

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, 2003 no impairment losses have been identified.

k. Revenue recognition:

The Company generates revenues primarily from sales of multimedia and
interactive digital training systems and use-of-force simulators specifically
targeted for law enforcement and firearms training and from service contracts
related to such sales (through IES), from providing lightweight armoring
services of vehicles (through MDT), and from sale of zinc-air battery products
for defense applications. To a lesser extent, revenues are generated from
development services and long-term arrangements subcontracted by the U.S
Government.

Revenues from products, training and simulation systems are recognized in
accordance with SEC Staff Accounting Bulletin No. 104, "Revenue Recognition"
("SAB No. 104") when persuasive evidence of an agreement exists, delivery has
occurred, the fee is fixed or determinable, collectability is probably, and no
further obligation remains.

The Company does not grant a right of return to its customers.

Revenues from long-term agreements, subcontracted by the U.S. government, are
recorded on a cost-sharing basis, when services are rendered and products
delivered, as prescribed in the related agreements. Provisions for estimated
losses are recognized in the period in which the likelihood of such losses is
determined. As of December 31, 2003, no such estimated losses were identified.

Deferred warranty revenues includes unearned amounts received from customers,
but not recognized as revenues.

Revenues from development services are recognized based on Statement of Position
No. 81-1 "Accounting for Performance of Construction - Type and Certain
Production - Type Contracts" ("SOP 81-1"), using contract accounting on a
percentage of completion method, based on completion of agreed-upon milestones
and in accordance with the "Output Method" or based on the time and material
basis. Provisions for estimated losses on uncompleted contracts are recognized
in the period in which the likelihood of such losses is determined. As of
December 31, 2003, no such estimated losses were identified.


                                     F - 23
<PAGE>


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

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

Revenues from lightweight armoring services of vehicles are recorded when
services are rendered and vehicle is delivered and no additional obligations
exists.

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.

l. Research and development cost:

Research and development costs, net of grants received, are charged to the
statements of operations as incurred.

Significant 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 believes that no impairment of
capitalized software development costs exists as of December 31, 2003.

m. Royalty-bearing grants:

Royalty-bearing grants from the Office of the Chief Scientist ("OCS") of the
Israeli Ministry of Industry and Trade and from the Israel-U.S. Bi-national
Industrial Research and Development Foundation ("BIRD-F") for funding approved
research and development projects are recognized at the time the Company is
entitled to such grants on the basis of the costs incurred, and included as a
deduction of research and development costs.

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 their 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 other restricted cash and trade
receivables. Cash and cash equivalents are invested 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.


                                     F - 24
<PAGE>


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

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

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.

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" ("SFAS No. 128").

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 22,194,211 and 4,394,803 and
3,170,334 for the years ended December 31, 2003, 2002 and 2001, 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" ("FIN No.
44") 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 2.54%, 3.5% and
3.5-4.5% for 2003, 2002 and 2001, 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 0.67 for 2003, 0.64 for 2002 and 0.82 for 2001; and a
weighted-average expected life of the option of 5 years for 2003, 2002 and 2001.


                                     F - 25
<PAGE>

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

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

      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,
                                                         -------------------------------------------------
                                                             2003*              2002              2001
                                                         ------------       ------------      ------------
<S>                                                      <C>                <C>               <C>
Net loss as reported                                     $ (9,237,621)      $(18,504,358)     $(18,483,455)
Add: Stock-based compensation expenses included in
   reported net loss                                            8,286              6,000            17,240
Deduct:  Stock-based compensation expenses
   determined under fair value method for all awards       (1,237,558)        (2,072,903)       (2,906,386)
                                                         ------------       ------------      ------------
                                                         $(10,466,893)      $(20,571,261)     $ 21,372,601
                                                         ============       ============      ============
Loss per share:
   Basic and diluted, as reported                        $      (0.25)      $      (0.57)     $      (0.76)
                                                         ============       ============      ============
   Diluted, pro forma                                    $      (0.27)      $      (0.64)     $      (0.88)
                                                         ============       ============      ============
</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 other restricted cash, trade receivables, short-term bank credit, and trade
payables approximate their fair value due to the short-term maturity of such
instruments.

Long-terms liabilities 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. 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" ("SFAS No. 106"). As of December 31,
2003 and 2002, the accumulated severance pay in that regard amounted to $
1,699,260 and $1,630,366, respectively.


                                     F - 26
<PAGE>

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

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

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 year ended December 31, 2003 amounted to $ 219,857 as
compared to severance income and expenses for the years ended December 31, 2002
and 2001, which amounted to $338,574 and $653,885, respectively.

t. Advertising costs:

The Company and its subsidiaries expense advertising costs as incurred.
Advertising expense for the years ended December 31, 2003, 2002 and 2001 was
approximately $34,732, $294,599 and $1,676,280 respectively.

NOTE 3:- RESTRICTED COLLATERAL DEPOSIT AND OTHER RESTRICTED CASH

The restricted collateral deposit is invested in a $706,180 certificate of
deposit that is used to secure certain real property lease arrangements, and a
currency hedging arrangement to protect the Company against change in the euro
versus the dollar in connection with IES's contract with the German police,
which is denominated in euros; a portion was also on deposit with an arbitrator
in connection with the Company's litigation with IES Electronic Industries, Ltd.

                                          December 31, 2003
                                          -----------------
        IES Deposit                         $    450,000
        Forward Deal                             205,489
        Property Lease                            41,412
        Other                                      9,279
                                            ------------
                                            $    706,180
                                            ============

NOTE 4:- OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES

                                                     December 31,
                                              -------------------------
                                                 2003           2002
                                              ----------     ----------

      Government authorities                  $   65,402     $  348,660
      Employees                                  246,004         23,959
      Prepaid expenses                           551,010        591,008
      Other                                      324,955         68,684
                                              ----------     ----------
                                              $1,187,371     $1,032,311
                                              ==========     ==========


                                     F - 27
<PAGE>

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

NOTE 5:- INVENTORIES

                                              December 31,
                                  --------------------------------------
                                        2003                 2002
                                  -----------------    -----------------

Raw and packaging materials        $      657,677       $      893,666
Work in progress                          634,221              296,692
Finished products                         622,850              521,121
                                  -----------------    -----------------

                                   $    1,914,748       $    1,711,479
                                  =================    =================


NOTE 6:- PROPERTY AND EQUIPMENT, NET

a. Composition of property and equipment is as follows:

                                                          December 31,
                                                    -------------------------
                                                        2003           2002
                                                    ----------     ----------
Cost:
         Computers and related equipment            $1,015,836     $  815,759
         Motor vehicles                                288,852        335,286
         Office furniture and equipment                402,726        519,092
         Machinery, equipment and                    4,866,904      4,715,182
           installations
         Leasehold improvements                        882,047        442,482
         Demo inventory                                150,996        154,689
                                                    ----------     ----------

                                                     7,607,361      6,982,490
                                                    ----------     ----------
Accumulated depreciation:
         Computers and related equipment               753,593        669,258
         Motor vehicles                                 95,434         39,281
         Office furniture and equipment                173,301        255,829
         Machinery, equipment and installations      3,637,111      3,106,389
         Leasehold improvements                        655,181        356,484
                                                    ----------     ----------

                                                     5,314,620      4,427,241
                                                    ----------     ----------

Depreciated cost                                    $2,292,741     $2,555,249
                                                    ==========     ==========

b. Depreciation expense amounted to $730,159, $473,739 and $530,013, for the
years ended December 31, 2003, 2002 and 2001, respectively.

As for liens, see Note 10.d.


                                     F - 28
<PAGE>

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

NOTE 7:- OTHER INTANGIBLE ASSETS, NET

a.

                                              Year ended December 31,
                                           ----------------------------
                                              2003             2002
                                           -----------      -----------
Cost:
  Technology                               $ 2,231,746      $ 1,795,000
  Capitalized research and
    development                                209,615               --
  Existing contracts                            46,000           46,000
  Covenants not to compete                      99,000           99,000
  Customer list                                827,250          812,000
                                           -----------      -----------

                                             3,413,611        2,752,000
Exchange differences                            25,438               --
Less - accumulated amortization             (1,502,854)         623,543
                                           -----------      -----------
                                           -----------      -----------

Amortized cost                               1,936,195        2,128,457
Trademarks                                     439,000          439,000
                                           -----------      -----------
                                           -----------      -----------

                                           $ 2,375,195      $ 2,567,457
                                           ===========      ===========

b.    Amortization expenses amounted to $879,311 for the year ended December 31,
      2003.

c.    Estimated amortization expenses for the years ended:

       Year ended December 31,
------------------------------------

2004                      $   552,443
2005                          541,466
2006                          366,421
2007                          244,734
2008 and forward              231,131
                          -----------

                          $ 1,936,195
                          ===========

NOTE 8:- PROMISSORY NOTES

In connection with the acquisition discussed in Note 1b, 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 its 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 the promissory notes are not treated as changed or
modified when the cash flow effect on a present value basis is less than 10% and
therefore the Company did not record any compensation related to these changes.
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 17.h.


                                     F - 29
<PAGE>

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

NOTE 9:- OTHER ACCOUNTS PAYABLE AND ACCRUED EXPENSES

                                                   December 31,
                                           --------------------------
                                              2003*           2002
                                           ----------      ----------
      Employees and payroll accruals       $1,232,608      $  615,292
      Accrued vacation pay                    216,768         137,179
      Accrued expenses                        842,760         342,793
      Minority balance                        149,441         289,451
      Government authorities                  357,095         497,428
      Deferred warranty revenues               40,936          95,831
      Litigation settlement accrual(1)      1,163,642              --
      Other                                   168,097          31,135
                                           ----------      ----------

                                           $4,171,347      $2,009,109
                                           ==========      ==========

----------
*   Restated (see Note 1.b.).
(1) See Note 17.h.

                                     F - 30
<PAGE>

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

NOTE 10:- COMMITMENTS AND CONTINGENT LIABILITIES (Cont.)

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 of 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, 2003, 2002 and 2001,
to the OCS amounted to $435, $32,801 and $75,791, respectively.

As of December 31, 2003, the total contingent liability to the OCS was
approximately $10,057,000. 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
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 Company'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, 2003.

As of December 31, 2003, 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.


                                     F - 30
<PAGE>

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

NOTE 10:- COMMITMENTS AND CONTINGENT LIABILITIES (Cont.)

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 2005.
The minimum rental payments under non-cancelable operating leases are as
follows:

                       Year ended December 31,
                  --------------------------------

                  2004              $      393,512
                  2005                     197,266
                                    --------------
                                    $      590,778
                                    ==============

Total rent expenses for the years ended December 31, 2003, 2002 and 2001, were
approximately $484,361, $629,101 and $456,701, respectively.

c. Guarantees:

The Company obtained bank guarantees in the amount of $51,082 in connection with
(i) a lease agreement of one of the Company's subsidiaries, (ii) a sales
obligation to a customer of one of the Company's subsidiaries, and (iii)
obligations of one of the Company's subsidiaries to the Israeli customs
authorities.

d. Liens:

As security for compliance with the terms related to the investment grants from
the state of Israel, EFL has 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.


                                     F - 31
<PAGE>

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

NOTE 11:- SHAREHOLDERS' EQUITY

a. Shareholders' 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. In May 2001, the Company issued a total of 4,045,454 shares of its
      common stock to a group of institutional investors at a price of $2.75 per
      share, or a total purchase price of $11,125,000. (See also Note 11.f.1 and
      11.f.2.)

      2. On November 21, 2001, the Company issued a total of 1,503,759 shares of
      its common stock at a purchase price of $1.33 per share, or a total
      purchase price of $2,000,000, to a single institutional investor.

      3. On December 5, 2001, the Company issued a total of 1,190,476 shares of
      its common stock at a purchase price of $1.68 per share, or a total
      purchase price of $2,000,000, to a single institutional investor.

      4. 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 11.f.3).

      5. 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.

c. Issuance of common stock to service providers and employees:

      1. On June 17, 2001 the Company issued a consultant a total of 8,550
      shares of its common stock in compensation for services rendered by such
      consultant for the Company for preparation of certain video
      point-of-purchase and sales demonstration materials. At the issuance date
      the fair value of these shares was determined both by the value of the
      shares issued as reflected by fair market price at the issuance date and
      by the value of the services provided and amounted to $15,488 in
      accordance with EITF 96-18. In accordance with EITF 00-18, the Company
      recorded this compensation expense as marketing expenses in the amount of
      $15,488.

      2. On September 17, 2001 the Company issued to selling and marketing
      consultants a total of 337,571 shares of its common stock in compensation
      for distribution services rendered by such consultant. At the issuance
      date the fair value of these shares was determined both by the value of
      the shares issued as reflected by fair market price at the issuance date
      and by the value of the services provided and amounted to $524,889 in
      accordance with EITF 96-18 and in accordance with EITF 00-18. The Company
      recorded this compensation expense as marketing expenses in the amount of
      $524,889.

      3. 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 fair
      market price at the issuance date and by the value of the services
      provided and amounted to $394,698 and $63,000, respectively, in accordance
      with EITF 96-18. In accordance with EITF 00-18, the Company recorded this
      compensation expense of $394,698 and $63,000, respectively, during the
      year 2002 and included this amount in marketing expenses.


                                     F - 32
<PAGE>

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

NOTE 11:- SHAREHOLDERS' EQUITY (Cont.)

      4. 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
      fair 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.

      5. 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 fair 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 00-18, the Company recorded this
      compensation expense of $154,331 during the year 2003 and included this
      amount in marketing expenses.

      6. 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 fair 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.

d. Issuance of shares to lenders

As part of the securities purchase agreement on December 31, 2002 (see Note
16.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 fair 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 notes receivable:

      1. As part of its purchase of the assets of IES Interactive Training, Inc.
      (see Note 1.c.), the Company issued a $450,000 convertible promissory note
      (see Note 8). 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 November 2000, the Company issued
      warrants to purchase an additional 1,000,000 shares of common stock to the
      investor, with exercise prices of $11.31 for 333,333 of these warrants and
      $12.56 per share for 666,667 of these warrants. In addition, the Company
      issued warrants to purchase 150,000 shares of common stock, with exercise
      prices of $9.63 for 50,000 of these warrants and $12.56 per share for
      100,000 of these warrants to an investment banker involved in this
      agreement. Out of these warrants issued to the investor, 666,667 warrants
      expire on November 17, 2005 and 333,333 warrants were to expire on August
      17, 2001.


                                     F - 33
<PAGE>

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

NOTE 11:- SHAREHOLDERS' EQUITY (Cont.)

As part of the transaction in May 2001 (see Note 11.b.1), the Company repriced
these warrants in the following manner:

      >>    Of the 1,000,000 warrants granted to the investor, the exercise
            price of 666,667 warrants was reduced from $12.56 to $3.50 and of
            333,333 warrants was reduced from $11.31 to $2.52. In addition, the
            333,333 warrants that were to expire on August 17, 2001, were
            immediately exercised for a total consideration of $840,000.

      >>    Moreover, the Company issued to this investor an additional warrant
            to purchase 250,000 shares of common stock at an exercise price of
            $3.08 per share, to expire on May 3, 2006.

      >>    Of the 150,000 warrants granted to the investment banker the
            exercise price of 100,000 warrants was reduced from $12.56 to $3.08
            and of 50,000 warrants was reduced from $9.63 to $3.08. In addition,
            the 50,000 warrants that were to expire on August 17, 2001 were
            extended to November 17, 2005.

As a result of the aforesaid modifications, including the repricing of the
warrants to the investors and to the investment banker and the additional grant
of warrants to the investor, the Company has recorded a deemed dividend in the
amount of $1,196,667, to reflect the additional benefit created for these
certain investors. The fair value of the repriced warrants was calculated as a
difference measured between (1) the fair value of the modified warrant
determined in accordance with the provisions of SFAS No. 123, and (2) the value
of the old warrant immediately before its terms are modified, determined based
on the shorter of (a) its remaining expected life or (b) the expected life of
the modified option. 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, 2001, without any effect on total shareholder's equity.

2. As part of the investment agreement in May 2001 (see Note 11.b.1), 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. The Company also issued to a financial
consultant that provided investment banking services concurrently with this
transaction a total of 125,000 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 and will expire on June 12, 2006. In addition the Company paid
approximately $562,000 in cash, which was recorded as deduction from additional
paid in capital.

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.


                                     F - 34
<PAGE>

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

NOTE 11:- SHAREHOLDERS' EQUITY (Cont.)

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.

3. As part of the investment agreement in January 2002 (see Note 11.b.4), 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.

g. Stock option plans:

      1. Options to employees and others (except consultants)

            a. The Company has adopted the following stock option plans, whereby
            options 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) 1991 Employee Option Plan - 2,115,600 shares reserved for
                  issuance, of which 53,592 were available for future grants to
                  employees as of December 31, 2003.

                  2) 1993 Employee Option Plan - as amended, 6,200,000 shares
                  reserved for issuance, of which no shares were available for
                  future grants to employees as of December 31, 2003.

                  3) 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,
                  2003.

                  4) 1995 Non-Employee Director Plan - 1,000,000 shares reserved
                  for issuance, of which 600,000 were available for future
                  grants to directors as of December 31, 2003.

            b. Under these plans, options generally expire no later than 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).

            c. A summary of the status of the Company's plans and other share
            options (except for options granted to consultants) granted as of
            December 31, 2003, 2002 and 2001, and changes during the years ended
            on those dates, is presented below:


                                     F - 35
<PAGE>

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

NOTE 11:- SHAREHOLDERS' EQUITY (Cont.)

<TABLE>
<CAPTION>
                                              2003                  2002                2001
                                     --------------------   -------------------- ---------------------
                                                 Weighted               Weighted              Weighted
                                                  average               average               average
                                                 exercise               exercise              exercise
                                       Amount     price      Amount      price      Amount     price
                                                 --------              ---------              --------
                                                     $                    $                      $
                                     ----------    -----   ----------    -----   ----------    -----
<S>                                   <C>          <C>      <C>          <C>      <C>          <C>
Options outstanding at beginning      5,260,366    $2.26    4,240,228    $2.74    2,624,225    $3.82
  of year
Changes during year:
Granted (1) (2)                       5,264,260    $0.71    1,634,567    $0.87    2,172,314    $1.55
Exercised (3)                           689,640    $0.64     (191,542)   $1.29     (159,965)   $1.31
Forfeited or cancelled                 (816,675)   $3.51     (422,887)   $1.92     (396,346)   $4.11
                                     ----------    -----   ----------    -----   ----------    -----

Options outstanding at end of year    9,018,311    $1.37    5,260,366    $2.26    4,240,228    $2.74
                                     ==========    =====   ==========    =====   ==========    =====

Options exercisable at end of year    5,826,539    $1.70    4,675,443    $2.26    2,643,987    $2.75
                                     ==========    =====   ==========    =====   ==========    =====
</TABLE>

      (1) Includes 2,035,000, 481,435 and 1,189,749 options granted to related
      parties in 2003, 2002 and 2001, respectively.

      (2) The Company recorded deferred stock compensation for options issued
      with an exercise price below the fair value of the common stock in the
      amount of $4,750, $0 and $18,000 as of December 31, 2003, 2002 and 2001,
      respectively. Deferred stock compensation is amortized and recorded as
      compensation expenses ratably over the vesting period of the option. The
      stock compensation expense that has been charged in the consolidated
      statements of operations in respect of options to employees and directors
      in 2003, 2002 and 2001, was $8,286, $6,000 and $17,240, respectively.

      (3) In June 2002 and December 2001, the employees exercised 100,000 and
      33,314, respectively, options for which the exercise price was not paid at
      the exercise date. The Company recorded the owed amount of $73,000 and
      $43,308, respectively, as "Note receivable from shareholders" in the
      statement of shareholders' 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 2001 and 2002. During the year 2002 the notes in the amount
      of $43,308 were entirely repaid and note at the amount of $36,500 was
      forgiven and appropriate compensation was recorded. During the year 2003,
      the company recorded compensation in amount of $38,500 due to increase in
      the market value of the company's shares.

d. The options outstanding as of December 31, 2003 have been separated into
ranges of exercise price, as follows:

<TABLE>
<CAPTION>
                          Total options outstanding                Exercisable options outstanding
              --------------------------------------------------- ----------------------------------
                                  Weighted
                 Amount            average                           Amount
 Range of     outstanding at      remaining         Weighted      exercisable at       Weighted
 exercise      December 31,      contractual         average       December 31,         average
  prices           2003             life         exercise price        2003         exercise price
---------     --------------     -----------     --------------   --------------    --------------
     $                              Years               $                                  $
---------                        -----------     --------------                     --------------
<S>               <C>                 <C>               <C>           <C>                  <C>
0.01-2.00         7,773,767           7.48              0.90          4,584,740            0.98
2.01-4.00           314,544           3.56              3.07            314,544            3.07
4.01-6.00           885,000           6.28              4.60            882,255            4.60
6.01-8.00            35,000           2.05              7.73             35,000            7.73
8.01                 10,000           3.75              9.06             10,000            9.06
                  ---------           ----              ----          ---------            ----
                  9,018,311           7.20              1.37          5,826,539            1.70
                  =========           ====              ====          =========            ====
</TABLE>


                                     F - 36
<PAGE>

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

NOTE 11:- SHAREHOLDERS' EQUITY (Cont.)

Weighted-average fair values and exercise prices of options on dates of grant
are as follows:

<TABLE>
<CAPTION>
                           Equals market price        Exceeds market price       Less than market price
                         ------------------------   ------------------------   ------------------------
                          Year ended December 31,    Year ended December 31,    Year ended December 31,
                         ------------------------   ------------------------   ------------------------
                          2003     2002     2001     2003     2002     2001     2003     2002     2001
                         ------   ------   ------   ------   ------   ------   ------   ------   ------
<S>                      <C>      <C>      <C>      <C>      <C>      <C>      <C>      <C>      <C>
 Weighted average        $0.950   $1.265   $1.579   $   --   $   --   $1.466   $   --   $0.755   $1.300
   exercise prices
 Weighted average fair
   value on grant date   $0.730   $0.560   $0.500   $   --   $   --   $0.560   $   --   $0.250   $0.790
</TABLE>

2. Options issued to consultants:

a. The Company's outstanding options to consultants as of December 31, 2003, are
as follows:

<TABLE>
<CAPTION>
                                      2003                         2002                         2001
                            ------------------------     -----------------------    ------------------------
                                           Weighted                    Weighted                     Weighted
                                           average                     average                      average
                                           exercise                    exercise                     exercise
                             Amount         price         Amount         price        Amount         price
                            --------       --------      --------      --------      --------       --------
                                              $                            $                            $
                                           --------                    --------                     --------
<S>                          <C>           <C>            <C>          <C>            <C>           <C>
Options outstanding at       245,786       $   5.55       245,786      $   5.55       175,786       $   6.57
  beginning of year
Changes during year:
  Granted (1)                 83,115       $   0.99            --            --       130,000       $   6.02
  Exercised                  (15,000)      $   0.49            --            --       (60,000)      $   5.13

Repriced (2):
  Old exercise price              --             --            --            --       (56,821)      $   9.44
  New exercise price              --             --            --            --        56,821       $   4.78
                            --------                     --------                    --------

Options outstanding at
  end of year                313,901       $   4.59       245,786      $   5.55       245,786       $   5.55
                            ========       ========      ========      ========      ========       ========

Options exercisable at
  end of year                193,901       $   3.46       125,786      $   6.42       125,786       $   6.42
                            ========       ========      ========      ========      ========       ========
</TABLE>

----------
(1) 120,000 options out of 130,000 options granted in 2001 to the Company's
selling and marketing consultants are subject to the achievement of the targets
specified in the agreements with these consultants. The measurement date for
these options has not yet occurred, as these targets have not been met, in
accordance with EITF 96-18. When the targets is achieved the Company will record
appropriate compensation upon the fair value at the same date at which the
targets is achieved

(2) During the year 2001 the Company repriced 56,821 options to its service
providers. The fair value of repriced warrants was calculated as a difference
measured between (1) the fair value of the modified warrants determined in
accordance with the provisions of SFAS 123, and (2) the value of the old warrant
immediately before its terms were modified, determined based on the shorter of
(a) its remaining expected life or (b) the expected life of the modified option.
As a result of the repricing, the Company has recorded an additional
compensation at the amount of $21,704, and included this amount in marketing
expenses.

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:

                                     2003              2002             2001
                                     ----              ----             ----
Dividend yield                          0%               --               0%
Expected volatility                    78%               --              82%
Risk-free interest                    2.3%               --         3.5-4.5%
Contractual life of up to         10 years               --         10 years


                                     F - 37
<PAGE>

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

NOTE 11:- SHAREHOLDERS' EQUITY (Cont.)

c. In connection with the grant of stock options to consultants, the Company
recorded stock compensation expenses totaling $29,759, $0 and $139,291 for the
years ended December 31, 2003, 2002 and 2001, 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.

h. Issuances in connection with acquisitions:

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.


                                     F - 38
<PAGE>

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

NOTE 12:- INCOME TAXES

a. Taxation of U.S. parent company (Arotech):

As of December 31, 2003, Arotech has operating loss carryforwards for U.S.
federal income tax purposes of approximately $17.0 million, which are available
to offset future taxable income, if any, expiring in 2010 through 2022.
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.

b. Israeli subsidiary (EFL):

1. Tax benefits under the Law for the Encouragement of Capital Investments, 1959
(the "Investments Law"):

A small part of EFL's manufacturing facility has been granted "Approved
Enterprise" status under the Investments Law, and is 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 approved investment program is in the amount of approximately $500,000. EFL
effectively operated the program during 1993, and is entitled to the tax
benefits available under the Investments Law. EFL is entitled to additional tax
benefits as a "foreign investment company," as defined by the Investments Law.

The tax-exempt income attributable to the "Approved Enterprise" can be
distributed to shareholders without subjecting the Company to taxes only upon
the complete liquidation of the Company. If these retained tax-exempt profits
are distributed in a manner other than in the complete liquidation of the
Company they would be taxed at the corporate tax rate applicable to such profits
as if the Company had not elected the alternative system of benefits, currently
between 25% for an "Approved Enterprise." As of December 31, 2003, the
accumulated deficit of the Company does not include tax-exempt profits earned by
the Company's "Approved Enterprise."

The entitlement to the above benefits is conditional upon the Company's
fulfilling the conditions stipulated by the Investments Law, regulations
published thereunder and the instruments of approval for the specific
investments in "approved enterprises." In the event of failure to comply with
these conditions, the benefits may be canceled and the Company may be required
to refund the amount of the benefits, in whole or in part, including interest.
As of December 31, 2003, according to the Company's management, the Company has
fulfilled all conditions.

The main tax benefits available to EFL are:

a) Reduced tax rates:

During the period of benefits (seven to ten years), commencing in the first year
in which EFL earns taxable income from the "Approved Enterprise," a reduced
corporate tax rate of between 10% and 25% (depending on the percentage of
foreign ownership, based on present ownership percentages of 15%) will apply,
instead of the regular tax rates.


                                     F - 39
<PAGE>

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

NOTE 12:- INCOME TAXES (Cont.)

The period of tax benefits, detailed above, is subject to limits of 12 years
from the commencement of production, or 14 years from the approval date,
whichever is earlier. Hence, the first program will expire in the year 2004. The
benefits have not yet been utilized since the Company has no taxable income,
since its incorporation.

b) Accelerated depreciation:

EFL 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.

Income from sources other than the "Approved Enterprise" during the benefit
period will be subject to tax at the regular corporate tax rate of 36%.

2. 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 2b, 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 has not provided deferred income taxes on
this difference between the reporting currency and the tax bases of assets and
liabilities.

3. Tax benefits under the Law for the Encouragement of Industry (Taxation),
1969:

EFL is an "industrial company," as defined by this law and, as such, is entitled
to certain tax benefits, mainly accelerated depreciation, as prescribed by
regulations published under the inflationary adjustments law, the right to claim
public issuance expenses and amortization of know-how, patents and certain other
intangible property rights as deductions for tax purposes.

4. Tax rates applicable to income from other sources:

Income from sources other than the "Approved Enterprise," is taxed at the
regular rate of 36%.

5. Tax loss carryforwards:

As of December 31, 2003, EFL has operating and capital loss carryforwards for
Israeli tax purposes of approximately $84.0 million, which are available,
indefinitely, to offset future taxable income.


                                     F - 40
<PAGE>

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

NOTE 12:- INCOME TAXES (Cont.)

c. 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:

<TABLE>
<CAPTION>
                                                                December 31,
                                                       -------------------------------
                                                           2003               2002
                                                       ------------       ------------
<S>                                                    <C>                <C>
Operating loss carryforward                            $ 33,958,434       $ 29,257,118
Reserve and allowance                                       843,453            303,204
                                                       ------------       ------------

Net deferred tax asset before valuation allowance        34,801,887         29,560,322
Valuation allowance                                     (34,801,887)       (29,560,322)
                                                       ------------       ------------

                                                       $         --       $         --
                                                       ============       ============
</TABLE>

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 regarding the loss carryforwards and other temporary
differences will not be realized. The change in the valuation allowance as of
December 31, 2003 was $5,241,565.

d. Loss from continuing operations before taxes on income and minority interest
in loss (earnings) of a subsidiary:

                                            Year ended December 31
                           ----------------------------------------------------
                               2003                2002                2001
                           ------------        ------------        ------------

Domestic                   $ (7,411,121)       $ (5,250,633)       $ (5,828,828)
Foreign                      (1,697,617)        (13,254,195)        (11,457,960)
                           ------------        ------------        ------------

                           $ (9,108,738)       $(18,504,358)       $(17,286,788)
                           ============        ============        ============
----------
*   Restated (see Note 1.b.).


                                     F - 41
<PAGE>

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

NOTE 12:- INCOME TAXES (Cont.)

e. Taxes on income were comprised of the following:

                                                Year ended December 31
                                  ----------------------------------------------
                                    2003           2002               2001
                                  --------    ---------------    ---------------

Current taxes                     $ 44,102    $            --    $            --
Taxes in respect of prior
  years                            352,091                 --                 --
                                  --------    ---------------    ---------------
                                  $396,193    $            --    $            --
                                  ========    ===============    ===============

Domestic                          $ 33,020    $            --    $            --
Foreign                            363,173                 --                 --
                                  --------    ---------------    ---------------

                                  $396,193    $            --    $            --
                                  ========    ===============    ===============

f. 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:

<TABLE>
<CAPTION>
                                                               Year ended December 31,
                                                      -------------------------------------------
                                                         2003            2002            2001
                                                      -----------     -----------     -----------
<S>                                                   <C>             <C>             <C>
Loss from continuing operations before taxes, as      $(9,108,738)    $(4,582,792)    $(4,025,789)
  reported in the consolidated statements of income
                                                      ===========     ===========     ===========

Statutory tax rate                                             35%             35%             35%
                                                      ===========     ===========     ===========
Theoretical tax income on the above amount at the     $(3,188,058)    $(1,603,977)    $(1,409,026)
  U.S. statutory tax rate
Deferred taxes on losses for which valuation
  allowance was not provided                            1,178,215       1,603,977       1,409,026
Non-deductible expenses                                 2,020,290              --              --
State taxes                                                33,020              --              --
Other                                                         635              --              --
Taxes in respect of prior years due to change in
  estimates                                               352,091              --              --
                                                      -----------     -----------     -----------

Actual tax expense                                    $   396,193     $        --     $        --
                                                      ===========     ===========     ===========
</TABLE>

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


                                     F - 42
<PAGE>

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

NOTE 13:- SELECTED STATEMENTS OF OPERATIONS DATA

Financial income (expenses), net:

<TABLE>
<CAPTION>
                                                              Year ended December 31,
                                                     -----------------------------------------
                                                        2003           2002           2001
                                                     -----------    -----------    -----------
<S>                                                  <C>            <C>            <C>
Financial expenses:
Interest, bank charges and fees                      $  (355,111)   $   (89,271)   $   (49,246)
Amortization of compensation related to beneficial
convertible feature of convertible debenture and
warrants issued to the holders of convertible
debenture                                             (3,928,237)            --             --
Foreign currency translation differences                 115,538         15,202        (16,003)
                                                     -----------    -----------    -----------

                                                      (4,167,810)       (74,069)       (65,249)
                                                     -----------    -----------    -----------
Financial income:
   Interest                                              129,101        174,520        327,830
                                                     -----------    -----------    -----------

Total                                                $(4,038,709)   $   100,451    $   262,581
                                                     ===========    ===========    ===========
</TABLE>

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

NOTE 14:- RELATED PARTY DISCLOSURES

<TABLE>
<CAPTION>
                                                           Year ended December 31,
                                                         ---------------------------
                                                         2003     2002        2001
                                                         ----   --------    --------
<S>                                                      <C>    <C>         <C>
Transactions:

Reimbursement of general and administrative expenses       --   $ 36,000    $ 23,850
                                                         ====   ========    ========
                                                                            --------
Financial income (expenses), net from notes receivable
  and loan holders                                         --   $ (7,309)   $(36,940)
                                                         ====   ========    ========
</TABLE>

NOTE 15:- SEGMENT INFORMATION

a. General:

The Company and its subsidiaries operate primarily in two business segments (see
Note 1a for a brief description of the Company's business) and follow the
requirements of SFAS No. 131.

The Company previously managed its business in three reportable segments
organized on the basis of differences in its related products and services. With
the discontinuance of Consumer Batteries segment (see Note 1.e-Discontinued
Operation) and acquiring two subsidiaries (see Notes 1.b.and c.), two reportable
segments remain: Electric Fuel Batteries, and Defense and Security Products. As
a result the Company reclassified 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.


                                     F - 43
<PAGE>

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

NOTE 15:- SEGMENT INFORMATION (Cont.)

b. The following is information about reported segment gains, losses and assets:

<TABLE>
<CAPTION>
                                                                 Defense and
                                                                  Security
                                            Batteries             Products           All Other              Total
                                          -------------        -------------       -------------        -------------
<S>                                       <C>                  <C>                 <C>                  <C>
2003*
Revenues from outside customers           $   5,868,899        $  11,457,742       $          --        $  17,326,641
Depreciation expense and amortization          (527,775)            (927,665)           (139,629)          (1,595,069)
Direct expenses (1)                          (5,945,948)         (10,892,933)         (4,200,772)         (21,039,653)
                                          -------------        -------------       -------------        -------------
Segment gross loss                             (604,824)            (362,856)         (4,340,401)          (5,308,081)
                                         ==============        =============       =============
Financial   income  (in   deduction  of              --                   --                  --           (4,039,950)
  minority rights)
                                                                                                        -------------
Net loss from continuing operation                                                                         (9,348,031)
                                                                                                        =============

Segment assets (2)                            2,128,062            1,628,562             450,864            4,207,488
                                         ==============        =============       =============        =============
Expenditures for segment assets                 247,989              208,497             124,463              580,949
                                         ==============        =============       =============        =============

2002
Revenues from outside customers           $   1,682,296        $   4,724,443       $          --        $   6,406,739
Depreciation expense and amortization          (252,514)            (676,753)           (194,014)          (1,123,281)
Direct expenses (1)                          (3,062,548)          (4,353,770)         (2,905,743)         (10,322,061)
                                          -------------        -------------       -------------        -------------
Segment gross loss                       $   (1,632,766)        $   (306,080)       $ (3,099,757)          (5,038,603)
                                         ==============        =============       =============        =============
Financial income                                                                                              100,451
                                                                                                        -------------
Net loss from continuing operation                                                                      $   4,938,152
                                                                                                       =============

Segment assets (2)                       $    2,007,291        $   1,683,825       $     575,612        $   4,266,728
                                         ==============        =============       =============        =============
Expenditures for segment assets          $      246,664        $      58,954       $      70,486        $     376,104
                                         ==============        =============       =============        =============

2001
Revenues from outside customers          $    2,093,632        $          --       $          --           $2,093,632
Depreciation expense                           (304,438)                  --            (225,577)            (530,015)
Direct expenses (1)                          (2,295,501)                  --          (3,556,486)          (5,851,987)
                                          -------------        -------------       -------------        -------------
Segment gross loss                       $     (506,307)        $         --        $ (3,782,063)          (4,288,370)
                                         ==============        =============       =============        =============
Financial income net                                                                                          262,581
                                                                                                        -------------
Net loss from continuing operations                                                                     $  (4,025,789)
                                                                                                        =============

Segment assets (2)                       $    2,044,257        $   1,175,521       $     702,915        $   2,744,172
                                         ==============        =============       =============        =============
Expenditures for segment assets          $      229,099        $     229,099       $     323,985        $     553,084
                                         ==============        =============       =============        =============
</TABLE>

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

(1)   Including sales and marketing, general and administrative expenses.

(2)   Including property and equipment and inventory.


                                     F - 44
<PAGE>

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

NOTE 15:- SEGMENT INFORMATION (Cont.)

c. Summary information about geographic areas:

The following presents total revenues according to end customers location for
the years ended December 31, 2003, 2002 and 2001, and long-lived assets as of
December 31, 2003, 2002 and 2001:

<TABLE>
<CAPTION>
                               2003                            2002                            2001
                   ---------------------------    -----------------------------   -----------------------------
                       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.              $10,099,652     $  6,778,050    $  2,787,250    $  6,710,367    $  1,057,939   $     60,531
Germany              2,836,725              -             38,160               -         526,766              -
England                 29,095              -             47,696               -          36,648              -
Thailand                95,434              -            291,200               -               -              -
Israel               3,576,139      2,954,441          2,799,365       3,367,320          13,773      2,160,275
Other                  689,596              -            443,068               -         458,506              -
                    -----------     ------------    ------------    ------------    ------------   ------------
                    $17,326,641     $  9,732,491    $  6,406,739    $ 10,077,687    $  2,093,632   $  2,220,806
                    ===========     ============    ============    ============    ============   ============
</TABLE>

d. Revenues from major customers:

<TABLE>
<CAPTION>
                                                            Year ended December 31,
                                              ----------------------------------------------------
                                                  2003               2002               2001
                                                                       %
                                              ----------------------------------------------------
<S>                                                   <C>                <C>               <C>
     Electric Fuel Batteries:
              Customer A                             --                 --                 22%
              Customer B                              2%                 7%                20%
              Customer C                              1%                 2%                13%
              Customer D                             27%                 8%                12%
     Defense and Security Products:
              Customer A                             17%                43%                --
              Customer B                             16%                --                 --
</TABLE>

e. Revenues from major products:

<TABLE>
<CAPTION>
                                                            Year ended December 31,
                                              ----------------------------------------------------
                                                  2003               2002               2001
                                              --------------     --------------     --------------
<S>                                            <C>                <C>                <C>
     EV                                        $   408,161        $   460,562        $   894,045
     WAB                                           703,084            647,896            951,598
     Military batteries                          4,757,116            573,839            247,989
     Car armoring                                3,435,715          2,744,382                  -
     Interactive use-of-force training           7,961,302          1,980,060                  -
     Other                                          61,263                  -                  -
                                               -----------         ----------         ----------
     Total                                     $17,326,641         $6,406,749         $2,093,632
                                               ===========         ==========         ==========
</TABLE>


                                     F - 45
<PAGE>

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

NOTE 16:- 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 are not treated as changed or
modified when the cash flow effect on a present value basis is less than 10%,
and therefore the Company did not record any compensation related to the change
in the conversion price of the convertible debentures.

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.

During 2003, an aggregate 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.

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 to 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, as earlier,
as financial expenses.

During 2003 the Company recorded an expense of $1,517,400, of which $548,100 was
attributable to amortization of the beneficial conversion feature of the
convertible debenture over its term and $969,300 was attributable to
amortization due to conversion of the convertible debenture into shares.


                                     F - 46
<PAGE>

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

NOTE 16:- CONVERTIBLE DEBENTURES (Cont.)

b. 8% Secured Convertible Debentures due September 30, 2006

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" ("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 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 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, as
earlier, as financial expenses.

During 2003, an aggregate 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 2003 the Company recorded an expense of $2,298,034, of which $205,858 was
attributable to amortization of the beneficial conversion feature of the
convertible debenture over its term and $2,092,176 was attributable to
amortization due to conversion of the convertible debenture into shares.

c. 8% Secured Convertible Debentures due December 31, 2006

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 December 31, 2006. These debentures are convertible at any time
prior to December 31, 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 December 31, 2006, warrants to purchase an aggregate of 1,500,000 shares of
common stock at any time prior to December 31, 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.


                                     F - 47
<PAGE>

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

NOTE 16:- CONVERTIBLE DEBENTURES (Cont.)

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 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 - December 31, 2006 - or to the actual conversion date, as
earlier, as financial expenses.

During 2003 the Company recorded an expense of $112,803, which represents the
amortization of the beneficial conversion feature of the convertible debenture
over its term.

During the nine months ended September 30, 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 17.c.

NOTE 17:- SUBSEQUENT EVENTS (UNAUDITED)

a. Debenture conversion:

In January 2004, a total of $1,150,000 principal amount of 9% debentures was
converted into an aggregate of 1,796,875 shares of common stock at a conversion
price of $0.64 per share. Additionally, through November 2004 a total of
$1,075,000 principal amount of 8% debentures was converted into an aggregate of
934,783 shares of common stock at a conversion price of $1.15 per share, and a
total of $1,612,500 principal amount of 8% debentures was converted into an
aggregate of 1,112,069 shares of common stock at a conversion price of $1.45 per
share.

b. Issuance of common stock to investors:

In January 2004, the Company issued to a group of investors 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. (See also Note 17.c.)

c. Issuance of warrants to investors:

As part of the investment agreement in January 2004 (see Note 17.b.), the
Company issued to a group of investors warrants to purchase an aggregate of
9,840,426 shares of common stock at a price of $1.88 per share. These warrants
are exercisable by the holder at any time after August 12, 2004 and will expire
on January 12, 2007. On July 14, 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. See Note 17.e.


                                     F - 48
<PAGE>


<PAGE>

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

NOTE 17:- SUBSEQUENT EVENTS (UNAUDITED) (Cont.)

d. Warrants issued in May 2001:

On July 14, 2004, the Company repriced the exercise price of warrants granted
previously in May 2001 (see also Note 11.f.2.) 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 (See Note 17.e.).

e. Issuance of shares and warrants in July 2004:

In July 2004, pursuant to a Securities Purchase Agreement dated July 15, 2004,
the Company issued to a group of investors 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.

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 Notes 17.c. and 17.d.). 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 aforesaid transactions, 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.

f. Acquisition of FAAC Incorporated:

In January 2004, the Company purchased all of the outstanding stock of FAAC
Incorporated, a Michigan corporation ("FAAC"), from FAAC's existing
shareholders. The assets acquired through the purchase of all of FAAC's
outstanding stock consisted of all of FAAC's assets, including FAAC's current
assets, property and equipment, and other assets (including intangible assets
such as goodwill, intellectual property and contractual rights). The
consideration for the assets purchased consisted of (i) cash in the amount of
$12,000,000, and (ii) the issuance of $2,000,000 in Arotech stock, plus an
earn-out based on 2004 net pretax profit, with an additional earn-out on the
2005 net profit from certain specific and limited programs. 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.


                                     F - 49
<PAGE>


<PAGE>

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

NOTE 17:-     SUBSEQUENT EVENTS (UNAUDITED) (Cont.)

g. Acquisition of Epsilor Electronic Industries, Ltd.:

In January 2004, the Company purchased all of the outstanding stock of Epsilor
Electronic Industries, Ltd., an Israeli corporation ("Epsilor"), from Epsilor's
existing shareholders. The assets acquired through the purchase of all of
Epsilor's outstanding stock consisted of all of Epsilor's assets, including
Epsilor's current assets, property and equipment, and other assets (including
intangible assets such as goodwill, intellectual property and contractual
rights). The consideration for the assets 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 under the
circumstances set forth in the acquisition agreement. 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.

h. Settlement of litigation:

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.

In respect of the above settlement, the Company recorded in 2003 an expense of
$689,714, 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.

i. Acquisition of Armour of America, Incorporated

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).


                                     F - 50
<PAGE>

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

NOTE 17:-     SUBSEQUENT EVENTS (UNAUDITED) (Cont.)

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 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 will be recorded as
additional purchase price. The purchase price also included $83,837 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.


j. Adjustment of warrants issued in 2000 and 2001


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 shares. 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 and the
issuance of new warrants, the Company recorded a deemed dividend in the amount
of approximately $1,163,000 in the nine months ended September 30 2004.


                                 - - - - - - - -


                                     F - 51
<PAGE>

                          SUPPLEMENTARY FINANCIAL DATA

 Quarterly Financial Data (unaudited) for the two years ended December 31, 2003

<TABLE>
<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 profit (loss) from continuing operations $   (1,291,122)  $   (2,788,348)  $      218,606   $   (5,487,167)
Net loss from discontinued operations....... $      (95,961)  $      179,127   $       (2,285)  $       29,529
Net profit (loss) for the period............ $   (1,387,083)  $   (2,609,221)  $      216,321   $   (5,457,638)
Net profit (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
<CAPTION>
                                                                       Quarter Ended
                                            --------------------------------------------------------------------
                    2002                        March 31         June 30        September 30     December 31
        ------------------------------      --------------------------------------------------------------------
<S>                                          <C>              <C>              <C>              <C>
Net revenue................................. $      570,545   $      425,053   $    3,262,711   $    2,148,430
Gross profit................................ $      186,917   $       48,807   $    1,593,770   $      155,497
Net loss from continuing operations......... $     (990,097)  $   (1,005,877)  $     (923,122)  $   (2,019,054)
Net loss from discontinued operations....... $   (2,324,109)  $   (1,654,108)  $   (8,716,422)  $     (871,567)
Net loss for the period..................... $   (3,314,208)  $   (2,659,985)  $   (9,369,544)  $   (2,890,621)
Net loss per share - basic and diluted...... $       (0.11)   $       (0.09)   $       (0.29)   $       (0.08)
Shares used in per share calculation........     30,149,210       30,963,919       33,441,137       34,758,048
</TABLE>

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


                                     F - 52
<PAGE>

                          FINANCIAL STATEMENT SCHEDULE

                      Arotech Corporation and Subsidiaries

                 Schedule II - Valuation and Qualifying Accounts

              For the Years Ended December 31, 2003, 2002 and 2001

<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, 2003
  Allowance for doubtful accounts...........    $      40,636    $      20,646   $       61,282
  Valuation allowance for deferred taxes....       29,560,322        5,241,565       34,801,887
                                                -------------    -------------   --------------
  Totals....................................    $  29,600,958    $   5,262,211   $   34,863,169
                                                =============    =============   ==============
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
                                                =============    =============   ==============
Year ended December 31, 2001
  Allowance for doubtful accounts...........    $      13,600    $      25,553   $       39,153
  Valuation allowance for deferred taxes....        8,987,750        3,652,353       12,640,103
                                                -------------    -------------   --------------
  Totals....................................    $   9,001,350    $   3,677,906   $   12,679,256
                                                =============    =============   ==============
</TABLE>


                                     F - 53
<PAGE>

                                  EXHIBIT INDEX

    Exhibit
    Number                       Description
    ------                       -----------

      23    Consent of Kost, Forer, Gabbay & Kassierer, a member of Ernst &
            Young Global

      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