Arotech Corporation Wall Street Analyst Forum Transcript

| About: Arotech Corporation (ARTX)

Arotech Corporation (NASDAQ:ARTX)

Wall Street Analyst Forum 20th Annual Analyst Conference

June 8, 2009 11:10 am ET

Executives

Peter Ender [ph] – Wall Street Analyst Forum

Robert Ehrlich – Chairman and CEO

Peter Ender

Good morning, ladies and gentlemen. My name is Peter Ender [ph] from the Wall Street Analyst Forum and I will be your host in this room for today. At this time, I would like to ask that all cell phones, pagers and other media devices be switched to the silent mode or turned off, so not to and to – so as not to interrupt the presentation. This is also in accordance with the University Club’s policy. After the presentation, you may join Arotech in the adjoining room for their breakout session.

So Arotech Corporation is a defense and security products services and services company engaged in three business areas, interactive simulation for military, law enforcement and commercial markets, armoring for military and non-military air and ground vehicles and batteries and charging systems mainly for the military. They are a multinational enterprise, operating in the USA and Israel with 450 full-time employees.

They operate primarily through their various subsidiaries which has organized into three divisions as follows. They develop, manufacture and market advanced high tech multimedia and interactive digital solutions for weapon simulation, use of force training and driving training of military law enforcement, security and other personnel through their training and simulation division. They also utilize sophisticated lightweight materials and advanced engineering processes to armor vehicles and to manufacture personnel and aviation armor through their armor division. And finally, they develop, manufacture and sell primary and rechargeable lithium and zinc-air batteries and their chargers for defense and security products and other military applications through their battery and power systems division. In addition, they produce water activated life jackets, life jacket lights for commercial aviation and marine applications.

So without further ado, here is Mr. Robert Ehrlich.

Robert Ehrlich

Thank you. Good morning and I am glad to be here. I am the Chairman and CEO of Arotech Corporation. We are on NASDAQ, ARTX. We’ve had an interesting history over the years. We started out in the business of developing batteries for electric vehicles, developed a wonderful battery that had only a fatal flaw that it was not rechargeable, it was refuelable and that wound us moving to other businesses.

In 2002, the CEO who was then also the Chief Engineer left the company and I became CEO and we changed the dynamic of the company to be a company in the defense and security products. The areas that we focus on are training, protecting and supplying. We don’t do hostile things like make guns and weapons like that. We believe, of course, we are a tremendously undervalued opportunity, which we hope to remedy with the number of these conferences.

Our history over the last several years, we in 2002, we reported revenues of $4 million. We finished last year at almost $69 million and are accelerating on that in 2009. Our profitability is largely affected. We have a profitable EBITDA, earnings before interest and taxes of almost $3 million.

But our net income is affected by the fact that we grew the business largely by acquisition and the accounting rules from when I was young to when I gotten older have changed, so that you have to now amortize all the costs, so the acquisitions you make in that are all non-cash charges, which lead us to a net income that’s a negative. Nevertheless, we are – we think we are growing very steadily. Sales continue to grow. Margins are good and our EBITDA keeps growing.

The businesses that we are in are law enforcement supporting the military and supporting commercial, what we call municipalities. In the training area, we do use a force training for law enforcement officials and now for the military, for MPs and people like that. We also provide protection to the law enforcement market with things like military life shields and leg guards as well as we are now we will be moving into helmets as well.

For the military, our biggest business for the military is providing driving simulators. Every vehicle that the US military drives, we simulate. We have about 100 and somewhat at the Portland. So every young man, every 18 year old soldier who is going to drive any kind of the US army vehicle goes to Portland learns on our simulator before he gets a three quarter of a million truck to drive in Afghanistan, he will learn how to drive with – in a simulation. So if you were to turn it over in simulation, hopefully you won’t do that in Afghanistan.

The other, the jeeps that you see there are new jeep we developed about three years ago which we sell to the Israeli defense forces called the David. We have delivered well over 200 and somewhat of them. We just got an order last week for another $2 million worth and are anticipating momentarily a very large order continuing for the Israelis for more of these vehicles.

We also make every kind of rechargeable and primary battery both for the Israeli military, for the Indian military and we are beginning to make batteries now for the US military, a major step forward for us in the battery business.

In the commercial and municipal area, we do again simulation. We have done the London Bus, we did the New York subway, we did the Fort Worth, Dallas Fort Worth light rail, we have done San Diego light rail. We do obviously New York City EMS facilities. What we do is we take a half a cab, either half a bus or half a cab and in a 180 degree simulation with interactive video provide all kinds of scenarios that you can train drivers on again before you put them in a New York subway or before you put him in a New York bus. The New York subway is the most sophisticated system that’s been delivered. We did four lines, four subway lines from the Bronx to the Coney Island, several hundred miles of track with all kinds of holes that we can build in so that you really train a driver in a cab, how to drive in a subway before you put him in the subway.

We also do armored vehicles which we did for Iraq and are now hopefully we will do it for Afghanistan as well against IEDs, that’s the new threat. And almost everybody can now make an armored car that will protect against bullets like an armor piercing AK-47. But the new challenge is to make vehicles that protect against IEDs, which we are now working on.

And the last thing you see here our lights that we have put on life jackets. Every time you fly over water, you have under your seat in the airplane a life jacket, which has on it a light that it activates when it goes into the water. It is meant to be for rescue. I call it the shark lights because it lights up and then they can find you.

Basically our three divisions are training and simulation, which is the largest part of our business and the most successful. Our armor business which is a good business, but up and down, because you are dependent on orders from the military and any delay in receiving those orders causes you to operate the facility without enough production to go through the facility and just try and catch it up later.

In the battery business, which was our original business is now that we have moved into lithium and rechargeable is growing very rapidly and we have currently something like a $15 million backlog and growing all the time. We just got some major orders from some US OEMs for being spec’d into products of this on to the US military.

In the training area, the war fighters, we develop driving simulators for the Striker, for Humvees. We also sale a thing called missile launcher simulator. Every US aircraft really was developed for top gun. But every US military aircraft has a target acquisition program built into the plane that tells you if there is a MIG 3 miles out, what weapons to use to bring it down. Our simulation which is now built in the aircraft actually is used to identify which missile to use to bring down that aircraft. As I said, first it was developed for training, but it so successful, it’s now been embedded in every US aircraft including the Joint Strike Fighter.

In the law enforcement area, we have a product called the MILO, which is an interactive system using video, tracking video, so that you can change those. Your instructor can change the scenario, so that you have a situation where someone is holding a hostage and the law enforcement officer, does he use maze, does he use a weapon, does he – is he able to talk to the perpetrator out of joining some harm, or does he have to shoot him.

When we – when I bought this company, they put me into a simulation like this and first the instructor showed me what he did. He – first person up in the bank robbery was a bad guy and he shot him and the next one up was a clerk and he didn’t shoot, third one up was another bank robber and then shot them. And said do you want to try? So I did it. First one up was a bank robber and I shot it. The second one was a clerk and I shot her. So they decided that I wasn’t quite qualified yet.

In our simulation business, which I said is the biggest and most successful part of our business. We do several different things, but all aimed at training law enforcement officials and soldiers, how to anticipate certain situations before they’re actually in the same situation either in combat or in a vehicle or in the use of force situation.

So as I said, the military ops that you see there is our ZAP system which tracks various, which missile to use to bring down another aircraft. Our driving simulators that you see are replicas of the cab. This is a truck and it has motion so that you can actually physically, at least psychologically turn it over. And the use of force training is where you use a laser in your own weapon, so you have your own weapon and you put a laser in it and then the instructor will put up various scenarios and you will go through it to see if you are able to mass through the situation. If not, you have to go over the course again.

And here we’ve developed the for the LA Fire Department for first responders, where every firehouse in LA can be connected by their computers, so a simulated situation of a fire or WMD and how they respond and who takes command, so that they don’t have situations like 9/11 where the police and the fire are not agreeing as to who is in charge and who is in command of a particular situation.

This is just more detail on the various kinds of training that we do, the disaster system and the embedded – or as I said, whenever aircraft and I will not go through all the detail everyone, but whenever a US aircraft including the ones that are about to be built, we are embedded them.

The MILO is a small box that does this interactive video. It trains law enforcement officers, what to do in a various given situation of whether to try and disarm someone. You can put maze in your weapon, you can put – you can have a baton, all of which are done with laser. And then you can see the reaction that the instructor can see the reaction that the policeman gives or EMC in the case of the military applications and then they can train them for when he is out in the field in actual situations.

We also have firearms training. This is a system we developed with the FBI that improves shooting. Apparently most of the FBI agents, the thing that they’re not good at is shooting. So we’ve developed a system because they are accountants and lawyers and are very smart, but they have to be thought how to shoot properly. This allows you to measure trigger pull, so that you can know that you are breathing and your trigger pull have to be coordinated and you can track it, so that you can teach an officer how to improve his shooting.

In the vehicle driving simulation, as I said, we have – we have trained over 150,000 US military personnel to drive all kinds of vehicles, the Striker, various trucks that the US big trucks the military drives Humvees and so on in various kinds of environments. We can change the environment from a sandstorm to an icy road in Afghanistan, so that the young soldier can have a full range of experiences before he is put in that very expensive vehicle and put on the road. And as I say, we have both fixed position and motion in those situations. We also do it as I say for train drivers, subway trains, light rail trains and buses, we have done both New York City bus and London with great success and they come back for upgrades periodically.

Our customers are all inclusive in terms of the kinds of people we sell. We have done airports, bus systems, trucks, police, fire and AMT. We are developing a program that combines our driving simulation for law enforcement with the use of force training so that you can have a simulation that has you driving through a – if you get a call, there is a call you have to got to a some neighborhood and you drive it through interactive video, get out of the car and it shifts to a demographic, where you can have actually a shooting situation, I am sorry, shifts from graphics to video, so that you can have a situation where you can train an officer not only to get to respond to an incident, but then how does he deal once he gets out the car and we are the only ones that have that offer these system.

In terms of what kind of research and development are we doing going forward to build the business, we are adding obviously new features to our various capabilities. One of the things that the army needs now is mine removal and IED protection in places like Iran and Afghanistan. So we are developing devices to add on to our driving simulators that will be features that you add on to the trucks that we will be able to remove mines and tester mines. And as I said, we are also working on this new police trainer which combines driving and shooting into a various program for all of California law enforcement officials. And we are working on the next generation MILO for interactive law enforcement training and field training so that we can stay as the leader in the field.

Our sim builder which is this missile-to-missile, this air-to-air missile training system is continuously being upgraded and we are trying to bring the cost down, so that we can sell it. We sell a secret version to the US air force and a non-secret version to other air forces like the Israelis and the Saudis, so they all have our systems. So that when they shoot their stuff, they both probably backup and go home.

Our simulation business obviously has grown dramatically. When we bought the company in 2004, it was $11 million. Last year, they reached $36 million, very handsome margins, very profitable business. Obviously a business we hope to continue to build. We made a small acquisition last year, which I will talk about a company called RTI that has enhanced our business and we are looking constantly for small add-on pieces that make our simulation business more state of the art than it is already out there.

In terms of the protection, we do the armored vehicles. This was a car that in sense it’s hard to say that we are proud of this car, but we are proud of this car. This car was a car that was blown up at the gates of Gaza. A very brave driver saw a truck coming with a truck bomb. Drove to the gate and the truck bomb hit the car, while the car was somewhat damaged, none of the passengers in the car were damaged and the truck bomber obviously blew himself up. But the Israeli army was so pleased with this protection that they gave us a special award and are now about to order a host of additional cars of this type.

We also do armoring for helicopters cockpits. We do Black Hawks, we do all kinds of different helicopters, where we protect basically the cockpit and some times the doors against fire from the ground.

We have plants. Our business is based in two locations. In Israel, we basically do R&D, develop the technology, because obviously it’s a laboratory unfortunately in place and so we develop the technology in Israel and then apply it both in Israel and now we have introduced into India, but then also into the US. Our customers are basically the Israeli government, all the different agencies of the Israeli government. We sell to the US army, we have sold to the USAID and we have sold to the contractors who bring armored vehicles for places like Iraq and Afghanistan.

Our AoA subsidiary does basically helicopter protection, both fixed wing and rotary aircraft, as well as now we have moved into vests and helmets and leg guards. Obviously the vehicles that we protect are all different types, not point in going through all the different places and all the kinds of protection that we offer them. But we also do for some boats, marine armor and we do we will move heavily into body armor and products like that.

The materials obviously, the research part of the business is developing lighter, cheaper, more perfective materials that’s the challenge for everyone in the business either by a ceramics or some combination of devices like aluminum and Kevlar, depends on what you do it. We are spending time and money now looking at various kinds of nano materials to make the place lighter and more protective. And we – all of our stuff is tested by HD Light before it’s submitted as well as by the Israeli IDF.

This is just some of the different kinds of vehicles we have armored. We have done Humvees, we have done jeeps, we have done land rovers, land cruisers, ambulances. This is again the picture of the David which we sold as I said over 240 of them and are anticipating an order for additional 70 any minute now.

We also developed a new vehicle which we will be showing at AUSA this year which is called the Gideon, which is a thing built on a Polaris which allows, I think the next picture shows allows you to carry, no let me go back, doesn’t go back. Yes, wounded soldiers, stretchers, because what – how did they find on Lebanon that when soldiers were wounded, they couldn’t get to them to get them out and the Israelis have a policy of never leaving a soldier behind, so they have to be to able to get to the wounded, somehow get them in a safe environment where they are not being shot at and get them out so that they can get them to the hospital. We developed this vehicle and the Israelis are now testing it as a way of sending an armor of a very mobile armored vehicle into any kind of terrain to pickup wounded and bring them back. We think that will be a significant product in another armies that we were at the show recently came and everyone wanted talk to us about it.

This is a car we developed for the Indian military. We are – we have a partner in India that we are they do the marketing because their area is well connected. There is a huge tender for some 800 armored vehicles in India now. We have submitted two vehicles to them for consideration. The cars are being delivered this month and they will be tested both on the road and then shot and they will have a decision by hopefully year end, and which would – if we are successful, it would bring us an order of major magnitude for the Indian military with our partners in 2010. Again as I said, we do both personnel armor as well as an aircraft armor for helicopters, boats and fixed wing aircraft.

This business has grown from when we bought it at a couple of million up to $18 million. It’s flattened out. Recently, we did $18 million in 2007, $18 million – $17.8 million in 2008 and we will probably do close to that or little more in 2009. Because of some delays and the orders, when the Israelis went into Gaza, an order that we were due to get in November, got pushed off till currently. So we had a few months where we were winding down one order and not yet ready to ramp up another one to keep growing the business.

In the battery business which I say is the growing part of business. We started in a chemistry called zinc-air, which is a non rechargeable called a primary battery, ties very high energy usage so that you can send the battery to one down to the bottom left there with a soldier into the field for 72 hours, which is much longer than any other batteries that will operate the field. But both of the soldiers like to use, like to carry batteries of given them a 24-hour mission, called the 5150. And we’ve now developed a rechargeable version of that battery, so that you can them a lighter battery into the field, use it for 24 hours or less and recharge it.

One of the big problems they had with that was though in the 5150s which is a primary battery, no one knew how much energy was left in the battery, so when a soldier went out for 12 hours, came back he would tend to throw away his battery, because he didn’t know if he had enough energy for the next day. We have developed for two of our customers, I think called the state-of-charge indicator, which goes on a primary battery which tells them how much energy is left in the battery. If there is enough energy left for him to do the next mission, he will keep and use that battery again. Again, we also do this in the rechargeables, but that’s just a normal part of the businesses.

We have also done batteries for UAVs which is a growing business obviously and we think it has a large opportunity. And we are expanding our business now finally with the US military and rechargeable batteries working with a number of the radio manufacturers, the UV, the night vision manufacturers that we spec’d into their product. Because once you get spec’d in, your battery sales is in good for the next three years to five years. And we also make this life jacket light which I joke about as the shark light.

Actually we have three units that make up our battery business, Epsilor Electronics which is our rechargeable battery – lithium battery and recharger company that sells to the Israeli military. It just sold recently through (inaudible) through the Austrian military. We’ve sold substantially to the Indian military. Our EFL subsidiary which is based in Auburn, Alabama principally makes zinc-air batteries for the US military. But we have now begun to get orders for OEMs in the US for rechargeable lithium batteries which we are now making. And EFLs makes these best batteries and we are now about to make the battery for life boats which has become required by law in all life boats on cruise ships have to have lights on them, we are making those as well.

As I said, our principal products are lithium-ion primary and rechargeable batteries, that’s the biggest part of the business and the growing part of the business. Zinc-air which is we are unique in has not grown steadily until this year it’s beginning to be used more in applications. But I think if I can go back and show you a picture of the soldier, this guy, we are building up for this soldier a kit that in his vest, he has a lithium – he is one of our zinc-air batteries and it charges all of his lithium devices, his heads, his radio, his night vision goggles, all of his other gear, it charges off our zinc-air battery and that’s the new product we are developing that the army is very excited about, because it’s lighter, it gives more energy, because it keeps recharging and it can leave the soldier out in the field for a longer period of time carrying less weight and weight is a critical feature for the soldiers.

I think I have covered this. We are also developing an ultra large battery for underwater vehicles. Again, rechargeable lithium batteries and also I think silver zinc, large batteries that will allow powering underwater vehicles. We are also working in with Raphael to develop batteries that power rockets so that as the guy who runs the business says, we want to be able to provide power for every circumstance from outer space to under the water, so we are hoping to be in that position to provide all of that. Again this business (inaudible) has been growing very rapidly, did $5 million in 2004. This past year, we did about $15 million. We should do more than that this year. Growing profitability, very fine business and one that now that we’ve begun to crack the US market, we will grow more rapidly. Our goal is to get this business in the next two years for $30 million.

So in conclusion, we think that we are a tremendously undervalued situation that in a number of fields that are very attractive supporting the militaries of Israel and the US and India and see great opportunities for us to continue to grow and hope that shareholders will see the same benefit. Thank you.

I will be happy to answer any questions than anybody has.

Question-and-Answer Session

Robert Ehrlich

Yes, sir.

Unidentified Participant

(Inaudible Question)

Robert Ehrlich

We think that we have a very strong of software engineers in armor. The problem is the customers keep wanting at certain definitions of the products, so they compel us to keep making variations. It’s very hard to make stuff off the shelf. As I say, we did the New York City subway. It’s the most advanced system that exists in terms of simulation. We can all – we have offered at the Chicago, we have offered (inaudible) railway, but then you are in price competition. It’s not that we can sell off the shelf. I mean that we have ready we are by far the best in that field. We would love to sell more of them. The buses we sell lot of them, the same bus package. For driving, it’s always a new vehicle, so you always have to have some tweaking of it, so but we see that the whole business is growing. We grow that business about 15% a year.

Unidentified Participant

(Inaudible Question)

Robert Ehrlich

No you don’t have to redo it.

Unidentified Participant

No.

Robert Ehrlich

No you don’t. We – that’s how we are able to grow it that we can take to know how we have built up on this vehicle and apply it when they come with the Striker which we have never done, then we do it on the striker. Now we are talking about track vehicles, tanks, so you can take the same basic technology and apply it now to Abrahams Tank or whatever else they want. Yes, we can do the same. Yes sir.

Unidentified Participant

Have you considered like another military customers, teams like there is other deals of activity now such as Pakistan is now really going after the Taliban, at least that’s what they have been saying. They seem, their probably be a great market, much bigger than the Israeli market for these armored vehicles.

Robert Ehrlich

The nature of the business has changed somewhat, protecting against bullets. They are now 50 companies that do that.

Unidentified Participant

I am not talking about bullets. I am talking about armors.

Robert Ehrlich

We are now developing IED protected vehicles that you can market it another – we have a unique problem of being Israeli we can’t sell to the Pakistanis.

Unidentified Participant

Why not?

Robert Ehrlich

You can sell to the Indians, because they don’t buy from us.

Unidentified Participant

They don’t want to protect their soldiers.

Robert Ehrlich

They want to find somebody else to provide. But we have partners who can sell to them and that’s right way of thinking, although the Indians don’t sell from either. But we in most instances, in Asia, all of our Asian business will be done through our Indian partner; there is a much more comfortable buying from the Indians. In places like Europe, South America, Central America, we can sell directly and we are beginning to – we’ve just – we had to wait till we had enough product to add marketing people that would make it sensible to go to those markets, we are just getting there. But, you are right. I mean there are lots of opportunities that we are only beginning to exploit. Yes sir.

Unidentified Participant

(Inaudible Question)

Robert Ehrlich

I will deal with number four first. I am the largest individual shareholder. I have about 9% of the stock.

Unidentified Participant

Insiders?

Robert Ehrlich

Insiders have, Steven our COO has about 4%, maybe about 17% among the officers and Directors. The rest in fact is widely held non-institutionally because we are too small, but we would love some institutions to get into that. In terms of my background and Tom, Tom and I are both experience guys. Tom was the CFO of Federated Stores and Montgomery Ward, so he has a tremendous financial background which is a tremendous asset for me to get good timely reports that you can trust.

I was at one time CFO of Mattell. I mean my history, I am afraid is too long to talk about in this meeting. I got involved in turnaround business, because a fraud was committed at the company. I was the CFO and help turn it around. I have been Chairman of a company called PSC. They make barcode scanners, now owned by Datalogic in Italy. And I was Chairman of a company called Fresenius Medical, which is on the New York Stock Exchange. That company, I took from $16 million in revenue as Delmed to Fresenius which when I left was $3.5 billion. So I know how to build businesses and I have a team that can really help us. We have got a terrific management team. We’re somewhat over qualified for a little company. We however we think our ambition is to get big enough where our skills are really usefully utilized. I think that was three out of four, I forgot the –

Unidentified Participant

(Inaudible Question)

Robert Ehrlich

We look at – my history has always been in acquisitions, mergers and acquisitions. So when people show me something, I look at everything. What I learned was to reject what doesn’t sit very quickly. When we had the opportunity to buy FAAC, it was $11 million and had a down the year and I looked at the business and said it’s a great company that we know we can grow. We have taken it to $35 million and I hope to get it to see to $70 million or $80 million before we add on some other pieces. Anybody else? Thank you.

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