Form 10-Q for IONATRON INC
17-May-2004
Quarterly Report
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
You should read the following discussion in conjunction with ourConsolidated Financial Statements included elsewhere in this Form 10-Q and anysubsequent filings. Certain of the statements contained herein may be consideredforward-looking statements.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements in this Quarterly Report on Form 10-Q constituteforward-looking statements for purposes of the securities laws. Forward-lookingstatements include all statements that do not relate solely to the historical orcurrent facts, and can be identified by the use of forward looking words such as"may", "believe", "will", "expect", "expected", "project", "anticipate","anticipated" estimates", "plans", "strategy", "target", "prospects" or"continue" These forward looking statements are based on the current plans andexpectations of our management and are subject to a number of uncertainties andrisks that could significantly affect our current plans and expectations, aswell as future results of operations and financial condition and may cause ouractual results, performances or achievements to be materially difficult from anyfuture results, performances or achievements expressed or implied by suchforward-looking statements. This Form 10-Q contains important information as torisk factors in the notes to financial statements and below. In making theseforward-looking statements, we claim the protection of the safe-harbor forforward-looking statements contained in the Private Securities Reform Act of1995. Although we believe that the expectations reflected in suchforward-looking statements are reasonable, there can be no assurance that suchexpectations will prove to have been correct. We do not assume any obligation toupdate these forward-looking statements to reflect actual results, changes inassumptions, or changes in other factors affecting such forward-lookingstatements.
OVERVIEW
On March 18, 2004, a subsidiary of U. S. Home & Garden Inc. (USHG), anon-operating, publicly traded company trading merged into IonatronTechnologies, Inc., formerly Ionatron, Inc. (the "Merger"). Following theMerger, USHG shareholders held 33.89 % and Ionatron shareholders held 66.11% ofthe outstanding USHG common stock. The combination has been accounted for as arecapitalization of Ionatron, Inc., from our inception on June 3, 2002, and theissuance of 19,346,090 common shares and 5,429,006 options and warrants to theUSHG shareholders on the date of merger in exchange for cash. The consolidatedfinancial statements reflect the historical results of Ionatron, Inc., prior toMarch 18, 2004 and the consolidated results of operations of the Company sinceMarch 18, 2004. On April 29, 2004, our shareholders approved the change of ourcorporate name to Ionatron, Inc., an increase of our authorized common stock to100,000,000 shares and the classification of our Board of Directors into threeclasses. We also changed our fiscal year end from June 30 to December 31. Thecommon stock and per share information in the consolidated financial statementsand related notes have been retroactively adjusted to give effect to there-capitalization.
Ionatron was formed on June 3, 2002 to develop and market DirectedEnergy Weapon technology products initially for sale to the U.S. Government. Thegoal of the Company is to initially produce products that incorporate ourtechnology for specific U.S. Government customer applications and platforms.Ionatron and the U.S. Government have entered into several contracts forproducts and services as well as Cooperative Research and Development Agreementsfor joint research on Laser Induced Plasma Channel ("LIPC") based directedenergy weapons. We expect to offer U.S. Government approved versions of ourproducts for commercial security applications in the future. During 2003 and2002, the Company engaged in research and development and business developmentactivities. Ionatron has demonstrated its laser guided man-made lightningdirected energy technology in the laboratory and now has government contractsfor effects testing, compact laser source development and the delivery of asystem on a mobile platform for field demonstration and testing.
We are a new technology company working under contracts with agenciesof the U.S. Government concerned with national security that has developed anddemonstrated in our laboratory a novel internally developed directed energyweapon technology called LIPC, our technology controls and directs electricalenergy between two points. Our business strategy is to continue long-termdevelopment of the technology for multiple national security and defenseapplications, as well as to in parallel develop, applications in othercommercial sectors. Many short-term military applications have been alreadydemonstrated to our customers. Our immediate plan is to manufacturetransportable demonstrators for those applications for various U.S. Governmentorganizations, in order to demonstrate the field utility of the technology. InApril 2004, we received a $9 million contract for one such unit. Upon completionof this contract our intent is to transition to building prototypes and alimited number of production units as soon as it is practicable. We cannotassure you that the demonstrator will perform to the specifications required orthat additional prototypes or units will be ordered.
Currently the LIPC technology lends itself to many non-lethal andlethal military applications. We have demonstrated the technology andeffectiveness for many application areas in our laboratory. We cannot assure youthat the technology will perform its intended applications outside of thelaboratory. Recently, we were requested by one branch of the military to putforth a proposal, which we have done, that details the requirements and fundingneeded to start low rate initial production and deliver units of a specificIonatron LIPC system during 2005. The funding for this proposal is currentlybeing identified with attempts to include it into the 2005 U.S. Defense Budget,that begins with the government fiscal year on October 1, 2004. We cannot assureyou that this proposal will result in contract awards.
We have had meetings and performed demonstrations of the technology forall branches of the U.S. Military, as well as many other U.S. Governmentorganizations involved in various defensive, anti-terrorism, or offensivemilitary type operations. We currently have many potential contracts in thenegotiation stage and have U.S. Government customers actively seeking short-termand long-term funding for Ionatron projects. We cannot assure you that any suchcontracts will become finalized in a timely manner or at all.
In order to help manage the Ionatron interface with our governmentcustomers and their congressional funding counterparts, we maintain an ongoingrelationship with a well known and qualified Washington, DC based governmentrelations firm. We also have an established Vice President of BusinessDevelopment, whose group will be expanding this year as we aggressively marketour U.S. Government products.
We also have various U.S. Government contracts in the following areas:
- Transportable demonstrator for field trials;
- Portal ingress/egress denial demonstration;
- Effects of LIPC technology on various targets; and
- Compact architecture development of the equipment to allow placement on smaller platforms.
The LIPC technology is designed as a line of sight weapon, which allowsthe propagation of various forms and quantities of electrical energy to be aimedand directs electrical energy between two points. The laboratory demonstrationsof the technology have gone from low voltage disruptive type energies to thetarget to very high voltages and currents which have demonstrated energydensities that physically damage different types of materials, such as ablatingconcrete.
We intend to take advantage of, and utilize, existing and mature lasertargeting and tracking technology for our systems with slight modifications. Weare in negotiations with three vendors to supply, to our specifications, theelectrical system requirements and have received a working prototype from onevendor. Outsourcing such supply requirements is intended to free up ourtechnical personnel and other resources to work on development of nextgeneration electrical sources, now that we have developed at least oneelectrical source that can be manufactured for us by outside sources. We alsohave optical components and sections of our laser sources manufactured byoutside vendors which are then assembled and integrated at Ionatron to producethe final laser source for our LIPC systems.
These LIPC systems will be self contained units that operate off ofexisting power supplies found on typical mobile military platforms, such asHMMWV's. Due to the low average power requirements of our systems, no additionalor exotic power systems will be required to support these systems. Futuresystems will utilize the advanced electrical technologies developed for othermilitary programs to support more compact sources, and smaller, lighter LIPCsystems that can be mounted on smaller, autonomous platforms now underdevelopment in other government programs.
The targets, effects, ranges, voltages and currents delivered, alongwith many other aspects of the technology are classified under specificDepartment of Defense guidelines and, consequently, cannot be disclosed to thepublic.
Patents/Proprietary Information
Ionatron has numerous patent applications in various stages ofpreparation and prosecution, which Ionatron believes it has novel intellectualproperty and that it might be able to secure patents that operate to protect ourproprietary technical information and capabilities that will give us thecompetitive advantage to continue to be the leader in the technology. Some ofthese patents will be evaluated by the government to determine if they will beclassified in nature, and thus may not be seen by the general public. Ionatronalso has proprietary information in the form of trade secrets and technologyspecific know how that should give us additional competitive advantages.
Research and development
Ionatron has funded its original research and development throughcapital investment by its founders and we retain the ownership of all theoriginal intellectual property, which we believe is necessary to the ability touse and control the technology. Ionatron also out sources certain research tasksto experienced individuals or companies for some activities that requiresophisticated laboratory equipment or optical modeling programs we do not haveat our disposal. We have over ten relationships of this kind, which provide thatany intellectual property developed under the agreement is the sole property ofIonatron.
Our short-term research and development goals are to complement ourexisting system design by developing more efficient and compact laser sources,electrical sources, and lower cost more efficient optical beam trains. Some ofthis development work is funded by our government customers. Most of ourresearch related work is funded internally in order to capture any intellectualproperty rights from novel processes and inventions that may arise.
Our long-term research is to identify the long-range physical limits ofthe technology. This work relates to understanding the long-range capabilitiesof our LIPC's from alternative and potentially technically superior opticalsources and new potential wavelengths that it may be advantageous to exploit.This work includes efforts to achieve a more complete understanding of theentire physical laws we work within regarding atmospheric physics, plasmaphysics, and the future capabilities of new solid-state laser materials andlaser processes that may enable the technology to be more fully exploited.
We also intend to explore other uses of the technology in the existingapplication area as well as completely novel applications in commercial sectorsoutside the defense and national security application areas.
Properties
Ionatron currently is located in a 25,000 square foot Research andDevelopment and prototyping facility. We have numerous LIPC system test beds,laser source design and assembly, optical design and assembly, machine shop,engineering, research and development, electrical source design and fabrication,indoor test and effects range, as well as the general and administrativefunctions. The facility is limited in production capabilities but is capable ofperforming on our existing contracts and the LIPC transportable demonstratorcontract.
As additional contracts are expected, we are preparing to moveoperations to the NASA Stennis Space facility located on the Gulf Coast ofMississippi in 2005. This facility is a 150,000 acre federally owned securefacility which currently has a decommissioned Army Ammunition Manufacturingfacility, with approximately 600,000 square feet available to meet our long-termsecure research, development, manufacturing, and test range requirements. We arecurrently negotiating to have just over 100,000 square feet upgraded, to ourspecifications, as soon as possible in order to relocate operations to theStennis facility.
It is expected that the cost of upgrading the facility will be paid forby through the U.S. Army's ARMS program. The actual facility moving expenses torelocate from Tucson, AZ to Mississippi is estimated at approximately $1,000,000to be incurred in 2005.
Employees
We currently have twenty-six employees, of whom six are in managementand general administrative, one is in human resources, twelve are in researchand engineering and seven are in manufacturing. We expect to significantlyincrease the number of our personnel by the end of the year, primarily inresearch, engineering and manufacturing.
CRITICAL ACCOUNTING POLICIES
The Company has identified the following accounting policy thatrequires significant judgment. The Company believes its judgments relating torevenue are appropriate.
Revenues
Revenues have been derived from ongoing contract work for effectstesting and the design and development of an in house demonstration system for agovernment customer. It is expected that continued work on effects testing,design and development of use specific Ionatron systems, advanced design andproof of principle on an existing contract, compact laser source development andthe manufacture of a transportable demonstrator will contribute to revenuesgoing forward in 2004. This work is expected to be generally performed undercost-plus contracts with U.S. Government customers.
Revenues under long-term U.S. Government contracts are recorded underthe percentage of completion method. Revenues under cost plus fixed feecontracts are recorded as costs are incurred and include estimated earned feesin the proportion that costs incurred to date bear to total estimated costs.Costs include direct labor, direct materials, and subcontractor costs andoverhead. As contracts can extend over one or more accounting periods, revisionsin costs and earnings estimated during the course of work are reflected duringthe accounting period in which the facts become known. When the current contractestimate indicates a loss, provision is made for the total anticipated loss inthe current period.
Revenues for other products and services are recognized when suchproducts are delivered and, in connection with certain sales to governmentagencies, when the products and services are accepted, which is normallynegotiated as part of the initial contract.
COMPARISON OF OPERATIONS FOR THE FIRST QUARTERS OF 2004 AND 2003
The following table sets forth certain financial data for each quarterending:
March 31, March 31, 2004 2003 --------- ---------
Revenue $ 272,442 $ -- Cost of Revenue 255,000 -- Expenses:General and Administrative 565,549 469,852Selling and Marketing 112,506 67,723Research and Development 180,765 421,475Interest 74,516 33,811Net loss (915,894) (992,861)
REVENUE
Revenue for the first quarter of 2004 was derived from continued work onexisting contracts. There was no revenue for the first quarter of 2003.
COST OF SALES
Our cost of sales in first quarter 2004 was $255,000. There were nosales in the first quarter of 2003 for Ionatron.
GENERAL, ADMINISTRATIVE AND SELLING EXPENSES
The increase in General, Administrative and Selling expenses during thefirst quarter of 2004 as compared with first quarter 2003 was primarily payrollrelated.
RESEARCH AND DEVELOPMENT EXPENSES
The decrease in Research and Development expenses during the firstquarter of 2004 as compared with first quarter of 2003 was primarily due to thetransfer of certain material, personal and consulting expenses to cost of salesin 2004 as certain research and development is funded under our contracts.
LIQUIDITY AND CAPITAL RESOURCES
Our cash position increased during the first quarter of 2004 by $8.4million primarily as a result of the merger with USHG that provided $8.9 millionof cash. At March 31, 2004 we had approximately $8.5 million of cash and cashequivalents. We used $1.0 million in operations and purchased $0.1 million ofequipment during the quarter, which was financed in part, by borrowings from ourChairman. Our borrowing arrangement with our Chairman was restructured, afterpay down of $500,000 and his contribution of $2 million to our capital, into a$3 million revolving credit arrangement.
We believe that we will have sufficient working capital to fulfill thisyear's existing contracts and expected contracts. The transportable demonstratorcontract and at least two of the other Ionatron contracts, that presentlyrepresent a major portion of our current activity, are on a cost plus fixed feebasis. This means all work performed is done at Ionatron government-approvedrates,
which include general and administrative costs, overhead, labor and materials,fees and profit. These costs are accrued as incurred and billed monthly. Othercontracts are at fixed prices which have commercial type gross marginsassociated with them.
RISKS AND UNCERTAINTIES
Future results of operations of Ionatron involve a number of known andunknown risks and uncertainties. Factors that could affect future operatingresults and cash flows and cause actual results to vary materially fromhistorical results include, but are not limited to:
- Failure or difficulties in managing our operations, including attracting and retaining qualified personnel;
- Failure or inability to attain profit levels necessary to sustain our business
- Interruption or failure of, or failure to manage, our technology and information systems;
- Changes in government policy, regulation and enforcement or adverse judicial or administrative interpretations and rulings or legislative action relating to procurement regulations, enforcement and pricing;
- Availability of budgetary allocations for governmental agencies to purchase our products;
- Inability to adapt to technological change;
- Inability to successfully manufacture and assemble our products;
- Competition from defense contractors with greater financial and manufacturing resources;
- Dependence upon sales to the U.S. government;
- Sales agreements with the U.S. government typically provide for termination at any time and may contain unfavorable terms;
- Dependence on qualified subcontractors for parts of our research and development activities;
- Inability to raise sufficient financing for expanded manufacturing and assembly activity;
- Failure to successfully field test our weapon products;
- Inability to collect amounts due to us from our customers; and
- Our failure to provide adequate customer service.
Negative developments in these areas could have a material effect onour business, financial condition and results of operations.
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