e10ksb

U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-KSB

(Mark one)


þ		ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2006


o		TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________ to _______________

Valentec Systems, Inc.

(Name of Small Business Issuer In Its Charter)


		2629 York Avenue
Delaware	59-2332857	Minden, LA 71055
(State or other jurisdiction	(IRS Employer	(Address of principal executive offices) (Zip Code)
of incorporation)	Identification No.)

Registrant’s telephone number, including area code: (318) 382-4574

Common Stock, par value $.001 per share

(Title of Class)

Securities Registered Under Section 12(b) of the Exchange Act: Common Stock, $0.01 par value

Securities Registered Under Section 12(g) of the Exchange Act: None

Check whether the issuer is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. o

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act, as amended (the “Exchange Act”) during the past 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 [ ]

Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [X]

Indicate by check mark whether the issuer is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]

Issuer’s revenues for its most recent fiscal year ended December 31, 2006 were: $19,624,038

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was sold, or the average bid and asked price of such common equity as of a specified date within the past 60 days, was: $3,107,633

There were 15,538,165 shares of the Issuer’s common stock outstanding on April 9, 2007.

Documents incorporated by reference: None

PART I

Item 1. Description of Business

This annual report contains forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as “may”, “will”, “should”, “expects”, “plans”, “anticipates”, “believes”, “estimates”, “predicts”, “potential” or “continue” or the negative of these terms or other comparable terminology. These statements are only predictions and involve known and unknown risks, uncertainties and other factors, including the risks in the section entitled “Risk Factors”, that may cause our company’s or our industry’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Except as required by applicable law, including the securities laws of the United States, we do not intend to update any of the forward-looking statements to conform these statements to actual results.

Our financial statements are stated in United States Dollars (US$) and are prepared in accordance with United States Generally Accepted Accounting Principles. In this annual report, unless otherwise specified, all dollar amounts are expressed in United States dollars and all references to “common shares” refer to the common shares in our capital stock.

As used in this annual report, the terms “we”, “us”, “our”, “the Company”, “Acorn” and “Valentec” means Valentec Systems, Inc. (which operated under the name Acorn Holding Corp. until April 10, 2006) and our wholly-owned subsidiary, Valentec Operating Corp. The term “Subsidiary” refers to Valentec Operating Corp., which previously operated under the name “Valentec Systems, Inc.” until April 10, 2006.

General

The Company formerly was incorporated under the laws of the State of Delaware on September 8, 1983. In fiscal year 2002, the Company operated as a holding company with one wholly owned subsidiary, Recticon Enterprises, Inc. (“Recticon”), and its principal business was the derivation of earnings from the operation of Recticon. Recticon manufactured two, three, four, five and six-inch monocrystalline silicon wafers, which were used by university research departments and microelectronic manufacturers. On June 23, 2003, the Company announced that Recticon had been advised by Recticon’s principal customer that the demand for Recticon’s products would not increase and there would be a sharp erosion in the price for such products going forward. The Board of Directors of Recticon and the Company determined that, since the Company did not have the financial resources to sustain the anticipated operating losses of Recticon and to try to limit the further erosion of Recticon’s assets, the management of Recticon was authorized to liquidate the assets of Recticon. As of December 31, 2003, all Recticon assets were liquidated and the Company became a public shell and remained a public shell until its acquisition of Valentec Operating Corp. (formerly Valentec Systems, Inc.) on June 6, 2005. As a result of the acquisition, Valentec Operating Corp. became a wholly owned subsidiary of the Company, and the principal business of Valentec became the derivation of earnings from the operation of the Subsidiary.

Valentec Operating Corp., the Subsidiary, was incorporated in Delaware on May 1, 1998. Valentec Operating Corp. designs, develops, manufactures, and sells ammunition and light weapons for military use. From January 1998 through January 2006, the Subsidiary’s business involved manufacturing armaments and providing property management services to the United States Army by maintaining the Army’s Louisiana Army Ammunition Plant and recruiting new tenants. This work involved infrastructure maintenance and evaluation of environmental considerations and physical security. However, beginning in 2003, Valentec began devoting significant time and money to realign its business to focus on more profitable business segments such as Systems Management/Systems Integration, Energetic Manufacturing and Metal Parts Manufacturing.

In order to build a strong strategic portfolio and to improve profitability, Valentec has focused on the following growth strategies and objectives:

	•		Enhance marketing and business development in foreign government agencies to increase sales and backlog.

	•		Acquisitions that complement existing operations.

	•		Capitalize on our systems management and systems integration experience with Soltam Systems and the Israeli Defense Forces to market the same capability to the United States Army.

	•		Expand energetic manufacturing from current 40mm to 105mm and 155mm.

Recent Developments

On April 10, 2006, after receipt of shareholder approval pursuant to a written consent, the Company (1) changed its name to Valentec System, Inc. on April 10, 2006 and (2) the capital stock of the Company was increased to 260,000,000 shares, with 250,000,000 authorized shares of common stock and 10,000,000 authorized shares of preferred stock.

The Company entered into an employment agreement with Robert A. Zummo effective as of January 1, 2006. The terms and conditions of this employment agreement are set forth in “Item 10. Executive Compensation.”

Also, on April 10, 2006, the Company changed the name of its operating subsidiary from Valentec Systems, Inc. to Valentec Operating Corp.

Description of Business

Valentec’s current business pursuits are categorized into 3 major product lines: Systems Management/System Integration, Energetic Manufacturing, and Metal Parts Manufacturing. These product lines are operated by Valentec Operating Corp.

Systems Management / Systems Integration

120MM Mortar Weapon System with Electronic Fire Control — “KESHET”

Valentec was awarded a system contract from Soltam Systems, Inc., a related party, for the production and integration of RMS6 120mm Mortar Weapon System for the Israeli Defense Forces (“IDF”) using U.S. Foreign Military Financing as described herein on page five. The mortar weapon system will be fitted with an Electronic Fire Control System and will be integrated into the M1064A3 Mortar carrier as well as the towed platform. Valentec Systems Inc. successfully completed assembly of the first RMS6 Mortar Weapon. Valentec anticipates that the remaining 81 RMS6 Mortar Weapons will be assembled and delivered in 2007.

Keshet (Hebrew for bow) 120mm self propelled mortar contains state of the art command, control and communication devices and offers infantry and armor commander unique enhanced operational capabilities. Improvements in inertial navigation systems further enhance the accuracy in target and weapon location and, combined with a more sophisticated laying system, it greatly increases the accuracy of mortar ammunition delivery. We believe that our 120mm Mortar Weapon System offers significant advantages in firepower, area coverage, tactical mobility, flexibility and survivability.

The program consists of technology transfer, configuration control, procurement, assembly, integration and testing of the 120MM Mortar Weapon System with Electronic Firing Control. It is anticipated a total of 82 complete integrated systems and 12 equivalent spare parts of the system will be delivered under this contract to the IDF for approximately $16,745,000. Valentec Systems Inc. was awarded an additional contract in March 2007 for the integration of the RMS6 Mortar Weapon into a 106AA3 Mortar Carrier and the modification of an ammunition carrier. The contract is valued at approximately $3.6 million.

Valentec has placed purchase orders with two forging houses and four other prime vendors for major subcomponents and has also placed numerous purchase orders with a host of smaller vendors for the parts necessary to assemble the system. Subcomponent deliveries have been timed to ensure an arrival that closely coincides with Valentec’s production schedule, yet leverages quantity and bulk buys.

Valentec is also responsible for the quality of all components and the reliability of each system. To this end, Valentec has tasked their vendors with a variety of tests and procedures intended to verify and validate compliance to specifications, functionality, and reliability. These tests include First Article Tests, fire control calibration tests, and function testing.

Mortar Ammunition

Valentec was awarded a 2-year systems integration and management contract in early 2005 from Soltam Systems to assemble and deliver mortar ammunition for the IDF using U.S. Foreign Military Financing. The mortar ammunition will be provided in 120mm, 81mm, and 60mm rounds with a contract value of approximately $20,000,000 over a two year period. The 120mm and 60mm were ordered with two different explosive fillers each and the 81mm was ordered in a single configuration for a total of five different rounds. Deliveries will begin in 4^th quarter 2007.

Mortars are used in the infantry or in a mechanized company against troops, light vehicles or similar targets or for incendiary and smoke spotting purposes. When a mortar round is loaded into the mortar firing system, it slides down the tube until a fixed firing pin at the bottom of the barrel ignites the ignition cartridge. The energy from the ignition cartridge ignites the propellant charge. Rapidly expanding gases from the burning propellant accelerates the round and launches it in its ballistic trajectory. The mortar is aerodynamically stabilized in flight by its fins. The fuse is armed after the projectile passes a minimum safe separation distance and, on impacting the ground, the fuse explodes the high explosive charge that shatters the shell body fragments, which are then propelled toward the target. Some mortars are designed to explode at a low height above the ground for maximum lethalness.

Valentec has placed purchase orders with 11 prime vendors for major subcomponents and numerous purchase orders with a host of smaller vendors for the parts necessary to assemble the ammunition. Subcomponent deliveries have been timed to ensure an arrival that closely coincides with Valentec’s production schedule, yet leverages quantity and bulk buys.

In addition to the procurement of necessary sub-components, Valentec is also responsible for the quality of these components and, of course, the quality and reliability of each mortar. To this end, Valentec has tasked their vendors with a variety of tests and procedures intended to verify and validate compliance to specifications, functionality, and reliability. These tests include First Article Tests, weight calibration and verification, and function testing. First Article Tests are required performance tests prior to acceptance by the U. S. Army.

In support of this major production effort, additional manufacturing space was leased and equipped with unique fixtures and tooling. As 120mm, 81mm and 60mm mortar ammunition is not unique to the IDF, we believe the facilitization accomplished by Valentec for this program has positioned us well to compete successfully on future mortar ammunition contracts in domestic and overseas markets.

In the Systems Management / Systems Integration segment, our sources and availability of raw materials present no unique challenges with the exception of obtaining M8M propellant from BMJ of Herzegovina. This requires import licensing for materials and export licenses for delivery of the complete product to Israel. Also, part of the State Department process mandates the provision of End User certificates. All of these requirements are known and actions are in process. Our primary suppliers for the Systems Management / Systems Integration projects are:


•	BMJ Belgrade, Herzegovina	M8M Propellant
•	Accurate Energetics, McCuen, TN	Explosive Loading
•	Medico, Wilkes-Barre, PA	Metal Parts
•	POCAL	Metal Parts


•	Lockheed-Martin, Scranton, PA	Metal Parts
•	Greene Tweed, Kulpsville, PA	O-ring & Seals
•	Pyrotechnics by Grucci	Explosive Increments

Energetic Manufacturing

Our energetic business includes various flares and simulators with multiple end uses. The flares can be used for illumination and/or signaling. The simulators are used for training purposes to simulate a battlefield environment. In the flare work, we are a member of a team that in May of 2005 was awarded a planned 5-year procurement of 40MM flares. Valentec’s part of this award is to produce 40MM, M583, White Star Parachute, flares. We believe this opportunity has a potential value of up to $50 million over 5 years dependent on assigned option quantities. The option year quantities are totally dependent on the annual appropriation authorized by the U.S. Congress as supported by the user (Army, Navy, Marines) community.

We believe that there are multiple additional areas/opportunities for pursuit in the pyrotechnic arena. We have successfully manufactured several test devices, which exhibit illumination and burn times that are significantly greater than specification requirements.

Energetic Manufacturing requires appropriate licensing by the Bureau of Alcohol, Tobacco, Firearms, and Explosives (BATFE) before conducting any energetic operations. We believe that we have completed all known applications and obtained all known licences. Additionally, a safety site application must be presented to the Defense Contract Management Agency (DCMA) for review and approval, which is complete and in place. Our primary suppliers are:


•	GOEX, Inc., Minden, LA	Black Powder
•	ATK, Radford, VA	Propellant
•	Flexible Concepts, Elkhart, IN	Metal Component
•	Woodlawn Manufacturing, Marshall, TX	Metal Component
•	B & T Screw, Bristol, CT	Metal Component
•	Spaulding Composites, Rochester, NH	Plastic Component

Metal Parts Manufacturing

The current U.S. government metal parts work consists of a contract for 83,508 units of 105MM, M14B4, Spiral Wrapped Cartridge Case (SWCC). This contract value is approximately $3.25 million with completion anticipated in 2007. We believe there will be a significant foreign interest once the success of our program is realized. Valentec has produced a large volume of these products in the past. We believe that the cost of this product is significantly less than the more traditional drawn/forged cartridge case and exhibits more insensitive munitions (IM) value than the solid cartridge cases. We believe that the use of this design (SWCC) should provide Valentec an advantage for the upcoming 105MM Illumination round requirements for the U.S. Army.

In addition, Valentec is evaluating several other metal part manufacturing opportunities, which will be procured in 2007 by U. S. Army.

Metal parts manufacturing and more specifically the spiral wrap cartridge case has only 4 primary components, and no specialty materials. Further, there are no exceptional government approvals required. Our primary suppliers are:


•	Vy-Comp, Shreveport, LA	Metal Components
•	Northwest Stamping, St. Louis, MO	Metal Components
•	Alta Max, New Orleans, LA	Packaging

Foreign Work

Valentec’s foreign business pursuits are associated with two contracting methods, “foreign military sales” and “foreign military financing.” A description of each method follows.

•

Foreign Military Sales

The foreign military sales program is the government-to-government method of selling U.S.defense equipment, services, and training. The program is managed by the Defense Security Cooperation Agency within the U.S. Department of Defense. Valentec participates in the program as a known supplier to approved foreign governments through a marketing network established in the foreign countries. Department of Defense Manual 5105.38-M describes the specific details concerning the program requirements.

The U.S. Department of Defense has launched a major effort to reform the current foreign military sales system and to ensure that this valuable program remains viable into the next millennium. This reform effort will focus on improving the foreign military sales system’s performance and adopting better business practices whenever possible. Currently, Valentec does not believe these anticipated changes will adversely affect its business. The foreign military sales program manages government-to-government purchases of weapons and other defense articles, defense services, and military training. The military of a foreign country buying weapons through the foreign military sales program does not deal directly with the business that manufactures the weapons, but rather, the Defense Department serves as an intermediary, usually handling procurement, logistics and delivery and often providing product support and training.

•

Foreign Military Financing

The foreign military financing program provides grants and loans to help foreign countries purchase U. S. produced weapons, defense equipment, defense services and military training through the foreign military sales program described above. On a much less frequent basis, foreign military financing also funds purchases made through the direct commercial sales program (described below), which oversees sales between foreign governments to private U.S. companies. Foreign military financing does not provide cash grants to other countries; it generally pays for sales of specific U. S.-manufactured goods or services through foreign military or direct commercial sales.

The State Department’s Bureau of Political-Military Affairs sets policy for the foreign military financing program, while the Defense Security Cooperation Agency, within the Defense Department, manages it on a day-to-day basis. Security assistance organizations and military personnel in U.S. embassies overseas play a key role in managing foreign military financing within recipient countries. Congress appropriates funds for foreign military sales through the yearly Foreign Operations Appropriations Act.

Foreign military financing exists primarily to fund arms transfers, as military training is normally granted through the International Military Education and Training Program. However, foreign military financing does support some of the training activities.

The Contracting Process

Valentec has Marketing / Sales representation at two of its largest customer locations in the United States: (1) Picatinny Arsenal in Dover, New Jersey and (2) the Joint Munitions Command in Rock Island, Illinois. These representatives keep Valentec informed as to any new business opportunities that are on the horizon that would fit into the company’s capabilities, and therefore, allows Valentec to conduct proposal activities prior to the actual receipt of any solicitation or request for a proposal. Typically, these solicitations or requests are of a “Best Value” evaluation criteria, meaning that the evaluation is based on many factors (not only price) such as past performance, quality assurance plans, manufacturing approach, etc. This kind of evaluation requires extensive proposal writing skills and we often use outside consultants who specialize in writing proposals that are responsive to the requirements of U.S. Government customers.

Typically, the U.S. Government allows 60 days for contractors to respond to their solicitations or requests for proposals. They, in turn, will take anywhere from 60 days or longer to conduct their evaluations and make the ultimate contract award. Most contracts are of a 12-month duration and require a First Article Test prior to the start of production. The U.S. Army has the ability to exercise option quantities under each contract.

With regard to international sales, Valentec uses Valentec International Limited of the United Kingdom and Soltam Systems, Inc. (“Soltam”) of Israel to market its products and capabilities. Each of these business entities is controlled by shareholders of the Company. All of Valentec’s international business has been through either foreign military sales or direct sales to the foreign country. In either case, the customer must submit to Valentec an “End User Certificate” that states who the End User will be. That End User Certificate is submitted to the U.S. State Department along with an entire copy of the contract between Valentec and its foreign customer. For example, if Valentec has a contract with Soltam to supply both weapon systems and ammunition for mortars, and Soltam Systems, Inc. in turn, has a contract with the Israeli Defense Forces for the same product, then the Israeli Defense Forces would be the End User. Because funds for this procurement would likely involve U.S. military grant dollars to Israel, the products would have to be manufactured in the United States. Valentec would ultimately ship these products by sea to the required location. Or, if Valentec had a contract with Valentec International Limited to supply 40mm illuminating rounds of ammunition to a country other than Israel, through a direct sale; i.e., no foreign military funds, the requirements for End User Certificate would still apply before the U.S. State Department would approve the sale. The end product would be produced by Valentec and shipped directly to the foreign customer.

Any and all foreign sales require End User Certificates and the U. S. State Department’s approval.

Customers

Soltam Systems, Inc.

Valentec has received an order from Soltam for the production and integration of the Keshet\RMS6 120mm Mortar Weapon System for the Israeli Defense Forces. The mortar weapon system will be fitted with an Electronic Fire Control System and will be integrated in to M1064A3 Mortar carriers as well as towed platforms. Delivery of the Mortar System will begin in the second quarter of 2007 and is anticipated to be completed in 2007.

The Keshet 120mm self propelled mortar contains state of the art command, control and communication devices and offers infantry and armor commanders unique enhanced operational capabilities. Improvements in inertial navigation systems further enhance the accuracy in target and weapon location and, combined with a more sophisticated laying system, it greatly increases the accuracy of mortar ammunition delivery. We believe that the 120mm mortar system offers significant advantages in firepower, area coverage, tactical mobility, flexibility and survivability.

The Keshet 120mm mortar is a Soltam design. The mortar weapon system will be produced at Valentec’s manufacturing facility in Minden, Louisiana. Valentec expects to complete this order in December 2007.

The program consists of technology transfer, configuration control, procurement, assembly, integration and testing of a 120MM Mortar Weapon System with electronic firing control. It is anticipated that, a total of 82 complete integrated systems and 12 equivalent spare parts of the system will be delivered under this contract to Soltam Systems, Inc. which in turn will deliver them to the End User, the IDF.

In addition, Valentec was awarded a 2-year systems integration and management contract in early 2005 from Soltam to assemble and deliver mortar ammunition to Soltam Systems, Inc. for delivery to the Israeli Defense Forces. The mortar ammunition will be provided in 120mm, 81mm, and 60mm rounds. The 120mm and 60mm were ordered with two different explosive fillers each and the 81mm was ordered in a single configuration for a total of five different rounds. Deliveries began in late 2006 and Valentec anticipates deliveries will be completed in December 2007.

DSE, Inc.

DSE, Inc., located in Tampa, Florida is a significant contractor for procurement of 40mm products. DSE, Inc. has ordered 266,816 40mm, M583 products from Valentec for deliveries in 2007 and 2008. Valentec expects to start the deliveries in May 2007. DSE, Inc. has been awarded U.S. Government Contract #W52P1J-05-O-0036. This contract pertains to the 40MM family of munitions and is projected to cover the next five years. Valentec has been named as the sub-contractor to produce the Illumination Rounds found in this contract. In the solicitation, the US Government estimated the annual requirement for Illumination Rounds would be 200,000 to 300,000 rounds per year. This would indicate substantial sales for Valentec dependent upon which option quantity the U.S. Government decides to procure.

Kingdom of Saudi Arabia

Valentec is currently fulfilling a contract received on assignment from Valentec International Limited to provide 250 M583A1 40mm illuminating parachutes and 500 M992 40mm IR and 200 40MM LV Smoke munitions for the Kingdom of Saudi Arabia. We anticipate completion of this purchase order in the fourth quarter of 2007.

U.S. Government

Valentec is currently fulfilling contracts from the U. S. Army for multiple products.

	•		83,508 — Spiral Wrap Cartridge Cases M14B4

	•		3,904 — 40MM White Star Cluster M585

	•		266,816 — 40MM White Star M583

The U. S. Army can exercise option quantities under each contract with Valentec.

Employees

Our current employees consist of the following:


•	Management	9
•	Accounting, Administrative, Contracts, Materials	7
•	Quality/Technical	10
•	Manufacturing	15

	Total Employees	41

All employees are employed full time. Valentec currently has no collective bargaining agreements with its employees and believes that it has good relations with them. On December 28, 2004, prior to the expiration of the facilities management agreement with the Louisiana National Guard, certain employees involved in plant security duty were members of the International Guard Union of America (I.G.U.A.) Local 81. With the expiration of the agreement and the resulting loss of employment, these employees filed a union membership grievance with Valentec, which has been turned over to the American Arbitration Association. We believe that the claim is without merit and any ruling by the American Arbitration Association would have minimum impact on earnings. An arbitration hearing was held on March 5, 2007. On April 6, 2007, the Arbitrator ruled in favor of Valentec Systems, Inc. and denied all claims of the Union. Since arbitration decisions are final and not appealable, the decision concludes the Union Grievance litigation.

Valentec sponsors a 401(k) retirement savings plan, which is categorized as a defined contribution plan. The plan is available to full time employees who meet the plan’s eligibility requirements.

On January 7, 2007, Valentec adopted the 2006 Equity Incentive Plan for the benefit of the employees, consultants and directors of the Company and of any affiliate thereof and reserved 2,000,000 shares of Common Stock designated for allocation under the plan. The reserved shares may be allocated under the plan either as (i) Incentive Stock Option or Non-Qualified Stock Option, or (ii) Restricted Stock.

Competition

Valentec’s competitors range from local firms to worldwide foreign and domestic firms depending on the business segment being considered. In general our competitors are better capitalized and more experienced than Valentec. Some competitive considerations for our business segments are as follows:


Business Segment		Competition

Systems Management / Systems Integration		Mostly large businesses such as General Dynamics and Alliant Tech Systems.

Energetic Manufacturing		All U.S. based small business firms with pyrotechnic capability. Primary competitors are: PSI, Inc., Martin Electronics, and Lance Ordnance.

Metal Parts Manufacturing		Valentec is not aware of any competition for its current 105MM Spiral Wrap Cartridge Case.

Government Regulations

In addition to all the federal laws regarding labor, safety and the environment, Valentec believes that it complies with all regulatory provisions that are identified in our various contracts. These provisions range from the Strom Thurmond National Defense Authorization Act, Public Law 105-261 (also known as the Buy American Act), to contracting with small disadvantaged business, to ozone depleting chemical prohibitions. In addition, Valentec is subject to regulations, which require it to discontinue operations pending root cause analysis and investigation associated with the occurrence of a critical defect. After ceasing operations, doing all the analytical work and discussing with multiple customer technical representatives, the contractor may be allowed to resume operations after implementation of all required corrective actions. Similar requirements will soon be added to all Department of Defense contract provisions; however, this requirement does not apply to foreign military sales or foreign military financing contracts.

Research and Development

Valentec has a continuous program of product — process improvement and of maintaining manufacturing flexibility to allow the addition of new products and processes to existing facilities. In addition the company is introducing three new systems to improve performance:

1. Enterprise Resource System

Valentec began in 2005 the implementation of an Enterprise Resource Planning (ERP) software system to manage all phases of the business on an integrated database. Additional computer hardware was added to the system which automatically integrates Purchasing and Supplier Management Production Planning, Scheduling and Inventory Management in real-time. The information provided will drive corrective actions that will mitigate risks and ensure that the manufacturing process supports contractual delivery commitments. This process was halted in early 2007 pending results of our acquisition of MAST, as detailed below in item 6, with the possible utilization of an ERP System in place at MAST.

2. Six Sigma Implementation

The Company has begun in the first quarter of 2006 the introduction of Six-Sigma methodology for planning and manufacturing. Key management personnel are being trained by a staff Six-Sigma Green Belt regarding Six-Sigma principles and methodology and tools for the evaluation of manufacturing process improvements.

In addition, the Company’s staff Green Belt attended additional training in 2006 that resulted in his achieving Black Belt status. Follow-on training will then be provided to key individuals to develop them into Green Belts who will identify and lead process improvement projects throughout the life of a contract.

3. ISO-9000 Certification

The company is actively pursuing ISO-9000-2000 Certification. It is the company’s goal to be ISO 9000-2000 certified by year-end 2007. This certification was delayed in 2006 due to a catastrophic fire experienced on the 40MM production line of Valentec Systems Inc and the resources required for expedited recovery.

Compliance with Environmental Laws

Environmental issues are no more difficult for munitions manufacturing than other energetics operations. However, to help with compliance, Valentec employs an environmental affairs coordinator to perform periodic operations audits and implement corrective actions and/or regulatory reporting, when required. Valentec does not anticipate that compliance with any laws or regulations relating to environmental protection will have a material effect on its capital expenditures, earnings or competitive position.

Pursuant to a 1994 environmental class action settlement, Valentec Dayron Corporation (currently Valentec Systems) along with Boise Cascade Corporation, Dictaphone Corporation, Harris Corporation, Martin Marietta Corporation, Medalist Industries, Inc and Rockwell International, Inc (herein Members) signed the Woodco Site Custody Account Agreement, dated October 5, 1994 as amended January 28, 2005 which established the “Woodco Site Custody Account” for the purposes of disbursing funds necessary to satisfy the obligations of the Members. Valentec’s current obligation is $3,474 in total for the years 2007, 2008 and 2009.

Intellectual Property / Trade Secrets

Valentec has not filed for any patents or trademarks. However, Intellectual property, trade secrets, proprietary rights and licenses are very important to product development and process improvements. Exclusive and non-exclusive licenses may be acquired from time to time. All salaried employees are subject to a confidentiality and non-compete agreement.

Investment Policies

Our current policy is to acquire assets primarily for income purposes, although we may in the future determine to make investments for purposes of seeking capital gains. Currently, there are no policy limitations on the nature of investments that we may make or the percentage of our assets, which may be invested in any one investment or type of investment. We may change our policy regarding investments, from time to time, without approval of our stockholders.

RISK FACTORS

Risks Related to Operations

WE MAY BE UNABLE TO SECURE NECESSARY EXPORT LICENSES, WHICH COULD ADVERSELY IMPACT OUR BUSINESS

United States law requires that Valentec obtain a government-issued export license to ship its ammunition products to other countries for each order it receives. Valentec could be forced to decline an order from a customer due to refusal of the government to issue the export license. Such refusals would be based on actual or perceived deficiencies of the recipient country’s government or other reasons. Failure to obtain an export licenses for sales to

Valentec’s traditional customer base could adversely affect our operations and financial results.

WE MAY EXPERIENCE PRODUCT FAILURES, SCHEDULE DELAYS OR OTHER PROBLEMS WITH EXISTING OR NEW PRODUCTS AND SYSTEMS, ANY OF WHICH COULD ADVERSELY IMPACT OUR BUSINESS.

We may experience product and service failures, schedule delays and other problems in connection with the manufacture or delivery of our products. In addition to any costs resulting from product warranties, contract performance, or required remedial action, these failures may result in increased costs or loss of revenues due to postponement of subsequently scheduled product and service deliveries. Performance penalties could also be imposed should we fail to meet delivery schedules or other measures of contract performance.

OUR REVENUE CONTINUES TO BE CONCENTRATED AMONG A SMALL NUMBER OF CUSTOMERS.

A significant percentage of our revenue is concentrated among a relatively small number of end-user customers. During the last five (5) calendar years, the U.S. Army, the U.S. Department of Defense, and the Government of Israel have provided the majority of our revenues, and currently we are substantially dependent on our contracts with Soltam. The loss of Soltam as a customer or the loss of any other significant customer or a substantial decrease in sales to such a customer would have a material adverse effect on our revenue and operating results.

OUR SUPPLIERS COULD BE LATE IN DELIVERY OF KEY SUPPLIES, WHICH WOULD DELAY OUR PRODUCTION AND HAVE A NEGATIVE IMPACT ON OUR FINANCIAL RESULTS.

Valentec’s operations are dependent on the ability of certain suppliers to deliver supplies on a timely basis. From time to time, we have experienced delays in receipt of needed supplies which has caused delays in Valentec’s production activities and which in turn has resulted in delays in recognition of revenue under the percentage of completion method of accounting.

OUR BUSINESS IS SUBJECT TO MANY FACTORS THAT COULD CAUSE OUR QUARTERLY OR ANNUAL OPERATING RESULTS TO FLUCTUATE AND OUR STOCK PRICE TO BE VOLATILE.

Our quarterly and annual operating results have fluctuated in the past and may fluctuate significantly in the future due to a variety of factors, many of which are outside of our control. If our quarterly or annual operating results do not meet the expectations of the investor community, the trading price of our common stock could significantly decline. Some of the factors that could affect our quarterly or annual operating results include:

	•		the timing and amount of, or cancellation or rescheduling of, orders for our products;

	•		our ability to develop, introduce, ship and support new products and product enhancements and manage product transitions, announcements, and new product introductions;

	•		our ability to achieve cost reductions;

	•		our ability to achieve and maintain production volumes and quality levels for our products;

	•		the volume of products sold and the mix of distribution channels through which they are sold;

	•		the loss of any one of our major customers or a significant reduction in orders from those customers; and

	•		increased competition, particularly from larger, better capitalized competitors.

Due to these and other factors, quarterly revenue, expenses and results of operations could vary significantly in the future, and period-to-period comparisons should not be relied upon as indications of future performance.

OUR FUTURE PERFORMANCE WILL DEPEND, IN PART, ON OUR ABILITY TO MANAGE OUR BUSINESS GROWTH EFFECTIVELY, AND THERE IS NO ASSURANCE THAT WE WILL BE ABLE TO SUCCESSFULLY GROW OR MANAGE SUCH GROWTH, WHICH MAY DIMINISH OUR CHANCES OF ACHIEVING PROFITABILITY.

Our future performance will depend, in part, on our ability to manage our business growth effectively. Towards that end, we will have to undertake the following tasks, among others:

•

Effectively enhance our operating, administrative, financial, and accountings systems and controls;

•

Establish and continuously improve coordination among our engineering, accounting, finance, marketing, and operations personnel; and

•

Develop and continuously enhance our management information systems capabilities.

WE MAY EXPERIENCE PRODUCT FAILURES, SCHEDULE DELAYS OR OTHER PROBLEMS WITH EXISTING OR NEW PRODUCTS AND SYSTEMS, ANY OF WHICH COULD ADVERSELY IMPACT OUR BUSINESS.

We may experience product and service failures, schedule delays and other problems in connection with the manufacture or delivery of our products. In addition to any costs resulting from product warranties, contract performance or required remedial action, these failures may result in increased costs or loss of revenues due to postponement of subsequently scheduled product and service deliveries. Performance penalties could also be imposed should we fail to meet delivery schedules or other measures of contract performance.

WE ARE NOT ABLE TO GUARANTEE THAT CONTRACT ORDERS INCLUDED IN OUR ESTIMATED BACKLOG WILL RESULT IN ACTUAL REVENUES IN ANY PARTICULAR FISCAL PERIOD OR THAT THE ACTUAL REVENUES FROM SUCH CONTRACTS WILL EQUAL OUR ESTIMATED BACKLOG.

There can be no assurance that any contracts included in our estimated backlog presented in this filing will result in actual revenues in any particular period or that the actual revenues from such contracts will equal our estimated backlog. Further, there can be no assurance that any contract included in our estimated backlog that generates revenue will be profitable.

WE ARE DEPENDENT UPON KEY PERSONNEL WHO WOULD BE DIFFICULT TO REPLACE AND WHOSE LOSS COULD IMPEDE OUR DEVELOPMENT.

We are highly dependent on Robert A. Zummo and Stephen Shows to manage our businesses, and their knowledge of business, management skills and technical expertise would be difficult to replace. The loss of these key employees could limit or delay our ability to develop new products and adapt existing products to our customers’ evolving requirements and would also result in lost sales and diversion of management resources. Because of competition for additional qualified personnel, we may not be able to recruit or retain necessary personnel, which could impede development or sales of our products. Our growth depends on our ability to attract and retain qualified, experienced employees. There is substantial competition for experienced engineering, technical, financial, sales and marketing personnel in our industry. If we are unable to retain our existing key personnel, or attract and retain additional qualified personnel, we may from time to time experience inadequate levels of staffing to develop and market our products and perform services for our customers.

OUR EMPLOYEES MAY ENGAGE IN IMPROPER ACTIVITIES WITH ADVERSE CONSEQUENCES TO OUR BUSINESS.

As with other government and other contractors, we are faced with the possibility that our employees may engage in misconduct, fraud or other improper activities that may have adverse consequences to our prospects and results of operations. Misconduct by employees could include failures to comply with U.S. federal government regulations, violation of requirements concerning the protection of classified information, improper labor and cost charging to contracts and misappropriation of government or third party property and information. The occurrence of any such employee activities could result in our suspension or debarment from contracting with the U.S. federal government, as well as the imposition of fines and penalties, which would cause material harm to our business.

DUE TO THE VOLATILE AND FLAMMABLE NATURE OF OUR PRODUCTS, FIRES OR EXPLOSIONS MAY DISRUPT OUR BUSINESS.

Many of our products involve the manufacture and/or handling of a variety of explosive and flammable materials. These activities may result in incidents which may shut down or otherwise disrupt manufacturing processes, cause production delays and result in liability for workplace injuries and fatalities. On August 14, Valentec experienced a small detonation in an unattended (by personnel) granulation process at its Louisiana facility. This detonation occurred in a facility that had concrete walls and was self-contained, however, the resulting fire completely destroyed 75,000 square feet of space at this manufacturing facility, completely eliminating our existing 40mm flare capability. We were leasing this facility from the State of Louisiana and had obtained the required insurance coverage. Currently, we are engaged in ongoing discussions with the State of Louisiana concerning the responsibility for rebuilding of this 65-year old facility and for debris removal because some of the original construction material contains small amounts of asbestos. Valentec contends that the insurance coverage as required by the lease was in place and that such insurance should cover any liability on the part of Valentec. Valentec has safety and loss prevention programs which require detailed pre-construction reviews of process changes and new operations, along with routine safety audits of operations involving explosive materials, to mitigate such incidents, as well as a variety of insurance policies. However, Valentec cannot ensure that it will not experience similar incidents in the future or that any similar incidents will not result in production delays or otherwise have a material adverse effect on its results of operations, financial condition, or cash flows.

Risks Related to our Industry

OUR BUSINESS COULD BE ADVERSELY IMPACTED BY REDUCTIONS OR CHANGES IN U.S. GOVERNMENT MILITARY SPENDING.

Our business is substantially dependent on U.S. Government contracts. U.S. Government contracts are dependent on the continuing availability of Congressional appropriations. Congress usually appropriates funds for a given program on a fiscal year basis even though contract performance may take more than one year. As a result, at the outset of a major program, the contract is usually incrementally funded, and additional monies are normally committed to the contract by the procuring agency only as Congress makes appropriations for future fiscal years. In addition, most U.S. Government contracts are subject to modification if funding is changed. Any failure by Congress to appropriate additional funds to any program in which we participate, or any contract modification as a result of funding changes, could materially delay or terminate the program. These delays or terminations could have a material adverse effect on our operating results, financial condition, or cash flows.

WE MAY NOT BE ABLE TO REACT TO INCREASES IN COSTS DUE TO THE NATURE OF U.S. GOVERNMENT CONTRACTS.

Our U.S. Government contracts can be categorized as either “cost-plus” or “fixed-price.”

Cost-Plus Contracts. Cost-plus contracts are cost-plus-fixed-fee, cost-plus-incentive-fee, or cost-plus-award-fee contracts. Cost-plus-fixed-fee contracts allow us to recover our approved costs plus a fixed fee. Cost-plus-incentive-fee contracts and cost-plus-award-fee contracts allow us to recover our approved costs plus a fee that can fluctuate based on actual results as compared to contractual targets for factors such as cost, quality, schedule, and performance.

Fixed-Price Contracts. Fixed-price contracts are firm-fixed-price, fixed-price-incentive, or fixed-price-level-of-effort contracts. Under firm-fixed-price contracts, we agree to perform certain work for a fixed price and absorb any cost underruns or overruns. Fixed-price-incentive contracts are fixed-price contracts under which the final contract prices may be adjusted based on total final costs compared to total target cost, and may be affected by schedule and performance. Fixed-price-level-of-effort contracts allow for a fixed price per labor hour, subject to a contract cap. All fixed-price contracts present the inherent risk of unreimbursed cost overruns, which could have a material adverse effect on operating results, financial condition, or cash flows. The U.S. Government also regulates the accounting methods under which costs are allocated to U.S. Government contracts.

OUR U.S. GOVERNMENT CONTRACTS ARE SUBJECT TO TERMINATION.

We are subject to the risk that the U.S. Government may terminate its contracts with its suppliers, either for its convenience or in the event of a default by the contractor. If a cost-plus contract is terminated, the contractor is entitled to reimbursement of its approved costs. If the contractor would have incurred a loss had the entire contract been performed, then no profit is allowed by the U.S. Government. If the termination is for convenience, the contractor is also entitled to receive payment of a total fee proportionate to the percentage of the work completed under the contract. If a fixed-price contract is terminated, the contractor is entitled to receive payment for items delivered to and accepted by the U.S. Government. If the termination is for convenience, the contractor is also entitled to receive fair compensation for work performed plus the costs of settling and paying claims by terminated subcontractors, other settlement expenses, and a reasonable profit on the costs incurred or committed. If a contract termination is for default:

•

the contractor is paid an amount agreed upon for completed and partially completed products and services accepted by the U.S. Government,

•

the U.S. Government is not liable for the contractor’s costs for unaccepted items, and is entitled to repayment of any advance payments and progress payments related to the terminated portions of the contract, and

•

the contractor may be liable for excess costs incurred by the U.S. Government in procuring undelivered items from another source.

WE ARE SUBJECT TO PROCUREMENT AND OTHER RELATED LAWS AND REGULATIONS, NON-COMPLIANCE WHICH MAY EXPOSE US TO ADVERSE CONSEQUENCES.

We are subject to extensive and complex U.S. Government procurement laws and regulations, along with ongoing U.S. Government audits and reviews of contract procurement, performance, and administration. We could suffer adverse consequences if we were to fail to comply, even inadvertently, with these laws and regulations or with laws governing the export of munitions and other controlled products and commodities; or commit a significant violation of any other federal law. These consequences could include contract termination; civil and criminal penalties; and, under certain circumstances, our suspension and debarment from future U.S. Government contracts for a period of time. In addition, foreign sales are subject to greater variability and risk than our domestic sales. Foreign sales subject us to numerous stringent U.S. and foreign laws and regulations, including regulations relating to import-export control, repatriation of earnings, exchange controls, the Foreign Corrupt Practices Act, and the anti-boycott provisions of the U.S. Export Administration Act. Failure to comply with these laws and regulations could result in material adverse consequences to us.

General Risks

IF WE CANNOT OBTAIN THE NECESSARY SECURITY CLEARANCES, WE MAY NOT BE ABLE TO PERFORM CLASSIFIED WORK FOR THE U.S. GOVERNMENT, AND OUR REVENUES MAY SUFFER.

Certain U.S. government contracts require our facilities and some of our employees to maintain security clearances. If we lose or are unable to obtain required security clearances, the client can terminate the contract or decide not to renew it upon its expiration. As a result, to the extent we cannot obtain the required security clearances for our employees working on a particular contract, we may not derive the revenue anticipated from the contract, which, if not replaced with revenue from other contracts, could seriously harm our operating results.

BECAUSE WE SELL SOME OF OUR PRODUCTS IN COUNTRIES OTHER THAN THE UNITED STATES, WE MAY BE SUBJECT TO POLITICAL, ECONOMIC, AND OTHER CONDITIONS THAT COULD RESULT IN REDUCED SALES OF OUR PRODUCTS AND WHICH COULD ADVERSELY AFFECT OUR BUSINESS.

Sales to customers outside the U.S. are subject to the political, economic, and other conditions affecting countries or jurisdictions other than the U.S., including the Middle East, Europe, and Asia. Any interruption or curtailment of trade between the countries in which we operate and their present trading partners, change in exchange rates, a significant shift in trade policies or a significant downturn in the political, economic, or financial condition of these countries could cause demand for and sales of our products to decrease, cause disruption of our supply channels or otherwise disrupt our operations, cause our costs of doing business to increase, or subject us to increased regulation including future import and export restrictions, any of which could adversely affect our business.

WE MAY NEED TO RAISE ADDITIONAL CAPITAL ON TERMS UNFAVORABLE TO OUR STOCKHOLDERS.

Based on our current level of operations, we believe that our cash flow from operations, together with amounts we are able to borrow under our existing lines of credit, will be adequate to meet our anticipated operating, capital expenditure and debt service requirements for the foreseeable future. However, we do not have complete control over our future performance because it is subject to economic, political, financial, competitive, regulatory and other factors affecting the defense and security industries. Further, our acquisition strategy will likely require additional equity or debt financings. Such financings could also be required to support our traditional and recently required operating units. There is no assurance that we will be able to obtain such financings to fuel our growth strategy and support our existing businesses.

WE MAY MAKE ACQUISITIONS WHICH REPRESENT ADDITIONAL RISK AND COULD IMPACT OUR FUTURE FINANCIAL RESULTS.

Our business strategy includes the potential for future acquisitions. Acquisitions involve a number of risks including integration of the acquired company with our operations and unanticipated liabilities or contingencies related to the acquired company. We cannot ensure that the expected benefits of any future acquisitions will be realized.

VALENTEC HAS A SUBSTANTIAL AMOUNT OF DEBT, AND THE COST OF SERVICING THAT DEBT COULD ADVERSELY AFFECT VALENTEC’S BUSINESS AND HINDER VALENTEC’S ABILITY TO MAKE PAYMENTS ON ITS DEBT.

Valentec has a substantial amount of indebtedness. As of December 31, 2006, Valentec had total debt of $13,546,699. In addition, Valentec had $70.000 of outstanding but undrawn letters of credit and, taking into account these letters of credit, an additional $883,301 of available credit under its revolving credit facility. Additional information on Valentec’s debt can be found in Item 7 of this report.

Valentec has demands on its cash resources in addition to interest and principal payments on its debt, including, among others, operating expenses. Valentec’s level of indebtedness and these significant demands on Valentec’s cash resources could:

	•		make it more difficult for Valentec to satisfy its obligations,

	•		require Valentec to dedicate a substantial portion of its cash flow from operations to payments on its debt, thereby reducing the amount of cash flow available for working capital, capital expenditures, share repurchases, acquisitions, and other general corporate purposes,

	•		Valentec’s flexibility in planning for, or reacting to, changes in the defense industries,

	•		place Valentec at a competitive disadvantage compared to competitors that have lower debt service obligations and significantly greater operating and financing flexibility, result in an event of default upon a failure to comply with financial covenants contained in Valentec’s senior credit facilities which, if not cured or waived, could have a material adverse effect on Valentec’s business, financial condition, or results of operations.

	•		limit, along with the financial and other restrictive covenants applicable to Valentec’s indebtedness, among other things, Valentec’s ability to borrow additional funds, and

	•		increase Valentec’s vulnerability to general adverse economic and industry conditions.

Valentec’s ability to pay interest on and repay its long-term debt and to satisfy its other liabilities will depend upon future operating performance and Valentec’s ability to refinance its debt as it becomes due. Valentec’s future operating performance and ability to refinance will be affected by prevailing economic conditions at that time and financial, business and other factors, many of which are beyond Valentec’s control.

If Valentec is unable to service its indebtedness and fund operating costs, Valentec will be forced to adopt alternative strategies that may include:

	•		reducing or delaying expenditures for capital equipment and/or share repurchases,

	•		seeking additional debt financing or equity capital,

	•		selling assets, or

	•		restructuring or refinancing debt.

There can be no assurance that any such strategies could be implemented on satisfactory terms, if at all.

OUR STOCK IS A PENNY STOCK. TRADING OF OUR STOCK MAY BE RESTRICTED BY THE SEC’S PENNY STOCK REGULATIONS AND THE NASD’S SALES PRACTICE REQUIREMENTS, WHICH MAY LIMIT A STOCKHOLDER’S ABILITY TO BUY AND SELL OUR STOCK.

Our stock is a penny stock. The Securities and Exchange Commission has adopted Rule 15g-9 which generally defines “penny stock” to be any equity security that has a market price (as defined) less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exceptions. Our securities are covered by the penny stock rules, which impose additional sales practice requirements on broker-dealers who sell to persons other than established customers and “accredited investors”. The term “accredited investor” refers generally to institutions with assets in excess of $5,000,000 or individuals with a net worth in excess of $1,000,000 or annual income exceeding $200,000 or $300,000 jointly with their spouse. The penny stock rules require a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document in a form prepared by the SEC which provides information about penny stocks and the nature and level of risks in the penny stock market. The broker-dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction and monthly account statements showing the market value of each penny stock held in the customer’s account. The bid and offer quotations, and the broker-dealer and salesperson compensation information, must be given to the customer orally or in writing prior to effecting the transaction and must be given to the customer in writing before or with the customer’s confirmation. In addition, the penny stock rules require that prior to a transaction in a penny stock not otherwise exempt from these rules, the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser’s written agreement to the transaction. These disclosure requirements may have the effect of reducing the level of trading activity in the secondary market for the stock that is subject to these penny stock rules. Consequently, these penny stock rules may affect the ability of broker-dealers to trade our securities. We believe that the penny stock rules discourage investor interest in and limit the marketability of our common stock.

In addition to the “penny stock” rules promulgated by the Securities and Exchange Commission, the NASD has adopted rules that require that in recommending an investment to a customer, a broker-dealer must have reasonable grounds for believing that the investment is suitable for that customer. Prior to recommending speculative low priced securities to their non-institutional customers, broker-dealers must make reasonable efforts to obtain information about the customer’s financial status, tax status, investment objectives and other information. Under interpretations of these rules, the NASD believes that there is a high probability that speculative low priced

securities will not be suitable for at least some customers. The NASD requirements make it more difficult for broker-dealers to recommend that their customers buy our common stock, which may limit your ability to buy and sell our stock.


ITEM 2.		Description of Property

Valentec conducts all operations on leased premises at 2629 York Avenue, Minden, Louisiana 71055. Valentec’s primary facility is leased from the State of Louisiana with a current term expiring in 2016 with renewal options available. Valentec negotiated a new lease during 2006 and reduced their monthly lease payment to approximately $17,841 per month in rent for its facilities for the next three years at which time it shall increase to approximately $24,845, which include manufacturing, storage and warehouse space plus igloos and administrative buildings totaling approximately 200,000 square feet. These facilities have undergone renovations and modifications for Valentec’s specialized operations, and Valentec believes these facilities are adequate for its current and future needs.


ITEM 3.		Legal Proceedings

On December 28, 2004, former employees of the Company, who were members of the International Guard Union of America I.G.U.A. Local 81, filed a union membership grievance. The grievance alleges violation of the collective bargaining agreement in that Valentec did not provide severance pay upon the termination of the guards. In total, the grievance asks for approximately $30,000 in termination pay to be distributed among the affected guards. The dispute has been turned over to the American Arbitration Association. We believe that the claim is without merit and any ruling by the American Arbitration Association would have minimum impact on earnings. The arbitration hearing was conducted on March 5, 2007 and on April 6, 2007 ruled in favor of Valentec Systems Inc.

Pursuant to a 1994 environmental class action settlement, Valentec Dayron Corporation (currently Valentec Systems, Inc.) along with Boise Cascade Corporation, Dictaphone Corporation, Harris Corporation, Martin Marietta Corporation, Medalist Industries, Inc and Rockwell International, Inc (herein Members) signed the Woodco Site Custody Account Agreement, dated October 5, 1994 as amended January 28, 2005 which established the “Woodco Site Custody Account” for the purposes of disbursing funds necessary to satisfy the obligations of the Members. Valentec’s current obligation is $1,158 per year for ten years from the date of the Amendment above.

On August 14, 2006, Valentec Systems, Inc. sustained a fire in its 40mm manufacturing facility. As a result of the fire, the Company experienced a loss of a significant amount of Machinery and Equipment, Inventory and Leasehold Improvements. The Company believed it had property insurance in the amount of $1,284,850. However in December 2006 the Company was notified by its Insurance Broker that the additional $249,850 in coverage requested and believed to be in place as of August 10, four days before the fire, had not been placed. The Broker claims they did not receive clear instructions as to when the additional coverage was to be made effective. Therefore on February 25, 2007, Valentec Systems, Inc filed suit against Moreman, Moore and Company, Inc and its agent Bryan Willis for damages suffered in the amount of $249,850 plus legal costs. The Company believes it has sufficient documentation to assert and sustain its claims against the defendants and is therefore confident in our ability prevail in the litigation.

There is no other litigation or outstanding claims by or against the Company other than disputes arising in the ordinary course of business


ITEM 4.		Submission of Matters to a Vote of Security Holders

None.

PART II


ITEM 5.		Market for the Registrant’s Common Equity and Related Stockholder Matters and Small Business Issuer Purchases of Equity Securities

The Common Stock is currently quoted on the Pink Sheets under the symbol “VSYN”. The following table shows the high and low prices of our common stock since January 1, 2004, as reported by the National Daily Quotation Service and the Pink Sheets. We began trading under the name of Acorn Holding Corp. on July 7, 1997.

The following table sets forth, for the fiscal periods indicated, the high and low bid prices of a share of Common Stock for the last eight quarterly periods. Such quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.


Period	High		Low
Fourth Quarter 2006	$	0.26	$	0.08
Third Quarter 2006	$	0.35	$	0.26
Second Quarter 2006	$	0.70	$	0.28
First Quarter 2006	$	0.69	$	0.44
Fourth Quarter 2005	$	0.60	$	0.44
Third Quarter 2005	$	0.45	$	0.20
Second Quarter 2005	$	0.25	$	0.14
First Quarter 2005	$	0.15	$	0.10
Fourth Quarter 2004	$	0.25	$	0.07
Third Quarter 2004	$	0.07	$	0.06
Second Quarter 2004	$	0.14	$	0.06
First Quarter 2004	$	0.14	$	0.05

As of April 9, 2007, we had approximately 377 holders of record of our common stock.

Transfer Agent & Registrar

Our transfer agent is Continental Stock Transfer & Trust Company of 17 Battery Place, New York, NY 10004. Their phone number is (212) 509-4000.

Dividends

We have not declared any cash dividends with respect to the Common Stock, and we do not intend to declare dividends in the foreseeable future. Our future dividend policy cannot be ascertained with any certainty. There are no material restrictions limiting, or that are likely to limit, our ability to pay dividends on either our common stock or preferred stock.

Equity Compensation Plan Information

Options granted under the plan to U.S. residents may qualify as incentive stock options within the meaning of Section 422 of the Code. The exercise price for incentive stock options must not be less than the fair market value on the date the option is granted, or 110.0% of the fair market value if the option holder holds more than 10.0% of our share capital.

On January 2007, the Board of Directors of the Company granted a total of 1,000,000 options to purchase shares of the Company’s common stock under the Company’s 2006 Equity Incentive Plan. The options were granted to several employees of the Company and are vested at a rate of 25% per year over 4 years.

In connection with their service as directors, Mr. Yarborough and Mr. Cianciolo appointed in March 2007 as members of our Board of Directors will receive Valentec’s standard non-employee director cash and equity compensation in accordance with the form of engagement letter approved by Valentec’s Board of Directors, including an annual grant of option to purchase up to 10,000 shares of Common Stock of Valentec under its 2006 Stock Incentive Plan as long as the director holds such office in Valentec, subject to approval by the Board. The shares subject to this option will vest in four equal annual installments upon the completion of each year of board service measured from the grant date.

Recent Sales of Unregistered Securities

On June 6, 2005, the transactions contemplated under the Stock Purchase and Share Exchange Agreement (the “Purchase Agreement”), dated May 27, 2005, by and among the Company, the Subsidiary and the two stockholders of the Subsidiary (the “Subsidiary Stockholders”) were consummated. Pursuant to the terms of the Purchase Agreement, the Company purchased all of the outstanding shares of common stock of the Subsidiary (i.e., 100 shares) in exchange for the issuance by the Company to the Subsidiary Stockholders on a pro rata basis of 5,423,130 newly-issued shares of the Company’s Common Stock. The shares of Common Stock are restricted securities that are exempt from the registration requirements of the Securities Act of 1933, as amended (the “Securities Act”), in reliance on the exemption provided by Rule 506 of Regulation D.

On August 19, 2005, Valentec completed a private placement of securities to each of Messrs. Zummo, Gilat, Matheson, and Kreizman pursuant to which each of Mr. Zummo and Mr. Gilat received Warrants to purchase up to 200,000 shares of Common Stock at an exercise price of $0.25 per share and each of Mr. Matheson and Mr. Kreizman received Warrants to purchase up to 100,000 shares of Common Stock at an exercise price of $0.25 per share. The Warrants became exercisable immediately and expire on August 19, 2008.

In connection with the private placement, Valentec relied on an exemption from registration provided by Section 4(2) of the Securities Act and Rule 506 promulgated thereunder. Messrs. Zummo, Gilat, Matheson, and Kreizman represented to Valentec that they were “accredited investors” as defined in Rule 501(a) promulgated in the Securities Act and that they were receiving the Warrants for their own account and not with a present view towards the public sale or distribution thereof.

Warrants issued to Board Members are defined in Item 11.


ITEM 6.		Management’s Discussion and Analysis and Plan of Operations

The following discussion should be read in conjunction with our consolidated audited financial statements and the related notes for the years ended December 31, 2006 and December 31, 2005 that appear elsewhere in this annual report. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below and elsewhere in this registration statement, particularly in the section entitled “Risk Factors” beginning on page 12 of this annual report.

Discussion of Results and Plan of Operation

As of December 31, 2003, the Company ceased its prior business operations and became a public shell and remained a public shell until its acquisition of Valentec Systems, Inc. which was completed on May 27, 2005 Thus, from December 31, 2003 until May 2005, the Company had no revenues from operations. However, the acquisition of Valentec Systems provided revenue and earnings beginning in 2005.

The acquisition of the Subsidiary by the Company has been accounted for as a purchase and treated as a reverse acquisition since the former owners of Valentec controlled 77.5% of the total shares of the Common Stock outstanding immediately following the Acquisition. On this basis, the historical financial statements prior to June 6, 2005 have been restated to be those of the accounting acquirer Valentec. The historical stockholders’ equity prior to the Acquisition has been retroactively restated (a re-capitalization) for the equivalent number of shares received in the Acquisition after giving effect to any difference in par value of the Common Stock and Valentec’s common stock. The original 100 shares of Valentec common stock outstanding prior to the reorganization have been reflected as an addition in the stockholders’ equity account of the Company on June 6, 2005.

In 2006 we experienced a 3% increase in gross revenue over fiscal year 2005 from $19,015,978 to $19,624,883 despite the fact that we lost our 40MM production facility in August 2006 due to a fire in our Louisiana facility, which we were leasing this facility from the State of Louisiana. This line is anticipated to begin full production in April 2007. Gross margin decreased from 34.2% to 22.2%. EBITDA, before one time expenses, decreased 197% from $2,439,199 to ($2,362,436) and pre tax earnings decreased from $79,324 to ($6,002,440) after one time expenses.

Energetic Manufacturing accounted for 14.1% of the gross revenue with Systems/Management Systems Integration and Metal Parts Manufacturing accounting for 80.5% and 5.4% respectively. The backlog at the end of the year was Energetic Manufacturing $1,661,019 (12.7%), Systems/Management Systems Integration $11,813,922 (87.3%) and Metal Parts Manufacturing $-0- (0.0%) for a total of $13,474,941

Valentec plans to make investments in bids and proposal activity that, if successful, will significantly increase backlog, future sales and future profits. We intend to bid on new U. S. Army systems ammunition requirements as well as new energetic and metal component requirements. We also intend to make investments in automation equipment for the energetic production that may improve efficiencies and future profits.

The Board intends to seek out other strategic acquisition candidates that could bring value added to Valentec in terms of increased revenue, profits, cost savings, management talent and diversification.

Along with its acquisition strategy, Valentec is actively seeking financing alternatives for acquisitions, working capital, product development, marketing, and business opportunities. In this regard, on April 28, 2005, the Company entered into a Standby Equity Distribution Agreement (“SEDA”) with Cornell Capital Partners, L.P., (“Cornell”) whereby it can “put” to Cornell, for cash, up to $15 million in our common stock over a two-year period of time. Valentec has no obligation to “put” or draw on this facility and should more attractive financing alternatives become available we will thoroughly evaluate the best opportunities for the Company and its shareholders.

In late 2006, Valentec Systems Inc. employed the services of an Investment Group, Carter Securities Inc. and Mallon and Associates, to assist in a Private Offering to raise capital for acquisitions, reduction of outstanding debt, working capital, marketing and business opportunities. In conjunction with pursuit of the Private Offering, Valentec entered in January 2007 into a binding term sheet to acquire MAST Technology, Inc. a Missouri based company hereinafter referred to as MAST, in a transaction structure yet to be formally determined, for $15 million in cash, stock and earn-out against future earnings. The term sheet expires on May 20, 2007. MAST is a manufacturer of ammunition and ordnance for the United States Government and other customers specializes in tight propellant charge tolerances and produces 40mm training practice rounds, igniters for demolitions and training and other specialty ammunition products. The transaction contemplated is subject to various conditions precedent and there can be no guaranty that the transaction will be completed..

Valentec has entered into a Master Factoring Agreement with Rockland Credit Finance as an additional source of financing. A credit line of $10,000,000 has been established to provide additional working capital for our growth as well as assistance in the rebuilding of our production facility destroyed by fire in 2006. We plan to use the additional funding for facilitization and additional equipment needed to support the increased backlog.

Valentec has retained the New York-based Public Relations firm of GW Communications. Mr. Glenn Wiener, President of GW Communications (212) 786-6011 will be the Account Manager of record. GW will work very close with Valentec’s Management and Board of Directors to provide a line of communication to shareholders, investors, the financial community and to the media. They will also provide important market feed back to support the Company’s strategic direction and operational performance.

The Company is actively structuring its operation to become ISO 9000 compliant. We have on staff experienced professionals with ISO experience and Six-Sigma training.

Stock Compensation Expense

Liquidity and Capital Resources

For the twelve months ended December 31, 2006, the Company had negative cash flow from operations of $6,499,164. On December 31, 2006, the Company had outstanding borrowings (non-related party) of approximately $13,546,699. On December 31, 2006, the Company had total assets of approximately $25,950,749. This is an increase in total assets of $3,274,458 on December 31, 2005.

The Company’s sources and uses of funds were as follows: (1) it used net cash of $6,499,164 in its operating activities in the twelve months ended December 31, 2006; (2) it received cash of $48,476 in investing activities in the twelve months ended December 31, 2006; and (3) it received $6,519,239 from financing activities in the twelve months ended December 31, 2006, consisting primarily of the release of restricted cash and proceeds from the line of credit. As of December 31, 2006, the Company had a working capital deficiency of $10,043,206.

The primary source of financing for the Company since its inception has been through the issuance of common stock and borrowings. The Company had cash and cash equivalents of $150,429 as of December 31, 2006 and $81,879 as of December 31, 2005. The Company is actively seeking financing alternatives for working capital, product development, marketing, and business opportunities. In this regard, on April 28, 2005, the Company entered into a Standby Equity Distribution Agreement (“SEDA”) with Cornell Capital Partners, L.P. (“Cornell”), whereby it can “put” to Cornell, for cash, up to $15 million in the Company’s common stock over a two-year period of time. The Company believes this equity financing should increase its chances of succeeding in its growth plans. The Company anticipates that if it will decide to use the $15 million SEDA, it will enable it to support and fund expenditures for bids and proposals, capital equipment automation and acquisitions, as well as working capital growth. In order to make use of the SEDA, the Company had to first increase its authorized capital, become listed on the Over-the-Counter Electronic Bulletin Board (“OTCBB”), what was already achieved, and register additional shares for public sale. There can be no assurance that the Company will be able to successfully comply with these conditions. Therefore, the Company continues to explore additional equity and debt financings, vendor-financing programs, letters of credit for manufacturing, leasing arrangements for its products, and equity participation for media purchases that will advertise its products. In late 2006, Valentec employed the services of an Investment Group, Carter Securities Inc. and Mallon and Associates, to assist in a Private Offering to raise capital for acquisitions, reduction of outstanding debt, working capital, marketing and business opportunities. Also, the Company believes that marketing and consumer awareness is central to generating monthly revenues. The Company believes that its products may have greater appeal to foreign consumers due to quality, performance and price.

In 2005, the Company entered into a Master Factoring Agreement with Rockland Credit Finance as an additional source of financing. In 2006, the Company increased the credit line from $7,500,000 to $10,000,000 for the purpose of providing additional working capital for the Company. The Company has used the additional funding for facilitization and additional equipment needed to support the increased backlog as well as the rebuilding of Valentec’s 40MM production line destroyed by fire in 2006. The Company plans to pay off all other credit lines in the future with current revenue and cash on hand.

The Company is indebted under notes payable to two stockholders of the Company. The notes bear interest at various rates based on prime rate per annum which was 8.25% as of December 31, 2006. In 2004, the two stockholders waived their right to interest under the notes and the Company recorded an in-kind contribution in the

amount of $33,705 which was included in the December 31, 2006 financial statements. The notes are due on demand and have an outstanding balance of $433,274 as of December 31, 2006.

The Company had a line of credit from Bank One in the amount of $2,000,000 which accrued interest at a rate of Prime less 0.75%. The line of credit was secured by a letter of credit from a related company and personal property of a stockholder. In September 2006, Bank One called this line of credit and it was paid off in full by the letter of credit from the related company, Mikal LTD, and a loan obtained against the personal property of a stockholder from Rockland Credit Finance. In return, the Company issued a promissory note in the amount of $1,000,000 to each of the lenders payable on or before October 31, 2007.

The Company has a line of credit from Bank Hapoalim in the amount of $4,000,000 accrues interest at a rate of Libor plus 1.75% (At December 31, 2006 7.10% per annum). The line of credit is secured by a letter of credit from a stockholder. At December 31, 2006 $3,930,000 was outstanding under this line.

The Company has a line of credit from Bank Leumi in the amount of $500,000 accrues interest at a rate of 7.13% per annum. The line of credit is secured by a letter of credit from a stockholder. At December 31, 2006 $500,000 was outstanding under this line.

The Company has a line of credit from Rockland Credit Finance with a facility limit of $10,000,000 accruing interest at 1% per month on outstanding balances plus Prime plus 2% per annum (at December 31, 2006 10.25%). The line of credit is secured under a Master Factoring Agreement which includes a line on all the assets of the Company. The total amounts available under the line vary based on the total billed and unbilled accounts receivable. The total available as of December 31, 2006 was $10,000,000 based on 70% of in-process receivables and 90% of accounts receivable. At December 31, 2006, $9,116,699 was outstanding under this line. The line of credit agreement requires the company to submit monthly and annual financial reports and stay in compliance with various state and federal laws.

Off-Balance Sheet Arrangements

The Company has no off-balance sheet arrangements.

Critical Accounting Policies

The Company’s discussion and analysis of its financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. The Company re-evaluates its estimates on an on-going basis. The Company’s estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

The Company believes the following are its critical accounting policies which affect its more significant judgments and estimates used in the preparation of its consolidated financial statements:

•

Revenue recognition via the percentage of completion method

Revenue Recognition via the Percentage of Completion Method. We believe our most critical accounting policies include revenue recognition and cost estimation on fixed price contracts for which we use the percentage of completion method of accounting.

Under the percentage of completion method, revenue is recognized on these contracts as work progresses during the period, based on the amount of actual cost incurred during the period compared to total estimated cost to be incurred for the total contract (cost-to-cost method). Management reviews these estimates as work progresses and the effect of any change in cost estimates is reflected in cost of sales in the period in which the change is identified. If the contract is projected to create a loss, the loss accrued for and is charged to operations beginning in the period it

first becomes known.

Accounting for the profit on a contract requires (1) the total contract value, (2) the estimated total cost to complete, which is equal to the sum of the actual incurred costs to date on the contract and the estimated costs to complete the contract’s scope of work, and (3) the measurement of progress towards completion. The estimated profit or loss on a contact is equal to the difference between the contract value and the estimated total cost at completion. Adjustments to original estimates are often required as work progresses under a contract, as experience is gained and as more information is obtained, even though the scope of work required under the contract may not change, or if contract modifications occur. A number of internal and external factors affect our cost of sales estimates, including labor rates and efficiency variances, material usage variances, delivery schedules and testing requirements. While we believe that the systems and procedures used by the Company, coupled with the experience of the management team, provide a sound basis for our estimates, actual results will differ from management’s estimates. The complexity of the estimation process and issues related to the assumptions, risks and uncertainties inherent with the application of the percentage of completion method affect the amounts reported in our financial statements.

Recent Accounting Pronouncements

Statement of Financial Accounting Standards (“SFAS”) No. 151, “Inventory Costs — an amendment of ARB No. 43, Chapter 4” SFAS No. 152, “Accounting for Real Estate Time-Sharing Transactions — an amendment of FASB Statements No. 66 and 67,” SFAS No. 153, “Exchanges of Non-monetary Assets — an amendment of APB Opinion No. 29,” and SFAS No. 123 (revised 2004), “Share-Based Payment,” were recently issued. SFAS No. 151, 152, 153 and 123 (revised 2004) have no current applicability to the Company and have no effect on the financial statements. In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46, “Consolidation of Variable Entities”, (FIN No. 46) an interpretation of Accounting Research Bulletin No. 51. FIN No. 46 requires that variable interest entities be consolidated by a company if that company is subject to a majority of the risk and loss from the variable interest entity’s activities or is entitled to receive a majority of the entity’s residual returns or both. FIN No. 46 requires disclosures about variable interest entities that companies are not required to consolidate but which the company has a significant variable interest. The consolidation requirements apply for newly formed variable interest entities created after January 31, 2003 and entities established prior to January 31, 2003, in the first fiscal year or interim period beginning after June 30, 2003. The adoption of FIN No. 46 is not expected to have a material impact on our consolidated results of operations and financial position.

In May 2005, the FASB issued SFAS 154, Accounting Changes and Error Corrections. This Statement replaces APB Opinion No,. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. SFAS 154 also requires that a change in depreciation, amortization or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate effected by a change in accounting principle. This Statement is effective in fiscal years beginning after December 15, 2005. The Company has not yet determined the effect of implementing this standard.

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments-an amendment of FASB Statements No. 133 and 140”, to simplify and make more consistent the accounting for certain financial instruments. SFAS No. 155 amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, to permit fair value re-measurement for any hybrid financial instrument with an embedded derivative that otherwise would require bifurcation, provided that the whole instrument is accounted for on a fair value basis. SFAS No. 155 amends SFAS No. 140, "Accounting for the Impairment or Disposal of Long-Lived Assets”, to allow a qualifying special-purpose entity to hold a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS No. 155 applies to all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006, with earlier application allowed. The adoption of this statement is not expected to have a material effect on the Company’s future reported financial position or results of operations.

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets, an amendment of FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”. This statement requires all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable, and permits for subsequent measurement using either fair value measurement with changes in fair value reflected in earnings or the amortization and impairment requirements of Statement No. 140. The subsequent measurement of separately recognized servicing assets and servicing liabilities at fair value eliminates the necessity for entities that manage the risks inherent in servicing assets and servicing liabilities with derivatives to qualify for hedge accounting treatment and eliminates the characterization of declines in fair value as impairments or direct write-downs. SFAS No. 156 is effective for an entity’s first fiscal year beginning after September 15, 2006. The adoption of this statement is not expected to have a material effect on the Company’s future reported financial position or results of operations.

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statements No. 109”. FIN 48 clarifies the accounting for uncertainty in income taxes by prescribing a two-step method of first evaluating whether a tax position has met a more likely than not recognition threshold and second, measuring that tax position to determine the amount of benefit to be recognized in the financial statements. FIN 48 provides guidance on the presentation of such positions within a classified statement of financial position as well as on derecognition, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The adoption of this statement is not expected to have a material effect on the Company’s future reported financial position or results of operations.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”. The objective of SFAS 157 is to increase consistency and comparability in fair value measurements and to expand disclosures about fair value measurements. SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements and does not require any new fair value measurements. The provisions of SFAS No. 157 are effective for fair value measurements made in fiscal years beginning after November 15, 2007. The adoption of this statement is not expected to have a material effect on the Company’s future reported financial position or results of operations.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment of FASB Statements No. 87, 88, 106, and 132(R)”. This statement requires employers to recognize the over-funded or under-funded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income of a business entity or changes in unrestricted net assets of a not-for-profit organization. This statement also requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. The provisions of SFAS No. 158 are effective for employers with publicly traded equity securities as of the end of the fiscal year ending after December 15, 2006. The adoption of this statement is not expected to have a material effect on the Company’s future reported financial position or results of operations.

In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB No. 108 addresses how the effects of prior year uncorrected misstatements should be considered when quantifying misstatements in current year financial statements. SAB No. 108 requires companies to quantify misstatements using a balance sheet and income statement approach and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative an qualitative factors. SAB No. 108 is effective for period ending after November 15, 2006. The Company is currently evaluating the impact of adopting SAB No. 108 but does not expect that it will have a material effect on its financial statements.

In February 2007, the Financial Accounting Standards Board (FASB) issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115”. This statement permits entities to choose to measure many financial instruments and certain other items at fair value. Most of the provisions of SFAS No. 159 apply only to entities that elect the fair value option. However, the amendment to SFAS No. 115 “Accounting for Certain Investments in Debt and Equity Securities” applies to all entities with available-for-sale and trading securities. SFAS No. 159 is effective as of the beginning of an entity’s

first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provision of SFAS No. 157, “Fair Value Measurements”. The adoption of this statement is not expected to have a material effect on the Company’s financial statements.


ITEM 7.		Financial Statements

The responses to this Item are submitted in a separate section of this Report. See Index to the Financial Statements on page F-1 hereto.


ITEM 8.		Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

On March 29, 2005, Grant Thornton LLP (“Grant Thornton”) advised the Company that it had resigned as the Company’s independent registered public accounting firm. That determination was a decision of Grant Thornton and was not recommended by the Company’s Board of Directors.

The audit report issued by Grant Thornton on the consolidated financial statements of the Company as of and for the year ended December 31, 2003 did not contain an adverse opinion or a disclaimer of opinion, nor was it modified as to uncertainty, audit scope, or accounting principles, except that it did contain an explanatory paragraph for the adoption of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, on January 1, 2002.

During the Company’s fiscal year ended December 31, 2003 and the subsequent interim period from January 1, 2004 through the date of this report, there were no disagreements with Grant Thornton on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of Grant Thornton, would have caused it to make reference to the subject matter of the disagreement in connection with its report on the Company’s consolidated financial statements.

On April 14, 2005, the Company engaged Webb & Company as its principal independent accountant. The Company’s Board of Directors approved the appointment of Webb and Company as the Company’s principal independent accountant on April 4, 2005.

On January 18, 2006, the Company subsidiary terminated Heard, McElroy & Vestal as the Company’s independent accountant due to Heard, McElroy & Vestal’s decision to not continue due to Valentec Systems, Inc. becoming a publicly traded company. Heard, McElroy & Vestal prepared the Company’s 2004 audited financial statements.

On January 23, 2006, the Company engaged Webb & Company to continue as its principal independent accountant. The Board of Directors approved the appointment of Webb and Company as the Company’s principal independent accountant on January 23, 2006.

During the two most recent fiscal years and through April 14, 2005, the Company did not consult with Webb & Company regarding either:

	(i)		the application of accounting principles to any specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on the Company’s financial statements, and neither a written report was provided to the Company nor oral advice was provided that Webb & Company concluded was an important factor considered by the Company in reaching a decision as to any accounting, auditing or financial reporting issue; or

	(ii)		any matter that was either subject of disagreement, as that term explained in Item 304(a)(1)(iv) of Regulations S-B and the related instruction to Item 304 of Regulation S-B, or an event, as that term is explained in Item 304(a)(1)(iv) of Regulation S-B.


ITEM 8A.		Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company’s chief executive officer, who is also the Company’s chief financial officer, has reviewed and evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this annual report. Based on that review and evaluation, the chief executive officer has concluded that the Company’s current disclosure controls and procedures, as designed are sufficiently effective to ensure that such officer is provided with information relating to the Company required to be disclosed in the reports the Company files or submits under the Exchange Act and that such information is recorded, processed, summarized and reported in a timely manner. However, due to recent changes in responsible financial reporting personnel and insufficient training, the implementation of said internal controls have been weakened to cause concerns as to their effectiveness. The Company’s chief executive officer has committed to ensuring sufficient training of responsible financial reporting personnel to correct said issue.

Changes in Internal Controls Over Financial Reporting

In connection with the evaluation of the Company’s internal controls during the Company’s last fiscal year, the Company’s Principal Executive Officer and Principal Accounting Officer have determined that due to changes in financial reporting personnel and inadequate training, the Company’s internal controls over financial reporting have weakened and is reasonably likely to materially effect the Company’s internal controls over financial reporting. A plan has been enacted to ensure adequate training of financial reporting personnel to resolve any potential internal control weaknesses.

Inherent Limitations on Effectiveness of Controls

The Company’s management does not expect that its disclosure controls or its internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.


ITEM 8B.		Other Information

None.

PART III


ITEM 9.		Directors, Executive Officers, Promoters, Control Persons and Corporate Governance; Compliance with Section 16(a) of The Exchange Act

The following is a list (along with certain biographical information) of the executive officers and directors of Valentec. All of our directors are serving a current term of office, which continues until the next annual meeting of stockholders:

Directors, Executive Officers and Control Persons


Name	Age		Position

Avraham (Miko) Gilat		57	Director
			(June 6, 2005 — Present)

Robert A. Zummo		65	Director, Chief Executive Officer and Chairman of the Board
			(June 6, 2005 — Present)

Zvi Kreizman		52	Director
			(June 6, 2005 — Present)

August Cianciolo			Director
			(March 13, 2007 — Present)

W. Glenn Yarborough, Jr			Director
			(March 13, 2007 — Present)

Stephen J. Shows		65	Vice President of Operations / General Manager
			(June 6, 2005 — Present)

AVRAHAM (MIKO) GILAT was named director of the Company on June 6, 2005 to serve until the next annual election of directors. Mr. Gilat has been a member of the Valentec Operating Corp. board of directors since 2000. He currently serves as the chair of Soltam Group and Soltam Systems, positions that he has held since 1999. Soltam Systems is one of Israel’s prominent defense companies. In 2000, Mr. Gilat purchased Valentec Operating Corp. with Mr. Zummo. He previously served as a director of Mikal Ltd., a holding company for a wide range of commercial activities, and in various positions with Israel Military Industries, including as vice president of marketing and vice president of business development. Mr. Gilat served in the Israeli Defense Forces as a command and armor corps officer and retired from reserve duty as a major. He received an M.B.A. from New York University and a B.A. in economics from Tel Aviv University.

ROBERT A. ZUMMO was named director of the Company on June 6, 2005 to serve until the next annual election of directors. Mr. Zummo also has been the President and Chief Executive Officer of the Company since June 6, 2005. Mr. Zummo has been a member of the Valentec Systems board of directors since October 2000. Mr. Zummo currently serves as the President and Chief Executive Officer of Valentec Systems, positions that he has held since October 2000. Mr. Zummo was also chairman of the board of directors of Valentec Systems. Prior to joining Valentec in 2000, Mr. Zummo served as Executive Vice President of General Defense; a Maryland based artillery-manufacturing company. Prior to that, Mr. Zummo served as Vice President of Program Management of Avco Aerostructures, a wing and stabilizer manufacturing company.

ZVI KREIZMAN was named director of the Company on June 6, 2005 to serve until the next annual election of directors. Mr. Kreizman currently serves as the Chief Financial Officer of the Soltam Group and Soltam Systems and has served in this capacity since 1993. Mr. Kreizman has also been a director of TGC, Ltd., which manufactures rubber products, since January of 2005. Mr. Kreizman is a graduate of the Haifia School of Management in certified accounting. He is certified by the Public Accountants Association of Israel.

STEPHEN J. SHOWS has been Vice President of Operations and General Manager of Valentec Systems, Inc. since 1998. Mr. Shows was General Manager for Thiokol Corporation at the Louisiana Army Ammunition Plant and Longhorn Army Ammunition Plant from 1985 to 1995. Mr. Shows began his career in 1962 at the Louisiana Plant as an engineering technician and has over 40 years managerial experience in the defense industry to include assembly and metal parts manufacturing. His experience also includes positions as Program Director, Operations

Director, Manufacturing Manager, Planning Manager and Materials Manager functions. Mr. Shows received his BS in Business Administration from Southwest University in Metairie, Louisiana.

(RET) LIEUTENANT GENERAL GUS CIANCIOLO was appointed as a member of the Board of Directors of the Company on March 17, 2007 to serve until the next annual election of directors. Mr. Cianciolo has held a wide variety of important command and staff positions during his 33-year Army career, culminating as the Military Deputy to the Assistant Secretary of the Army for Research, Development, and Acquisition. He also served as the Director of the Army Acquisition Corps. General Cianciolo’s diverse background in research, development, and acquisition included service as the Deputy Commanding General for Research, Development, and Acquisition, Army Material Command, and as Commanding General, U.S. Army Missile Command. He was also Project Manager for two major Army Weapon systems programs, one involving international participation by four NATO countries. After retiring from the U.S. Armed Forces, Mr. Cianciolo served as Senior Vice President of Cypress International, a global business development organization that assists clients in the marketing of their defense products and relations services worldwide. He later joined the SPECTRUM Group as an associate and was named President in January 2007. The SPECTRUM Group is a privately held corporation that provides consulting services to corporations that primarily conduct business with the U.S. government and related agencies. Its membership consists of more than 65 distinguished professionals with experience, expertise and relationships at the highest levels of government and business. In addition to his board role with Valentec, Mr. Cianciolo sits on the Board of Directors of Nammo, Inc., a privately held supplier of electronics and aviation munitions. He also sits on the Advisory Boards of Fabrique National Manufacturing Inc., CPU Technologies and Combined Systems, Inc. He holds a B.S. degree in Business Administration from Xavier University and a M.S. degree from the University of Southern California.

W. GLENN YARBOROUGH, JR. was appointed as a member of the Board of Directors of the Company on March 17, 2007 to serve until the next annual election of directors. He retired from the U.S. Army as Colonel, after a distinguished 27 years of service. He is currently the Founder of Chief Executive Officer of WGY & Associates, LLC, a high technology defense, management and government relations consulting practice. Before founding the firm in 2001, he served as President and Chief Executive Officer of Allied Research Corporation, a publicly traded diversified defense and commercial electronic security firm (now Allied Defense Group). While with Allied, he helped the Company grow via acquisition and strengthen its global operations and, he successfully led a financial turnaround, making Allied one of the industry’s fastest growing companies. Before joining Allied, Mr. Yarborough was Director of Marketing of the Grumman Corporation, overseeing three business programs in the areas of test equipment, vehicular intercom systems and advanced radars. Earlier in his career, he served as the Washington Manager with Ford Aerospace / BDM Corporation, where he was responsible for contract generation with government agencies and as Director of Operations with Italian Advanced Industries, where he helped launch the Company’s U.S. operations with a key focus on the U.S. military. Throughout his career, Glenn has worked closely with many detailed segments of the Department of Defense, Department of the Air Force, Army, Navy, DARPA, FBI, Transportation Security Administration, Department of Homeland Security, NSA, the CIA and the Authorization and Appropriation Committees of the House and Senate. Before retiring from the U.S. Armed Forces, he served as Military Assistant to the Assistant Secretary of the Army for Research, Development and Acquisition. Mr. Yarborough serves on the Board of Directors of Carleton Technology, EADA North America Defense Company, Easter Seals, So Others Might Eat (SOME), Friends of the McLean Community Center, the Patton Museum of Armor and Cavalry, the U.S. Cavalry Association and the Board of the Moore School of Business at the University of South Carolina. He holds a B.A. and M.B.A. from the University of South Carolina and is a graduate of the Executive Program, University of Virginia, the Naval War College and the Army’s Command & General Staff College.

There are no family relationships between any executive officers or directors of the Company.

Valentec announced in January 2007 that as part of the term sheet signed with MAST as further detailed above, it was agreed that Gerald Pickens, President and CEO of MAST will join Valentec as Chief Operating Officer subject to the consummation of the transaction. Mr. Pickens has enjoyed a 35+year career in the defense sector, working in the areas of manufacturing, product development, operations, logistics, quality control and finance. Before his appointment to President of CEO of MAST, he served as Director of Operations and prior to, was Operations Manager at Day and Zimmerman, Inc. Mr. Pickens is a member of the National Management

Association, American Management Association and National Defense Industrial Association and received a Bachelors of Science (B.S.) from Sam Houston State University.

Additionally, Jay Bell, formerly Vice President of Sales and Marketing of MAST Technology who has been appointed as MAST Technology’s President, a position he will assume upon closing of the transaction. Bell had previously served as President and CEO of MAST Technology from 1999-2004 before taking on sales and marketing responsibilities when Gerald Pickens was appointed to that role. Mr. Bell is active in a number of defense, operations and financial institutions and is a member of the NDIA Small Arms Committee. He holds a Bachelors of Arts (B.A.) from the University of Southern California.

Director Compensation

Each Director receives $250 per meeting plus travel expenses. Compensation is subject to change as new Directors are added to the Board. We have no formal plan for compensating our directors for their service in their capacity as directors, although such directors may in the future receive stock options to purchase Common Stock as awarded by our board of directors or (as to future stock options) a compensation committee which may be established. Directors are entitled to reimbursement for reasonable travel and other out-of-pocket expenses incurred in connection with attendance at meetings of our board of directors. Our board of directors may award special remuneration to any director undertaking any special services on our behalf other than services ordinarily required of a director. No director received and/or accrued any compensation for their services as a director, including committee participation and/or special assignments.

Committees of the Board

We do not have a separate audit committee at this time. Our board of directors acts as our audit committee.

Audit Committee Financial Expert

Our board of directors has determined that it does not have a member of its audit committee that qualifies as an “audit committee financial expert” as defined in Item 401(e) of Regulation S-B, and is “independent” as the term is used in Item 7(d)(3)(iv) of Schedule 14A under the Securities Exchange Act of 1934, as amended. We believe that the members of our board of directors are collectively capable of analyzing and evaluating our financial statements and understanding internal controls and procedures for financial reporting. In addition, we believe that retaining an independent director who would qualify as an “audit committee financial expert” would be overly costly and burdensome and is not warranted in our circumstances given the early stages of our development and the fact that we have not generated any material revenues to date.

Section 16(a) Compliance

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires that the Company’s directors, executive officers and persons who own more than 10% of the outstanding shock of the Company file initial reports of ownership and reports of changes in ownership in such common stock with the SEC. Officers, directors and stockholders who own more than 10% of the outstanding common stock of the Company are required by the SEC to furnish the Company with copies of all Section 16(a) reports they file. To the knowledge of the Company, based solely on the review of the copies of such reports furnished to the Company and written representations that no other reports were required during the year ended December 31, 2006, all officers, directors and 10% stockholders other than Avraham Gilat and Zvi Kreizman complied with all applicable Section 16(a) filing requirements.

Code of Ethics

Effective April 3, 2006, our board of directors adopted a preliminary Code of Business Conduct and Ethics that applies to, among other persons, our senior executives (being our principal executive officer, principal accounting officer and senior vice presidents, as well as persons performing similar functions. As adopted, our Code of Business Conduct and Ethics sets forth written standards that are designed to deter wrongdoing and to promote:

	1.		honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships;

	2.		full, fair, accurate, timely, and understandable disclosure in reports and documents that we file with, or submit to, the Securities and Exchange Commission and in other public communications made by us;

	3.		compliance with applicable governmental laws, rules and regulations;

	4.		the prompt internal reporting of violations of the Code of Business Conduct and Ethics to an appropriate person or persons identified in the Code of Business Conduct and Ethics; and

	5.		accountability for adherence to the Code of Business Conduct and Ethics.

Our Code of Business Conduct and Ethics requires, among other things, that all of our Senior Officers commit to timely, accurate and consistent disclosure of information; that they maintain confidential information; and that they act with honesty and integrity.

In addition, our Code of Business Conduct and Ethics emphasizes that all employees, and particularly Senior Officers, have a responsibility for maintaining financial integrity within our company, consistent with generally accepted accounting principles, and federal and state securities laws. Any Senior Officer who becomes aware of any incidents involving financial or accounting manipulation or other irregularities, whether by witnessing the incident or being told of it, must report it to our company. Any failure to report such inappropriate or irregular conduct of others is to be treated as a severe disciplinary matter. It is against our policy to retaliate against any individual who reports in good faith the violation or potential violation of our Code of Business Conduct and Ethics by another.

Our Code of Business Conduct and Ethics is filed as an exhibit to this annual report on Form 10-KSB. We will provide a copy of the Code of Business Conduct and Ethics to any person without charge, upon request. Requests can be sent to: Valentec Systems, Inc., 2629 York Avenue, Minden, Louisiana 71055.

Corporate Governances

The Board of Directors is currently reviewing but has not yet adopted a comprehensive corporate governance policy. As part of our review, we are currently examining our corporate governance and other policies and procedures. Following such examination, we expect to adopt Corporate Governances applicable to all directors, officers and employees.


ITEM 10.		Executive Compensation

The following table sets forth the compensation awarded by the Company for the fiscal years ended December 31, 2006, 2005 and 2004 to the Company’s named executive officers and directors.

SUMMARY COMPENSATION TABLE


							Nonqualified
						Non-Equity	Deferred
Name and				Stock	Option	Incentive Plan	Compensation	All Other
Principal		Salary	Bonus	Awards	Awards	Compensation	Earnings	Compensation	Total
Position	Year	($)	($)	($)	($)	($)	($)	($)	($)
Robert Zummo Director, President And CEO	2006	514,113	0	0	0	0	0	0	514,113
	2005	382,997	50,000	0	200,000	0	0	0	432,997
	2004	334,113	0	0	0	0	0	0	334,113


							Nonqualified
						Non-Equity	Deferred
Name and				Stock	Option	Incentive Plan	Compensation	All Other
Principal		Salary	Bonus	Awards	Awards	Compensation	Earnings	Compen-sation	Total
Position	Year	($)	($)	($)	($)	($)	($)	($)	($)
Stephen J. Shows Vice President and General Manager	2006	154,784	0	0	0	0	0	0	154,784
	2005	149,234	20,000	0	0	0	0	0	169,234
	2004	147,022	12,500	0	0	0	0	0	159,522

OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END

Option Awards

Stock Awards

Number of Securities

Equity Incentive Plan

Name

Underlying Unexercised Options

Equity Incentive Plan Awards

Award

Market

Payout

Value

Number

Unearned

Shares,

Number

Units

Shares,

Units

of Shares

Units or

Securities

or Units

Stock

Other

Underlying

of Stock

That

Rights

Unexercised

That Have

Have

That Have

Unearned

Option

Not

(#)

Options

Exercise

Expiration

Vested

Exercisable

Un-exercisable

(#)

Price ($)

Date

(#)

($)

(#)

($)

Robert Zummo Director, President and CEO

200,000

0.25

August
19,2008

Stephen J. Shows Vice President and General Manager

Compensation of Directors

Each non-employee director receives (i) $500 per meeting in which the director attends; (ii) an annual grant of option to purchase up to 10,000 shares of Common Stock of Valentec under its 2006 Stock Incentive Plan as long as the director holds such office in Valentec, subject to approval by the Board. Directors are entitled to reimbursement for reasonable travel and other out-of-pocket expenses incurred in connection with attendance at meetings of our board of directors. Our board of directors may award special remuneration to any director undertaking any special services on our behalf other than services ordinarily required of a director. No director received and/or accrued any compensation for their services as a director, including committee participation and/or special assignments.

The table below summarizes the compensation that we paid to non-employee directors for the fiscal year ended December 31, 2006.

DIRECTOR COMPENSATION

Nonqualified

Non-Equity

Deferred

Fees Earned or Paid

Incentive Plan

Compensation

All Other

in Cash

Stock Awards

Option Awards

Compensation

Earnings

Compensation

Total

Name

($)

Avraham (Miko) Gilat

-0-

Zvi Kreizman

-0-

August Cianciolo

-0-

W. Glenn Yarborough, Jr.

-0-

Stock Option Grants and Values

During the fiscal year ended December 31, 2006, there were no stock option grants or stock appreciation rights granted to any of the Company’s officers or directors. Effective September 30, 2003, all previous executive officers and directors relinquished their rights to any unexercised stock options held by such under the Company’s stock option plans. In May 2005, the board of directors cancelled all outstanding options to purchase common stock. Accordingly, as of December 31, 2005, there were no exercisable or non-exercisable options held by any employee, officer, director or other person.

Employment Arrangements

Mr. Zummo, Chairman and CEO, has entered into a two (2) year employment agreement with automatic one-year extensions effective January 1, 2006; pursuant to which, Valentec agrees to pay Mr. Zummo a base salary at the annual rate of $520,000. The Board of Directors resolved that upon consummation of the transaction with MAST, Mr. Zummo’s annual base salary shall be $320,000. In addition, Mr. Zummo is eligible for a bonus payable at, and in an amount to be determined by, the Board of Directors. He is also entitled to benefits provided to other members of Valentec’s senior management. In the event Mr. Zummo is terminated for reasons other than: conviction of a felony; any act involving moral turpitude; commission of a misdemeanor where imprisonment is imposed; commission of any act of theft, fraud, dishonesty or falsification of any employment or company records; improper disclosure of confidential or proprietary information; actions detrimental to Valentec’s reputation or business; failure to perform reasonable duties; breach of his employment agreement; a course of conduct amounting to gross incompetence; chronic and unexcused absenteeism; unlawful appropriation of a corporate opportunity; or misconduct in connection with the performance of duties, then Mr. Zummo is entitled to a severance payment equal to the balance of the term of his agreement. If Mr. Zummo terminates his employment due to a change of ownership of Valentec or a change in location of his employment, he will be entitled to full compensation including benefits for the remainder of the term of his employment agreement. In addition, Mr. Zummo is subject to confidentiality provisions.

Mr. Shows (Vice President/General Manager) has entered into an employment agreement with Valentec Operating Corp. on July 1, 2003; pursuant to which, Valentec Operating Corp. agrees to pay Mr. Shows a base salary at the annual rate of $150,000. In addition, Mr. Shows is eligible for a bonus payable at, and in an amount to be determined by, Valentec’s Chairman. He is also entitled to benefits provided to other members of Valentec’s senior management. In the event Mr. Shows is terminated for reasons other than: conviction of a felony; any act involving moral turpitude; commission of a misdemeanor where imprisonment is imposed; commission of any act of theft, fraud, dishonesty or falsification of any employment or company records; improper disclosure of confidential or proprietary information; actions detrimental to Valentec’s reputation or business; failure to perform reasonable duties; breach of his employment agreement; a course of conduct amounting to gross incompetence; chronic and unexcused absenteeism; unlawful appropriation of a corporate opportunity; or misconduct in connection with the performance of duties, then Mr. Shows is entitled to a severance payment equal to 52 weeks of his base salary. If Mr. Shows terminates his employment due to a change of ownership of Valentec or a change in location of his employment, he will be entitled to full compensation including benefits for the remainder of the term of his employment agreement. In addition, Mr. Shows is subject to confidentiality provisions. This agreement was automatically renewed December 31, 2006 for a period of one year.


ITEM 11.		Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The following table sets forth certain information regarding the beneficial ownership of the Common Stock, and the address of such beneficial owner, as of April 9, 2007 for (i) each person known by the Company to be the beneficial owner of five percent or more of the outstanding common stock (the “Principal Stockholders”), (ii) each of the Company’s officers, directors and consultants, and (iii) all of the Company’s executive officers, directors, consultants as a group. The notes accompanying the information in the table below are necessary for a complete understanding of the figures provided below. The number of shares of Common Stock owned includes shares of Common Stock issuable upon the exercise of options that are currently exercisable or will become exercisable within 60 days of April 9, 2007. For each beneficial owner, officer, director or consultant, his or her percentage of shares outstanding is based upon 15,538,165 shares outstanding as of April 9, 2007.


	As of April 9, 2007
	Beneficially			Percentage of
Name and Address⁽¹⁾	Owned			Class⁽⁸⁾
Robert A. Zummo		6,804,610	⁽²⁾		43.8	%
Global Systems, Inc.		6,604,610	⁽³⁾		42.5	%


	As of April 9, 2007
	Beneficially			Percentage of
Name and Address⁽¹⁾	Owned			Class⁽⁸⁾
Avraham (Miko) Gilat		6,804,610	⁽⁴⁾		43.8	%
Armament Systems International, Inc.		6,604,616	⁽⁵⁾		42.5	%
Zvi Kreizman		100,000	⁽⁶⁾		0.6	%
Larry Matheson		100,000	⁽⁷⁾		0.6	%
Stephen J. Shows		0			0	%
August Cianciolo		0			0	%
W. Glenn Yarborough, Jr.		0			0	%
All Current directors and executive officers as a group (6 persons)		13,809,220			88.87	%⁽⁸⁾

(1)		Unless otherwise indicated, the address of all the Company’s directors and executive officers is c/o the Company’s principal executive offices at 2629 York Avenue, Minden, Louisiana 71055.

(2)		Includes 200,000 shares issuable upon exercise of an immediately exercisable warrant and 6,604,610 shares of Common Stock held directly by Global Systems, Inc. of which Mr. Zummo is President and CEO.

(3)		Includes 6,604,610 shares of Common Stock held directly by Global Systems, Inc. Global Systems, Inc.’s address is 9475 High Meadows Ranch, Durango, Colorado 81301.

(4)		Includes 200,000 shares issuable upon exercise of an immediately exercisable warrant and 6,604,610 shares of Common Stock held directly by Armament Systems International, Inc. of which Mr. Gilat is President and CEO

(5)		Includes 6,604,610 shares of Common Stock held directly by Armament Systems International, Inc. Armament Systems International, Inc.’s address is 3 Bethesda Metro Center, Suite 750, Bethesda, Maryland 20814.

(6)		Includes 100,000 shares issuable upon exercise of an immediately exercisable warrant.

(7)		Includes 100,000 shares issuable upon exercise of an immediately exercisable warrant.

(8)		As of April 9, 2007, the Company had 15,538,165 shares of Common Stock issues and outstanding.

Equity Compensation Plan Information

Our 2006 Equity Incentive Plan was approved by a written consent of the holders of a majority of our outstanding common stock.

On January 7, 2007, 2,000,000 shares of common stock were authorized for issuance, 1,000,000 of such options shares have been granted with a weighted average exercise price of $0.18 per shares and 1,000,000 stock options for shares of common stock are available for issuance of stock options available for future grants under our 2006 Equity Incentive Plan.

The following table provides information as of December 31, 2006, with respect to the shares of common stock that may be issued under our existing equity compensation plan.

Equity Compensation Plan Information

Number of securities

remaining available for

Number of shares of

Weighted-average

future issuance under

common stock to be issued

exercise price of

equity compensation plans

upon exercise of

outstanding

(excluding securities

outstanding options,

options, warrants

reflected in the second

Plan Category

warrants and rights

and rights

1,000,000 column)

Equity compensation plans approved by security holders

1,000,000

Equity compensation plans not approved by security holders

—

Total

1,000,000

ITEM 12. Certain Relationships, Related Transactions and Director Independence

Valentec regularly engages in business with Soltam and Valentec International Limited (VIL) and their affiliates. Avraham (Miko) Gilat, director of Valentec is the chair of Soltam and an indirect equity owner of Soltam Systems. VIL is controlled by directors Avraham (Miko) Gilat and Robert A. Zummo and is owned by Mr. Zummo and Soltam.

Valentec is currently fulfilling orders from Soltam to provide 120mm Weapon Mortar Systems as well as 60mm, 81mm, and 120mm ammunition to the Israeli Defense Forces.

Valentec had a line of credit that was guaranteed by Mr. Zummo and by Soltam. Mr. Zummo used personal property to guarantee $1,000,000 of the Line of Credit at Bank One and Soltam Systems put up a $1,000,000 Letter of Credit to use as collateral on the additional $1,000,000 Line of Credit at Bank One. During 2006 Bank One called this line of credit. Mikal LTD paid for the $1,000,000 guaranteed by Soltam Systems and Mr. Zummo arranged a loan for $1,000,000 with Rockland Credit Finance against personal property. In return, Valentec issued a promissory note in the amount of $1,000,000 to each of the lenders payable on or before October 31, 2007. Soltam has also put up a $500,000 Letter of Credit to guarantee a note at Bank Leumi in New York for a $500,000 Line of Credit for an aggregate Credit Line of $2,500,000.

Valentec obtained loans from Soltam Systems and Robert A. Zummo. The loans to the Company were made in the amount of $400,000 each and were used for working capital in 2001. The balance due as of December 31, 2006 for each loan was $216,637 respectively.

Valentec has a line of credit at Bank Hapoalim for $4,000,000 guaranteed by a letter of credit from Mikal Corporation in which Mr. Gilat is a controlling party.

Valentec and Mikal have previously entered into a management fees arrangement, according to which Mikal is entitled to receive an amount of $324,000 per annum in consideration for management services provided by Mikal. The Board of Directors resolved that upon consummation of the transaction with MAST, Mikal annual management fees shall be $120,000.

On March 13, 2007, our Board of Directors approved the entry into Indemnification Agreements (the “Indemnification Agreement”), between the Company and each of the directors and officers of the Company.

Pursuant to the form of Indemnification Agreement, subject to the exceptions and limitations provided therein,

Valentec has agreed to hold harmless and indemnify its directors and officers to the fullest extent authorized by Valentec’s certificate of incorporation, Bylaws and the Delaware law, and against any and all expenses, judgments, fines and settlement amounts actually and reasonably incurred by them in connection with any threatened, pending or completed action, suit or proceeding arising out of their services as directors or officers, as applicable.

We believe that all of the above transactions and arrangements were advantageous to us and were on terms no less favorable to us than could have been obtained from unaffiliated third parties. There can be no assurance, however, that future transactions or arrangements between us and our affiliates will be advantageous, that conflicts of interest will not arise with respect to these transactions or arrangements, or that if conflicts do arise, they will be resolved in a manner favorable to us. Any future transactions will be approved by a majority of the independent and disinterested members of our board of directors, outside the presence of any interested director and, to the extent deemed necessary or appropriate by the board of directors, we will obtain fairness opinions or stockholder approval in connection with any such transaction.

ITEM 13. Exhibits

(a) Exhibits:


Exhibit Number	Title of Document	Location

3.1	Certificate of Incorporation of Registrant	Incorporated by reference as Exhibit 3.1 to Form 8-K filed on April 11, 2005

3.2	Certificate of Incorporation of Valentec Systems, Inc.	Incorporated by reference as Exhibit 3.2 to Form 8-K filed on April 11, 2005

3.3	By-laws of Registrant	Incorporated by reference as Exhibit 3 to Form 10-QSB filed on November 7, 1996

3.4	By-laws of Valentec Systems, Inc.	Incorporated by reference as Exhibit 3.2 to Form 8-K filed on December 14, 2005

10.1	Stock Purchase and Share Exchange Agreement, dated May 27, 2005, by and among Registrant, Valentec Systems, Inc. and the stockholders of Valentec Systems, Inc.	Incorporated by reference as Exhibit 10.1 to Form 8-K filed on May 27, 2005

10.2	Assignment and Assumption Agreement, dated as of June 6, 2005, by and between Acorn Holdings Corp. and Valentec Systems, Inc.	Incorporated by reference as Exhibit 10.1 to Form 8-K filed on June 10, 2005

10.3	Standby Equity Distribution Agreement, dated as of April 28, 2005, by and between Valentec Systems, Inc. and Cornell Capital Partners, LP	Incorporated by reference as Exhibit 10.2 to Form 8-K filed on June 10, 2005

10.4	Promissory Note of Valentec Systems, Inc., dated as of April 28, 2005, to Montgomery Equity Partners, Ltd.	Incorporated by reference as Exhibit 10.3 to Form 8-K filed on June 10, 2005

10.5	Security Agreement, effective as of April 28, 2005, by and between Valentec Systems, Inc. and Montgomery Equity Partners, Ltd.	Incorporated by reference as Exhibit 10.4 to Form 8-K filed on June 10, 2005


Exhibit Number	Title of Document	Location


10.6	Warrant to Purchase Common Stock issued by Valentec Systems, Inc. to Cornell Capital Partners, LP on April 28, 2005	Incorporated by reference as Exhibit 10.5 to Form 8-K filed on June 10, 2005

10.7	Registration Rights Agreement, dated as of April 28, 2005, by and between Valentec Systems, Inc. and Cornell Capital Partners, LP	Incorporated by reference as Exhibit 10.6 to Form 8-K filed on June 10, 2005

10.8	Placement Agent Agreement, dated as of April 28, 2005 between Valentec Systems, Inc. and Newbridge Securities Corporation	Incorporated by reference as Exhibit 10.7 to Form 8-K filed on June 10, 2005

10.9	Escrow Agreement, dated as of April 28, 2005, by and among Valentec Systems, Inc., Cornell Capital Partners, LP. And David Gonzalez, Esq., as Escrow Agent	Incorporated by reference as Exhibit 10.8 to Form 8-K filed on June 10, 2005

10.10	Lock-Up Agreement, dated April 28, 2005, by and between Valentec Systems, Inc. and Cornell Capital Partners, LP	Incorporated by reference as Exhibit 99.3 to Schedule 13D filed on October 3, 2005

10.11	Warrant to Purchase Common Stock issued by Registrant to Robert Zummo, on August 19, 2005	Incorporated by reference as Exhibit 10.1 to Form 8-K filed on August 24, 2005

10.12	Warrant to Purchase Common Stock issued by Registrant to Avraham (Miko) Gilat, on August 19, 2005	Incorporated by reference as Exhibit 10.2 to Form 8-K filed on August 24, 2005

10.13	Warrant to Purchase Common Stock issued by Registrant to Larry Matheson, on August 19, 2005	Incorporated by reference as Exhibit 10.3 to Form 8-K filed on August 24, 2005

10.14	Warrant to Purchase Common Stock issued by Registrant to Zvi Kreizman, on August 19, 2005	Incorporated by reference as Exhibit 10.4 to Form 8-K filed on August 24, 2005

10.15	Master Factoring Agreement, dated as of September 1, 2005, by and among Registrant and Valentec Systems, Inc. and Rockland Audit Finance LLC	Incorporated by reference as Exhibit 10.1 to Form 8-K filed on September 8, 2005

10.16	Addendum No. 1 to Master Factoring Agreement, dated as of September 1, 2005, by and among Registrant and Valentec Systems, Inc. and Rockland Credit Finance LLC	Incorporated by reference as Exhibit 10.2 to Form 8-K filed on September 8, 2005

10.17	Revolving Credit Promissory Note issued by Registrant and Valentec Systems, Inc. to Rockland Credit Finance LLC on September 1, 2005	Incorporated by reference as Exhibit 10.3 to Form 8-K filed on September 8, 2005

10.18	Instrument of Assignment, dated August 23, 2005, by and between Rockland Credit Finance LLC and Valentec Systems, Inc.	Incorporated by reference as Exhibit 10.12 to Form 8-K filed on December 14, 2005


Exhibit Number	Title of Document	Location


10.19	Award/Contract No. W52P1J-05-0015, dated February 3, 2005, by and between HQAFSC (US Army) and Valentec Systems, Inc.	Incorporated by reference as Exhibit 10.5 to Form 8-K filed on December 14, 2005

10.20	Award/Contract No. W52PIJ-05-C-0024, dated April 18, 2005, by and between HQAFSC (US Army) and Valentec Systems, Inc.	Incorporated by reference as Exhibit 10.6 to Form 8-K filed on December 14, 2005

10.21	Amendment of Solicitation/Modification of Contract No. W52PIJ-05-C-0024, dated July 15, 2005, by and between HQAFSC (US Army) and Valentec Systems, Inc.	Incorporated by reference as Exhibit 10.7 to Form 8-K filed on December 14, 2005

10.22	Amendment of Solicitation/Modification of Contract No. W52PIJ-04-C-0103, dated July 11, 2005, by and between HQAFSC (US Army) and Valentec Systems, Inc.	Incorporated by reference as Exhibit 10.9 to Form 8-K filed on December 14, 2005

10.23	Facility Use Agreement, dated January 1, 2005 by and between Louisiana Military Department and Valentec Systems, Inc.	Incorporated by reference as Exhibit 10.15 to Form 8-K filed on December 14, 2005

10.24	Employment Agreement, effective as of January 1, 2006, by and between the Registrant and Robert A. Zummo	Incorporated by reference as Exhibit 10.24 to Form 10-KSB filed on April 17, 2006

10.25	Promissory Note to Soltam Systems, Inc.	Incorporated by reference as Exhibit 10.25 to Form 10-KSB filed on April 17, 2006

10.26	Promissory Note to Robert Zummo	Incorporated by reference as Exhibit 10.26 to Form 10-KSB filed on April 17, 2006

10.27	Promissory Note to Bank Leumi USA	Incorporated by reference as Exhibit 10.27 to Form 10-KSB filed on April 17, 2006

10.28	Promissory Note to Bank Hapoalim	Incorporated by reference as Exhibit 10.28 to Form 10-KSB filed on April 17, 2006

10.29	Promissory Note to Robert Zummo dated November 19, 2006	Provided Herewith

10.30	Promissory Note to Mikal Ltd. dated November 19, 2006	Provided Herewith

10.31	Form of Directors and Officers Indemnification Agreement	Incorporated by reference as Exhibit 99.3 to Form 8-K filed on March 13, 2007

10.32	2006 Equity Incentive Plan	Incorporated by reference as Exhibit 99.1 to Form 8-K filed on January 8, 2007


Exhibit Number	Title of Document	Location


10.33	Form of Directors Engagement Letter	Incorporated by reference as Exhibit 99.2 to Form 8-K filed on March 13, 2007

14.1	Code of Business Conduct and Ethics	Incorporated by reference as Exhibit 14.1 to Form 10-KSB filed on April 17, 2006

21	List of subsidiaries of the Company	Incorporated by reference as Exhibit 21 to Form 10-KSB filed on November 17, 2005

31.1	Certification by the Chief Executive Officer and Principal Accounting Officer pursuant to Rule 13a-14(a) of the Exchange Act	Provided herewith

32.1	Certification of the Chief Executive Officer and Principal Accounting Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	Provided herewith

(b) Report on Form 8-K

On January 8, 2007 the Company filed a Current Report on Form 8-K announcing that it obtained the written consent, in lieu of a meeting of stockholders of the Company, from the holders of a majority of the outstanding voting power of the Company’s common stock, approving the recommendation of the board of directors of the Company to (i) adopt the 2006 Equity Incentive Plan for the benefit of the employees, consultants and directors of the Company and of any affiliate thereof, a copy of which is attached as an exhibit hereto (the “Plan”), and (ii) to reserve 2,000,000 shares of Common Stock designated for allocation under the Plan (the “Reserved Shares”).

On January 16, 2007 the Company filed a Current Report on Form 8-K announcing that its Board of Directors granted a total of 1,000,000 options to purchase shares of the Company’s common stock under the Company’s 2006 Equity Incentive Plan.

On January 22, 2007, the Company filed a Current Report on Form 8-K announcing it entered into a binding term sheet to acquire all of the outstanding capital stock of MAST Technology, Inc., a Missouri based company hereinafter referred to as MAST, in a transaction structure yet to be formally determined.

On March 13, 2007, the Company filed a Current Report on Form 8-K announcing the appointment of (ret.) Colonel W. Glenn Yarborough, Jr. and (ret.) Lieutenant General Gus Cianciolo as members of its Board of Directors to hold office until the next annual meeting of stockholders and until their successors are elected and qualified or their earlier resignation or removal. The Company also announced the approved of entry into Indemnification Agreements with each of the directors and officers of the Company.

On March 26, 2007, the Company filed a Current Report on Form 8-K announcing that it has been awarded a $3.6 million contract to produce and integrate 56, 120mm Recoiling Mortar Systems (“RMS6”) for the Israeli Defense Forces.

On April 12, 2007, the Company filed a Current Report on Form 8-K announcing that it has received $3.1 million in new orders to produce its 40mm White Star Parachute flares for the U.S. Army.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors of
Valentec Systems, Inc. and Subsidiary:

We have audited the accompanying consolidated balance sheet of Valentec Systems, Inc. and subsidiary as of December 31, 2006 and the related statements of operations, changes in stockholders’ deficiency and cash flows for the years ended December 31, 2006 and 2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits 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 financial position of Valentec Systems, Inc. and subsidiary as of December 31, 2006 and the results of its operations and its cash flows for the years ended December 31, 2006 and 2005 in conformity with accounting principles generally accepted in the United States of America.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 16 to the financial statements, the Company has a working capital deficiency of $10,043,206 and a negative cash flow from operations of $6,499,164. These factors raise substantial doubt about its ability to continue as a going concern. Management’s plans concerning this matter are also described in Note 16. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

WEBB & COMPANY, P.A.

Boynton Beach, Florida
May 14, 2007

F-1

VALENTEC SYSTEMS, INC. AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2006


ASSETS
CURRENT ASSETS
Cash	$	150,429
Accounts receivable and in-process billings, net		17,409,093
Prepaid and other expenses		90,383
Inventories, net		413,929
Total Current Assets		18,063,834


PROPERTY AND EQUIPMENT, NET		1,670,706


OTHER ASSETS
Deferred income tax		92,513
Insurance Proceeds Due		249,850
Contract development cost, net		5,841,910
Deposits		31,936

Total Other Assets		6,216,209


TOTAL ASSETS	$	25,950,749


LIABILITIES AND STOCKHOLDERS’ EQUITY

CURRENT LIABILITIES
Accounts payable and accrued expenses		8,461,574
Accrued salaries and payroll withholding		166,480
Lines of credit		13,546,699
Note payable — stockholders		2,509,333
Deferred revenue		1,426,599
Due to related party		1,468,683
Current Portion — Capital Leases		26,585
Customer Deposits		25,845
Deferred income taxes payable		475,241

Total Current Liabilities		28,107,039


COMMITMENTS AND CONTINGENCIES
LONG TERM LIABILITIES
Capital Leases — Long Term		107,912

Total Long Term Liabilities		107,912


TOTAL LIABILITIES		28,214,951

STOCKHOLDERS’ EQUITY (DEFICIENCY)
Preferred stock, $0.01 par value, 10,000,000 authorized, none issued and outstanding		-0-
Common stock, $0.01 par value, 250,000,000 shares authorized, 15,538,165 shares issued and outstanding		155,382
Additional paid in capital		3,170,682
Accumulated Deficiency		(5,393,517	)
Stockholder Advance		(196,749	)

Total Stockholders’ Deficiency		(2,264,202	)


TOTAL LIABILITIES AND STOCKHOLDERS’ DEFICIENCY	$	25,950,749

See accompanying notes to consolidated financial statements.

F-2

VALENTEC SYSTEMS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005


	2006			2005
REVENUES
Contract revenues	$	19,624,038		$	19,015,978

COST OF GOODS SOLD		15,268,010			12,497,159


GROSS PROFIT		4,356,028			6,518,819

OPERATING EXPENSES
Fringe benefit expenses		589,804			662,099
Overhead expenses		3,503,185			2,130,485
General and administrative		3,464,258			2,714,664

Total Operating Expenses		7,557,247			5,507,248


INCOME (LOSS) FROM OPERATIONS		(3,201,219	)		1,011,571

OTHER INCOME (EXPENSE)
Fire Casualty Loss		(442,837	)		-0-
Interest income		2,640			46,019
Miscellaneous		9,685			—
Interest expense		(2,365,222	)		(415,471	)

Total Other Income (Expense)		(2,795,734	)		(369,452	)


INCOME (LOSS) BEFORE INCOME TAXES		(5,996,953	)		642,119

Provision for Income Taxes		5,487			241,731


NET INCOME (LOSS)	$	(6,002,440	)	$	400,388


Net income (loss) per share — basic and diluted	$	(0.39	)	$	0.06


Weighted average number of shares outstanding during the period — basic and diluted	$	15,529,392		$	6,363,183

See accompanying notes to consolidated financial statements.

F-3

VALENTEC SYSTEMS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (DEFICIENCY)
FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005


	Preferred Stock				Common Stock				Additional						Deferred
									Paid-In			Retained			Offering			Stockholder
	Shares		Amount		Shares		Amount		Capital			Earnings			Costs			Loan			Total

Balance, December 31, 2004		—		—		5,423,130		54,231		2,938,038			208,535			—			—			3,200,804


Stock issued in reverse merger		—		—		1,573,970		15,740		(15,740	)		—			—						—

Fair value of warrants issued for deferred offering costs		—		—		—		—		26,458			—			(26,458	)					—

Deferred offering costs of SEDA		—		—		—		—		—			—			(621,254	)					(621,254	)

Fair value of warrants issued to directors		—		—		—		—		15,575			—			—						15,575

Fair value of warrants issued with note payable		—		—		—		—		26,458			—			—						26,458

In-Kind Stockholder Loan Interest										42,846												42,846

Net income, 2005		—		—		—		—		—			400,388			—						440,388


Balance, December 31, 2005		—		—		6,997,100		69,971		3,033,635			608,923			(647,712	)		—			3,064,817


In-Kind Stockholder Loan Interest										33,705												33,705

Write Off Deferred Offering Costs																647,712						647,712
Stock issued due to Stock Purchase and Share Exchange Agreement						7,786,050		77,861		(77,861	)											—

Stock Issued to Consultants						755,015		7,550		181,203												188,753

Advance to Stockholder																			(196,749	)		(196,749	)

Net Loss, 2006													(6,002,440	)								(6,002,440	)


BALANCE, DECEMBER 31, 2006			$			15,538,165	$	155,382	$	3,170,682		$	(5,393,517	)	$	—		$	(196,749	)	$	(2,264,202	)

See accompanying notes to consolidated financial statements.

F-4

VALENTEC SYSTEMS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005


	2006			2005
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (Loss)	$	(6,002,440	)	$	400,387
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization		826,458			884,460
Fire Casualty Loss		442,837			—
Write off of Deferred Offering Costs		647,712			—
Fair value of stock options issued		—			15,575
Amortization of note payable discount		—			26,458
Interest expense contributed in-kind		33,705			42,846
Changes in operating assets and liabilities:
(Increase) decrease in:
Accounts receivable and in-process billings		(4,802,165	)		(10,785,380	)
Inventory		196,093			(716,250	)
Prepaid expense		33,980			(156,299	)
Increase (decrease) in:
Accounts payable and accrued expenses		3,512,488			2,947,888
Due to related party		476,445			(334,911	)
Accrued interest related party		26,059			—
Deferred income taxes		—			236,653
Deferred revenue		(1,890,337	)		888,994

Net Cash Provided By (Used In) Operating Activities		(6,499,165	)		(6,549,578	)


CASH FLOWS FROM INVESTING ACTIVITIES:
Restricted cash		—			1,327,468
Development fees capitalized		—			(512,961	)
Cash received from insurance settlement		1,035,000			—
Purchase of property and equipment		(986,524	)		(556,393	)

Net Cash Provided By (Used In) Investing Activities		48,476			258,114


CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock		—			26,458
Proceeds from notes payable — stockholders		2,050,000			(196,749	)
Proceeds from line of credit		6,482,623			6,781,618
Proceeds from note payable		—			1,000,000
Repayment of note payable		(1,999,545	)		(1,000,000	)
Payments on capital leases		(13,839	)		—
Due to shareholders		—			(500,181	)

Net Cash Provided By Financing Activities		6,519,239			6,111,146


NET INCREASE (DECREASE) IN CASH		68,550			(180,318	)

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		81,879			262,197


CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	150,429		$	81,879


SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

Deferred offering costs	$	(188,753	)	$	—
Cash paid for interest	$	2,365,222		$	376,625

Cash paid for income taxes	$	5,487		$	—

See accompanying notes to consolidated financial statements.

F-5

VALENTEC SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005


NOTE 1	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ORGANIZATION

	*(A) Organization*

	Valentec Systems, Inc., f/k/a Acorn Holding Corp. (a holding company) is a Delaware corporation incorporated on September 8, 1983.

	Valentec Operating Corp. is an ammunition and systems integration company that provides ammunition to the United States Army and systems integration for foreign governments. The Company was incorporated on May 1, 1998 in the state of Delaware.

	On May 27, 2005, Valentec Systems, Inc. consummated an agreement with Valentec Operating Corp, pursuant to which Valentec Operating Corp. exchanged all of its 100 shares then issued, and outstanding shares of common stock for 5,423,130 shares or approximately 78% of the common stock of Valentec Systems, Inc. As a result of the agreement, the transaction was treated for accounting purposes as a recapitalization by the accounting acquirer Valentec Systems, Inc.

	Accordingly, the financial statements include the following:

	(1)	The balance sheet consists of the net assets of the acquirer at historical cost and the net assets of the acquiree at historical cost.

	(2)	The statement of operations includes the operations of the acquirer for the periods presented and the operations of the acquiree from the date of the merger.

	Valentec Systems, Inc. f/k/a Acorn Holding Corp. and its wholly owned subsidiary Valentec Operating Corp are hereafter referred to as (the “Company”).

	*(B) 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 reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates for 2006 include amortization of development costs, estimation of cost to complete long term contracts, valuation allowance on deferred tax asset and allocation of overhead costs.

	*(C) Cash and Cash Equivalents*

	For purposes of financial statement presentation, the Company considers all highly liquid debt instruments with initial maturities of ninety days or less to be cash equivalents.

F-6

VALENTEC SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005


		As of December 31, 2006, the Company does not have any balances in excess of federally insured limits.

		*(D) Principles of Consolidation*

		The 2006 consolidated financial statements include the accounts of Valentec Systems, Inc., f/k/a Acorn Holding Corp. and its subsidiary, Valentec Operating Corp. The 2005 consolidated financial statements include the accounts of Valentec Systems, Inc from May 27, 2005 and Valentec Operating Corporation. All significant inter company accounts and transactions have been eliminated.

		*(E) Inventory*

		Inventories are valued at the lower of cost or market. Cost is determined using the first-in, first-out (FIFO) method. Provision for potentially obsolete or slow moving inventory is made based on management’s analysis of inventory levels and future sales forecasts.

		*(F) Property and Equipment*

		Property and equipment are recorded at the original cost to the Company. Assets are being depreciated using the straight line balance method over predetermined lives of three to ten years.

		*(G) Contract Revenue*

		Revenue from fixed-price type contracts is recognized under the percentage-of-completion using the cost-to-cost method of accounting, with cost and estimated profits included in contract revenue as work is performed. If actual and estimated costs to complete a contract indicate a loss, a provision is made currently for the loss anticipated on the contract. Advance payments received are reported in the accompanying balance sheet as deferred revenue.

		Revenue from time and materials type contracts is recognized as costs are incurred at amounts represented by the agreed-upon billing amounts.

		Revenue recognized on contracts for which billings have not been presented to customers is included in the accounts receivable and in-process billings classification on the balance sheet.

		*(H) Fair Value of Financial Instruments*

		The carrying amounts of the Company’s financial instruments including accounts receivable, accounts payable, notes payable, lines of credit and deferred revenue approximate fair value due to the relatively short period to maturity for these instruments.

F-7

VALENTEC SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005


		*(I) Earnings Per Share*

		Basic and diluted net earnings per common share is computed based upon the weighted average common shares outstanding as defined by Financial Accounting Standards No. 128, “Earnings Per Share.” The effect of 1,000,000 and 1,000,000 warrants are not included in the 2006 and 2005 calculation of diluted net income (loss) as the effect is anti-dilutive.

		*(J) Product Information*

		The company operates in three major product lines, systems management and integration, energetic manufacturing and metal parts.


	Systems		Energetic			Metal Parts		Total
Revenues	$	15,861,000	$	2,690,805		$	1,072,233	$	19,624,038
Gross Margin		5,338,794		(1,317,573	)		334,807		4,356,028
Order Backlog		11,813,922		1,661,019			-0-		13,474,941


		*(K) Long-Lived Assets*

		The Company accounts for long-lived assets under the Statements of Financial Accounting Standards Nos. 142 and 144 “Accounting for Goodwill and Other Intangible Assets” and “Accounting for Impairment or Disposal of Long-Lived Assets” (“SFAS No. 142 and 144”). In accordance with SFAS No. 142 and 144, long-lived assets, goodwill and certain identifiable intangible assets held and used by the Company are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. For purposes of evaluating the recoverability of long-lived assets, goodwill and intangible assets, the recoverability test is performed using undiscounted net cash flows related to the long-lived assets.

		*(L) Reclassification*

		Certain amounts from prior periods have been reclassified to conform to the current year presentation.

		*(M) Income Taxes*

		The Company accounts for income taxes under the Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“Statement 109”). Under Statement 109, deferred tax assets and liabilities are recognized for the future tax consequences

F-8

VALENTEC SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005


		attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under Statement 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

		*(N )Stock Option Policy*

		The Company accounts for stock options and warrants under SFAS No. 123R, Accounting for Stock-Based Compensation, defines a fair value method of accounting for stock options and similar equity instruments. Under the fair value method, compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service period, which is usually the vesting period.

		*(O) Recent Accounting Pronouncements*

		In May 2005, the FASB issued SFAS 154, Accounting Changes and Error Corrections. This Statement replaces APB Opinion No,. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. SFAS 154 also requires that a change in depreciation, amortization or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate effected by a change in accounting principle. This Statement is effective in fiscal years beginning after December 15, 2005. The Company has not yet determined the effect of implementing this standard.

		In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments-an amendment of FASB Statements No. 133 and 140”, to simplify and make more consistent the accounting for certain financial instruments. SFAS No. 155 amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, to permit fair value re-measurement for any hybrid financial instrument with an embedded derivative that otherwise would require bifurcation, provided that the whole instrument is accounted for on a fair value basis. SFAS No. 155 amends SFAS No. 140, “Accounting for the Impairment or Disposal of Long-Lived Assets”, to allow a qualifying special-purpose entity to hold a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS No. 155 applies to all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006, with earlier application allowed. The adoption of this statement is not expected to have a material effect on the Company’s future reported financial position or results of operations.

F-9

VALENTEC SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005


		In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets, an amendment of FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”. This statement requires all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable, and permits for subsequent measurement using either fair value measurement with changes in fair value reflected in earnings or the amortization and impairment requirements of Statement No. 140. The subsequent measurement of separately recognized servicing assets and servicing liabilities at fair value eliminates the necessity for entities that manage the risks inherent in servicing assets and servicing liabilities with derivatives to qualify for hedge accounting treatment and eliminates the characterization of declines in fair value as impairments or direct write-downs. SFAS No. 156 is effective for an entity’s first fiscal year beginning after September 15, 2006. The adoption of this statement is not expected to have a material effect on the Company’s future reported financial position or results of operations.

		In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statements No. 109”. FIN 48 clarifies the accounting for uncertainty in income taxes by prescribing a two-step method of first evaluating whether a tax position has met a more likely than not recognition threshold and second, measuring that tax position to determine the amount of benefit to be recognized in the financial statements. FIN 48 provides guidance on the presentation of such positions within a classified statement of financial position as well as on derecognition, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The adoption of this statement is not expected to have a material effect on the Company’s future reported financial position or results of operations.

		In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”. The objective of SFAS 157 is to increase consistency and comparability in fair value measurements and to expand disclosures about fair value measurements. SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements and does not require any new fair value measurements. The provisions of SFAS No. 157 are effective for fair value measurements made in fiscal years beginning after November 15, 2007. The adoption of this statement is not expected to have a material effect on the Company’s future reported financial position or results of operations.

		In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment of FASB Statements No. 87, 88, 106, and 132(R)”. This statement requires employers to recognize the over-funded or under-funded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income

F-10

VALENTEC SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005


		of a business entity or changes in unrestricted net assets of a not-for-profit organization. This statement also requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. The provisions of SFAS No. 158 are effective for employers with publicly traded equity securities as of the end of the fiscal year ending after December 15, 2006. The adoption of this statement is not expected to have a material effect on the Company’s future reported financial position or results of operations.

		In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB No. 108 addresses how the effects of prior year uncorrected misstatements should be considered when quantifying misstatements in current year financial statements. SAB No. 108 requires companies to quantify misstatements using a balance sheet and income statement approach and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative an qualitative factors. SAB No. 108 is effective for period ending after November 15, 2006. The Company is currently evaluating the impact of adopting SAB No. 108 but does not expect that it will have a material effect on its financial statements.

		In February 2007, the Financial Accounting Standards Board (FASB) issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115”. This statement permits entities to choose to measure many financial instruments and certain other items at fair value. Most of the provisions of SFAS No. 159 apply only to entities that elect the fair value option. However, the amendment to SFAS No. 115 “Accounting for Certain Investments in Debt and Equity Securities” applies to all entities with available-for-sale and trading securities. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provision of SFAS No. 157, “Fair Value Measurements”. The adoption of this statement is not expected to have a material effect on the Company’s financial statements.

NOTE 2		ACCOUNTS RECEIVABLE AND IN-PROCESS BILLINGS

		Accounts receivable consist of billed and unbilled accounts under contracts in progress with governmental units, principally with the Department of Defense and the Government of Israel. The components of accounts receivable at December 31, 2006 are:


Billed: US Army	$	2,150,843
Government of Israel		1,461,031
Miscellaneous Commercial		47,442

Total Billed Receivables	$	3,659,316

F-11

VALENTEC SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005


Unbilled: US Army	$	2,266,787
Government of Israel		11,482,990
Miscellaneous Commercial		—

Total Unbilled Receivables	$	13,749,777

Total Billed and Unbilled Accounts Receivable	$	17,409,093


		Unbilled accounts receivable relates to work that has been performed for which billings have not been presented to customers. It is anticipated that the unbilled amounts will be collected within the next fiscal year.

		Currently there is an ongoing Request for Equitable Adjustment (REA) dispute with the U.S. Army in the amount of $1,085,192, which is included in the Accounts Receivable from the U.S. Government, and unbilled receivables of $295,476.

		The Company received advance payments from the Department of Defense, Israel and applied it to unbilled receivables as a percentage of unbilled accounts receivable to liquidate the advance payments upon completion of the contracts under the previsions of each contract.

NOTE 3		INVENTORY

		Inventory is stated at the lower of cost or market value using the average cost method. Inventories at December 31, 2006 consist of:


Finished goods		$	413,929


		The Company reviews its inventory for impairment, and as of December 31, 2006 and 2005 there were none.

NOTE 4		PROPERTY AND EQUIPMENT

		The following is a summary of property and equipment at December 31, 2006:


Furniture and fixtures	$	100,388
Machinery and equipment		2,259,655
Leasehold improvements		691,978

		3,052,021
Less accumulated depreciation		(1,381,315	)

	$	1,670,706

F-12

VALENTEC SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005


		Depreciation expense was $391,250 and $386,639 for the years ended December 31, 2006 and 2005.

		On August 14, 2006, Valentec Systems, Inc. sustained a fire in its 40mm manufacturing facility. As a result of the fire, the Company experienced a loss of a significant amount of Machinery and Equipment, Inventory and Leasehold Improvements. As of the date of these financial statements the Company is still in the rebuilding process. The Company had insurance coverage however we were informed by the insurance broker that the additional coverage requested prior to the fire had not been placed as anticipated. Therefore the Company began litigation against the insurance company for $249,850 (see Note 13). As a result of the fire, the loss the Company sustained due to Involuntary Conversion was $442,837 (see Note 15).

NOTE 5		DEVELOPMENT COSTS

		The Company incurred development cost associated with the development of three new product lines of $6,261,979 at 2004 and an additional $512,961 at 2005 for a total of $6,774,940. These costs are being allocated to associated contracts beginning in 2005. The cost relates to the following product lines:


Keshet — Systems Integration	$	3,026,140
Ammunition Mortar Rounds (60,81,120 mm)		854,108
40mm		2,894,692

		6,774,940
Less development cost amortization		(933,030	)

	$	5,841,910


		Total amortization expense for the years ended December 31, 2006 and 2005 was $435,208 and $497,821, respectively.

		Future amortization of development costs expected over the next five years are as follows;


Year	Amount
2007	$	727,313
2008	$	1,058,346
2009	$	1,459,490
2010	$	1,973,174
2011	$	623,587

F-13

VALENTEC SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005


NOTE 6		LINES OF CREDIT

		The company had a line of credit from Bank One in the amount of $2,000,000 and accrued interest at a rate of Prime less 0.75%. The line of credit was secured by a letter of credit from a related company and personal property of a stockholder. On September 1, 2006, the outstanding balance of $1,999,545 was called by Bank One. The line of was guarantted by a related company and stockholder who repaid the loan in full.

		The company has a line of credit from Bank Hapoalim in the amount of $4,000,000 that accrues interest at a rate of Libor plus 1.75% (at December 31, 2006 — 7.10% per annum). The line of credit is secured by a letter of credit from a stockholder. At December 31, 2006 $3,930,000 was outstanding under this line.

		The company has a line of credit from Bank Leumi in the amount of $500,000 that accrues interest at a rate of 7.13% per annum. The line of credit is secured by a letter of credit from a stockholder. At December 31, 2006 $500,000 was outstanding under this line.

		The company has a line of credit from Rockland Credit Finance with a facility limit of $10,000,000 accruing interest at 1% per month on outstanding balances plus Prime plus 2% per annum (at December 31, 2006 10.25%). The line of credit is secured under a Master Factoring Agreement which includes a lien on all the assets of the Company. The total amounts available under the line varies based on the total billed and unbilled accounts receivable. The total available as of December 31, 2006 was $10,000,000 based on 70% of in-process receivables and 90% of accounts receivable. At December 31, 2006, $9,116,699 was outstanding under this line. The line of credit agreement requires the company to submit monthly and annual financial reports and stay in compliance with various state and federal laws. During 2006, the Company received a waiver under the agreement from the Lender for two events of Default.

NOTE 7		NOTE PAYABLE — RELATED PARTY

		The Company is indebted under notes payable to two stockholders of the Company. The notes bear interest at various rates based on prime rate per annum which was 8.25% as of December 31, 2006. During 2006 and 2005, the two stockholders waived their right to interest under the notes and the Company recorded an in-kind contribution in the amount of $33,705 which was included in the December 31, 2006 and 2005 financial statements. The notes are due on demand and have an outstanding balance of $433,274 as of December 31, 2006.

		Bank One called the Line of Credit Note secured by a related party and Stockholder. The related party repaid $1,000,000 of the Bank One Notes Payable. The notes payable to Mikal LTD is in the amount of $1,000,000 and accrues interest at the rate of LIBOR plus 2.00% (at December 31, 2006 — 7.31%). The note payable is an interest only note and the principal is payable in full on October 31, 2007. (see note 6)

F-14

VALENTEC SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005


		Bank One called the Line of Credit Note secured by a related party and Stockholder. The Stockholder repaid $1,000,000 of the Bank One Notes Payable by securing a loan against personal real estate from Rockland Credit Finance. The original amount of the note payable to Rockland Credit Finance was $1,050,000, which included incurred and accrued closing costs on the real estate. The note bears an interest rate of 20.0% payable monthly. The note is an interest only note and the principal balance is payable in full on October 31, 2007. (see note 6)

NOTE 8		INCOME TAXES

		Income tax expense for the years ended December 31, 2006 and 2005 differed from amounts computed by applying the statutory U.S. federal corporate income tax rate of 34% and Louisiana State corporate tax rate of 3.6% to income before income tax benefit as a result of the following:


	2006			2005
Expected income tax expense from operations	$	—		$	224,741
Permanent Differences		7,917			43,490
Wage Tax Credits		(30,750	)		(26,500	)
	$	(22,833	)	$	241,731


		The effects of the temporary differences that gave rise to significant portions of deferred tax assets and liabilities at December 31, 2006 and 2005 are as follows:


Deferred tax assets:	2006		2005
Net operating loss carryforward (benefit)	$	92,513	$	92,513

Total gross deferred tax assets		92,513		92,513
Less valuation allowance		—		—

Net deferred tax assets	$	92,513	$	92,513


Deferred tax liabilities:	2005		2004
Amortization and depreciation	$	475,241	$	237,207

Net deferred tax liabilities	$	475,241	$	237,207

F-15

VALENTEC SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005


		The significant components of the Company’s net deferred tax assets are as follows for the years ended December 31:


	2006			2005
Deferred tax assets:
Net operating loss carryforwards	$	5,107,812			($891,672	)
Depreciation and amortization		874,335			884,463
Accrued Expenses		192,018			293,150

Total deferred tax assets	$	6,174,165		$	285,941
Valuation allowance		($6,174,165	)		($285,941	)

Net deferred tax assets	$	—		$	—

SFAS 109 requires a valuation allowance to reduce the deferred tax assets reported if, based on the weight of the evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. After consideration of all the evidence, both positive and negative, management has determined that a full valuation allowance of $6,174,165 against its net deferred taxes is necessary as of December 31, 2006. The change in valuation allowance for the years ended December 31, 2006 and 2005 is $5,888,224 and $285,941 respectively.

At December 31, 2006, the Company had approximately $6,174,165 of U.S. net operating loss carryforwards remaining, which expire beginning in 2025. The Company will record the benefit of approximately $2,323,338 of the net operating loss carryforwards through additional paid-in capital if and when the net operating loss carryforwards are utilized, as such amounts relate to the unrecognized tax benefit from stock option exercises.

As a result of certain ownership changes, the Company may be subject to an annual limitation on the utilization of its U.S. net operating loss carryforwards pursuant to Section 382 of the Internal Revenue Code. A study to determine the effect, if any, of this change, has not been undertaken.

A reconciliation of the Company’s income taxes to amounts calculated at the federal statutory rate is as follows for the years ended December 31:


	2006			2005
Federal statutory taxes		(34.00	)%		(34.00	)%
State income taxes, net of federal tax benefit		(3.63	)		(3.63	)
Change in valuation allowance		37.63			37.63

		—	%		—	%

F-16

VALENTEC SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005


NOTE 9		EQUITY

		A) COMMON STOCK
		On June 6, 2005, Valentec Operating became a wholly-owned subsidiary of Valentec Systems. The stockholders of Valentec Operating exchanged 100% of their stock for 5,423,130 shares of common stock in Valentec Systems. The stockholders of Valentec Operating own approximately 78% of Valentec Systems after the merger, and pursuant to the “Stock Purchase and Share Exchange Agreement” upon approval of an increase in authorized capital, the stockholders of Valentec Operating will receive an additional 7,786,090 shares of common stock.

		During 2005, the Company issued 1,573,946 shares of common stock in a reverse merger transaction.

		The Company also entered into an agreement in April 2005 with an investment firm to provide up to $15,000,000 of equity per a Standby Equity Distribution Agreement (SEDA). The common stock issued under the SEDA would be at 98% of market value. In addition, each advance has a 5% transaction fee. In connection with this transaction, the Company or its surviving company, issued a warrant to the investment company to acquire 200,000 shares of common stock at an exercise price of $.01 per share. The warrants were valued based on the Black-Scholes option pricing model with the following assumptions: dividend yield of 0%, term of 2 years, volatility of 130% and risk-free rate of 4.05%. The Company recorded $647,712 of fees associated with these various transactions as deferred offering costs. During 2006, the Company wrote off the $647,712 in Deferred Offering Costs.

		During 2006, as a result of increasing its authorized common shares, the Company issued 7,786,056 shares of common stock to stockholders of Valentec Operating Corporation under the “Stock Purchase and Share Exchange Agreement”. The Company also issued 755,015 shares to one investment company under the SEDA Agreement. The shares were originally recorded as a liability as the Company did not have the required shares at the time the SEDA transaction occurred. The total fair value at the date of the agreement was $188,573.

		B) WARRANTS AND OPTIONS

		On August 19, 2005, the Company issued to each of Robert Zummo, Avraham (Miko) Gilat, Larry Matheson and Zwika Kreisman a Warrant to Purchase Common Stock, relating to shares of Acorn’s common stock, par value $0.01 (the “Common Stock”). The aggregate number of shares of Common Stock that each of Mr. Zummo and Mr. Gilat can purchase pursuant to the Warrants to Purchase Common Stock (the “Warrants”) is 200,000 shares of Common Stock at an exercise price of $0.25 per share and the aggregate number of shares of Common Stock that each of Mr. Matheson and Mr. Kreisman can purchase is 100,000 shares of Common Stock at an exercise price of $0.25. The Warrants became exercisable

F-17

VALENTEC SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005


		immediately and expire on August 19, 2008. The Company recorded an expense of $15,575 during 2005. Messrs. Zummo, Gilat, Matheson and Kreisman have all been appointed to fill vacancies on the Valentec Board of Directors, and the Warrants are intended to compensate them for their service to Valentec as Board members. Messrs. Zummo and Gilat are Chairman and Vice Chairman of the Board, respectively.

		Pursuant to the stock purchase and share exchange agreement between Valentec Systems and Valentec Operating, 200,000 warrants were issued to Montgomery Equity Partners at an exercise price of $0.01 per share. The warrants with value based on the Black-Scholes option pricing model with the following assumptions: dividend yield of 0%, term of 2 years, volatility of 130% and risk-free interest rate of 4.05%.

		Pursuant to the SEDA Agreement between Cornell Capital Partners and Valentec Systems, 200,000 warrants were issued to Cornell Capital Partners at an exercise price of $0.01 per share. The fair value of $26,458 is recorded as deferred offering costs and will be amortized upon receipt of the SEDA funding. The warrants with value based on the Black-Scholes option pricing model with the following assumptions: dividend yield of 0%, term of 2 years, volatility of 130% and risk-free interest rate of 4.05%.

NOTE 10		PROFIT SHARING PLAN

		The Company has adopted a qualified 401(k) Profit Sharing Plan for all present and future eligible employees. The Company matches employee contributions, $0.50 cents for every dollar, up to 3% of salaries and may contribute a discretionary amount annually as determined by the Board of Directors. The contribution is limited to the maximum contribution allowed under the Internal Revenue Service regulations, which is presently 15% of their gross annual earnings limited to $7,000, as indexed for inflation. Employees vest 100% in all salary reduction contributions. The Company’s matching and discretionary contributions vest 100% after two years of service. The Company contributed $41,138 for the year ended December 31, 2006 and $40,938 for the year ended December 31, 2005, as a match to employees and did not make any annual discretionary contributions for either year.

NOTE 11		RELATED PARTY

		The Company’s principal stockholders also have interest in other companies whose operations are similar to those of the Company. The Company purchases and sells materials and services to these entities. Following is a summary of transactions and balances with affiliates for the years ended December 31, 2006 and 2005:

F-18

VALENTEC SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005


	2006		2005
Sales to affiliates	$	16,072,523	$	8,731,814

Due from affiliates (included in advances - stockholders in accompanying balance sheet)	$	196,749	$	196,749

Due to related party	$	1,468,683	$	992,236

Advance payment on a contract — related party	$	-	$	3,266,725


		For the year ended December 31, 2006 and 2005, consulting fees of approximately $444,000 and $418,782, were incurred from related parties which are directors of the Company.

		The Company paid consulting fees to TSC Consulting Services which is owned by a related party. For the years ended December 31, 2006 and 2005, the consulting fees paid were $40,080 and $91,261, respectively.

NOTE 12		CONTRACT STATUS

		The Company has provided products and services to the government under fixed price contracts. In these types of contracts, prices are not subject to any adjustment on the basis of costs incurred to perform the required work under the technical data package (TDP). The award of any negotiated contract in excess of $100,000 ($500,000 for Department of Defense, National Aeronautics and Space Administration and Coast Guard) with certain exemptions as provided by regulation, requires certification by the contractor that cost and pricing data used to negotiate the final price is current, accurate and complete. This certification entitles the government to a price adjustment, including profit or fee, of any significant amount by which the price was increased because of defective data. The Company is also restricted in the amount it can bill under each contract until it has passed its first article (inspection) test. That limit is 10% of the contract amount. The Company, in the normal course of business, periodically reviews its cost estimates on all contracts. In the opinion of management, the potential for any price adjustment on open contracts is remote and, if adjusted, would not have a material effect on the Company’s financial position or results of operations for the period.

F-19

VALENTEC SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005


		Backlog — The Company has authorized but uncompleted contracts on hand for which work is in progress at December 31, 2006 approximately as follows:


Total contract price of initial contract awards including exercised options and approved change orders (modifications)	$	42,741,283*
Completed to date		29,266,342


Authorized backlog	$	13,474,941**


		* Included in this amount is $36,745,000 in contracts from a related party (Soltam Systems).

		**Included in this amount is $11,492,648 in authorized backlog from a related party (Soltam Systems)

NOTE 13		COMMITMENTS AND CONTINGENT LIABILITIES

		*(A)* *Litigation*

		Prior to the expiration of the facilities management agreement with the Louisiana National Guard, certain employees involved in plant security duty were members of the International Guard Unit of America (I.G.U.A.) Local 81. With the expiration of the agreement and the resulting loss of employment, these employees filed a union membership grievance (December 28, 2004) with the Company, which has been turned over to the American Arbitration Association. The arbitration hearing was conducted on March 5, 2007 and on April 6, 2007 ruled in favor of Valentec Systems Inc.

		Pursuant to a 1994 environmental class action settlement, Valentec Dayron Company (currently Valentec Operating Systems) along with Boise Cascade Company, Dictaphone Company, Harris Company, Martin Marietta Company, Medalist Industries, Inc and Rockwell International, Inc (herein Members) signed the Woodco Site Custody Account Agreement, dated October 5, 1994 as amended January 28, 2005 which established the “Woodco Site Custody Account” for the purposes of disbursing funds necessary to satisfy the obligations of the Members. Valentec’s total current obligation for the next three years is $3,474.

		On August 14, 2006, Valentec Systems, Inc. sustained a fire in its 40mm manufacturing facility. As a result of the fire, the Company experienced a loss of a significant amount of Machinery and Equipment, Inventory and Leasehold Improvements. The Company believed it had property insurance in the amount of $1,284,850. However in December 2006 the Company was notified by its Insurance Broker that the additional $249,850 in coverage requested and believed to be in place as of August 10, 2006; four days before the fire, had not been placed. The Broker claims they did not receive clear instructions as to

F-20

VALENTEC SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005


		when the additional coverage was to be made effective. Therefore on February 25, 2007, Valentec Systems, Inc filed suit against its agent for damages suffered in the amount of $249,850 plus legal costs. The Company believes it has sufficient documentation to assert and sustain its claims against the defendants and is therefore confident in our ability prevail in the litigation.

		There is no other litigation or outstanding claims by or against the Company.

		*(B)* *Consulting Agreement*

		In 2005, the Company entered into a consulting agreement to compensate a consultant 70,000 shares upon the completion of the merger with Valentec Operating, Inc. As of December 31, 2005, the Company did not have adequate shares available and recorded the fair value of shares due in accrued expenses. These shares were issued to the Company on May 10, 2006.

		*(C)* *Leases*

		The Company renewed its operating lease with the State of Louisiana, Louisiana Military Department for administrative and production facilities on November 1, 2006. The lease is an operating lease, which expires October 31, 2016. The Company currently pays a discounted monthly rent of $17,941 until November 1, 2009. At that time the Company will pay a monthly rent of $24,845 until expiration of the lease.

		The Company leases space at the Radford Army Ammunition Plant for equipment used in increment loading. The annual rate of the lease is $9,336 and is renewable every twelve months.

		The Company leases office equipment for administration purposes. The lease is an operating lease, which expires on June 16, 2009. The Company pays a monthly rate of $1,095.

		The Company leases a vehicle for purposes of travel. The lease is an operating lease, which expires on January 20, 2009. The Company pays a monthly payment of $862.

		The Company leases a vehicle on behalf of the CEO. The lease is an operating lease, which expires on January 31, 2010. The Company pays a monthly payment of $645.

F-21

VALENTEC SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005


		Future minimum lease payments under the operating leases at December 31, 2006, consist of the following:


Year	Amount
2007	$	215,292
2008	$	215,292
2009	$	215,292
2010	$	298,144
2011	$	298,144
Thereafter	$	1,490,720


		The Company leases equipment under capital leases in which the present value of the minimum lease payments was calculated using discount rates ranging from 8% to 10% over five-year terms. A summary of capital lease obligations that remain at December 31, 2006 is as follows:


Total obligations under capital leases Less: current portion of lease obligations	$	134,497 26,585

Long Term Capital Lease Obligations	$	107,912


		Minimum lease payments due in years subsequent to December 31, 2006 are as follows:


For Years Ending December 31,	Amount
2007	$	37,355
2008		37,355
2009		37,355
2010		34,360
2011		17,076

Total minimum lease payments		163,501
Less: amount representing interest		29,004

Present Value of Minimum Lease Payments	$	134,397


NOTE 14		CONCENTRATIONS

		*(A)* *Revenue and Receivables*

		The Company’s operations are dependent on governmental funding of defense and ammunition projects. Significant changes in the level of government funding of these projects could have a favorable or unfavorable impact on the operating results of the

F-22

VALENTEC SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005


		Company. During 2006 and 2005, the Company had two customers which made up 18.0% and 81.1% of total sales in 2006 and 47.6% and 52.4% in 2005, US Army and the Israeli Department of Defense (through a related party entity located in Israel).

		*(B) Material and Suppliers*

		The Company is dependent upon a number of major suppliers. If a major supplier were to cease doing business, the Company could be adversely affected to the extent the supplier could not be replaced. The Company is dependent on some sole source suppliers. As of December 31, 2006, only two suppliers provided more than 10% of total purchases. These suppliers were POCAL Industries and MEDICO Industries who provide materials for the Mortar Contract for the Israeli Department of Defense (through a related party entity located in Israel) of 19.2% and 22.2%; respectively, of all 2006 material purchases. No one supplier represented more than 10% of purchases in 2005.

		If a critical supplier had operational problems or ceased making material available to the Company, operations could be adversely affected. In some cases, materials are supplied by sole source vendors.

		*(C)* *Foreign Operations*

		The Company sells to foreign customers. The sales to one foreign customer were 81% in 2006 and 46% in 2005. Significant changes in the level of government funding of these projects could have a favorable or unfavorable impact on the operating results of the Company.

NOTE 15		LOSS ON INVOLUNTARY CONVERSION

		On August 14, 2006, Valentec Systems, Inc. sustained a fire in its 40mm manufacturing facility. As a result of the fire, the Company experienced a loss of a significant amount of Machinery and Equipment, Inventory and Leasehold Improvements. The Company believed it had property insurance in the amount of $1,284,850. However, in December 2006 the Company was notified by its Insurance Broker that the additional $249,850 in coverage requested and believed to be in place as of August 10, 2006, four days before the fire, had not been placed. The table below shows the amount of the insurance claim, the net book value of the assets destroyed, the resulting loss from involuntary conversion and the receivable due from the insurance company as of December 31, 2006:


	NET BOOK
ASSET DESTROYED	VALUE
Machinery and Equipment	$	98,128
Leasehold Improvements	$	467,068
Finished Goods Inventory	$	1,058,212
Work in Process Inventory	$	104,279

F-23

VALENTEC SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005


Total Net Book Value	$	1,727,687
Less: Insurance Proceeds Received as of December 31, 2006	$	1,035,000
Insurance Receivable as of December 31, 2006	$	249,850

Involuntary Loss	$	442,837


NOTE 16		GOING CONCERN
		As reflected in the accompanying consolidated financial statements, the Company has a working capital deficiency of $10,043,206 negative cash flow from operations of $6,497,164. These factors raise substantial doubt about our ability to continue as a going concern. The financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern. Management is making a conscious effort to restructure finances and improve cash flow through cost reductions and improving manufacturing performance. Management believes that actions presently being taken will provide the opportunity for the Company to continue as a going concern.

NOTE 17		SUBSEQUENT EVENTS

		In January 2007, the Board of Directors of the Company granted a total of 1,000,000 options to purchase shares of the Company’s common stock under the Company’s 2006 Equity Incentive Plan. The options were granted to several employees of the Company and are vested at a rate of 25% per year over 4 years. Because the Stock Options were not granted until 2007 no Stock Compensation Expense was recognized in 2006.

F-24


	2006		2005
Audit and related fees		65,152		62,495
Tax fees		—		8,243
All other fees		—		5,948
Total		65,152		76,686


Dated: May 17, 2006
	VALENTEC SYTEMS, INC.
	By:	/s/ Robert Zummo
		Robert Zummo, Chairman, President and
		Chief Executive Officer


		Page No.
Item 1.	Description of Business		3

Item 2.	Description of Properties		18

Item 3.	Legal Proceedings		18

Item 4.	Submission of Matters to a Vote of Security Holders		18

	PART II

Item 5.	Market for the Registrant’s Common Equity and Related Stockholder Matters and Small Business Issuer Purchases of Equity Securities		19

Item 6.	Management's Discussion and Analysis or Plan of Operations		20

Item 7.	Financial Statements		26

Item 8.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		26

Item 8A.	Controls and Procedures		27

Item 8B.	Other Information		27

	PART III

Item 9.	Directors, Executive Officers, Promoters, Control Persons and Corporate Governance; Compliance with Section 16(a) Of the Exchange Act		27

Item 10.	Executive Compensation		31

Item 11.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		34

Item 12.	Certain Relationships and Related Transactions and Director Independence		36

Item 13.	Exhibits		37

Item 14.	Principal Accountant Fees and Services		41

SIGNATURES			42
Exhibit 10.29.	Promissory Note to Robert Zummo dated November 19, 2006
Exhibit 10.30.	Promissory Note to Mikal Ltd. dated November 19, 2006
Exhibit 31.1	Certification by the CEO and Principal Accounting Officer Pursuant to Rule 13a-14(a)
Exhibit 32.2	Certification of CEO and Principal Accounting Officer Pursuant to Section 906
Promissory Note to Robert Zummo
Promissory Note to Mikal Ltd.
Certification Pursuant to Rule 13a-14(a)
Certification Pursuant to 18 U.S.C. Section 1350


Signature	Title	Date

/s/ Robert A. Zummo Robert A. Zummo	Chairman, President and Chief Executive Officer, Director and Principal Accounting Officer

/s/ Avraham (Miko) Gilat Avraham (Miko) Gilat	Director

/s/ Zvi Kreizman Zvi Kreizman	Director

/s/ August Cianciolo	Director
August Cianciolo

/s/ W. Glenn Yarborough, Jr.	Director
W. Glenn Yarborough, Jr.


PAGE	F-1	REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

PAGE	F-2	CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 2006

PAGE	F-3	CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005

PAGE	F-4	CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ DEFICIENCY FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005

PAGE	F-5	CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005

PAGES	F-6 — F-24	NOTES TO CONSOLIDATED FINANCIAL STATEMENTS