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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



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(Mark One)

|x | Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | ---------------------------------------------------------------------------------------



FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2003



OR



| ̈ | Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | ----------------------------------------------------------------------------------------



COMMISSION FILE NUMBER: 333-13105



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FIREARMS TRAINING SYSTEMS, INC.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|DELAWARE                                                       |  | 57-0777018                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



7340 MCGINNIS FERRY
ROAD

SUWANEE, GEORGIA 30024

(Address of principal executive offices)



TELEPHONE NUMBER (770) 813-0180

(Registrants telephone number, including area code)



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



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange
Act).    Yes ̈No  x



As of February 10, 2004, there were 70,153,159 shares of the
Registrants Class A Common Stock outstanding.



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##### Table of Contents

FIREARMS TRAINING SYSTEMS, INC.



INDEX



|         |  |                                                                                                                   |  |            
|-------- |  | ----------------------------------------------------------------------------------------------------------------- |  | -----------
|         |  |                                                                                                                   |  | Page number
|PART I.  |  | FINANCIAL INFORMATION                                                                                             |  |            
|         |  |                                                                                                                  
|ITEM 1.  |  | CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:                                                                      |  |            
|         |  |                                                                                                                  
|         |  | Condensed Consolidated Statements of OperationsThree and nine months ended December 31, 2003 and 2002 (unaudited) |  | 3          
|         |  |                                                                                                                  
|         |  | Condensed Consolidated Balance SheetsDecember 31, 2003 (unaudited) and March 31, 2003                             |  | 4          
|         |  |                                                                                                                  
|         |  | Condensed Consolidated Statements of Cash FlowsNine months ended December 31, 2003 and 2002 (unaudited)           |  | 5          
|         |  |                                                                                                                  
|         |  | Notes to Condensed Consolidated Financial Statements (unaudited)                                                  |  | 6          
|         |  |                                                                                                                  
|ITEM 2.  |  | MANAGEMENTS DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS                              |  | 12         
|         |  |                                                                                                                  
|ITEM 3.  |  | QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK                                                         |  | 21         
|         |  |                                                                                                                  
|ITEM 4.  |  | CONTROLS AND PROCEDURES                                                                                           |  | 21         
|         |  |                                                                                                                  
|PART II. |  | OTHER INFORMATION                                                                                                 |  |            
|         |  |                                                                                                                  
|ITEM 1.  |  | LEGAL PROCEEDINGS                                                                                                 |  | 22         
|         |  |                                                                                                                  
|ITEM 6.  |  | EXHIBITS AND REPORTS ON FORM 8-K                                                                                  |  | 22         
|         |  |                                                                                                                  
|         |  | SIGNATURES                                                                                                        |  | 23         



2



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##### Table of Contents

|PART I. | FINANCIAL INFORMATION
|------- | ---------------------



|ITEM 1. | CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|------- | -------------------------------------------



FIREARMS TRAINING SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited and in thousands, except per share amounts)



|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|----------------------------------------------------- |  | ------------------------------ | ------ | - | ----------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                      |  | Three Months EndedDecember 31, |        |   | Nine Months EndedDecember 31, |  
|                                                      |  | 2003                           |        |   | 2002                          |   |        | 2003 |  |   | 2002   |  
|Revenue                                               |  | $                              | 16,479 |   |                               | $ | 12,463 |      |  | $ | 45,027 |   |  | $ | 42,660 |  
|                                                      |  |                                |        |  
|Cost of revenue                                       |  |                                | 10,270 |   |                               |   | 7,984  |      |  |   | 30,644 |   |  |   | 28,544 |  
|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Gross margin                                          |  |                                | 6,209  |   |                               |   | 4,479  |      |  |   | 14,383 |   |  |   | 14,116 |  
|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Operating expenses                                    |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|                                                      |  |                                |        |  
|Selling, general and administrative                   |  |                                | 3,161  |   |                               |   | 2,507  |      |  |   | 9,068  |   |  |   | 7,957  |  
|Research and development                              |  |                                | 766    |   |                               |   | 1,007  |      |  |   | 2,013  |   |  |   | 2,557  |  
|Depreciation and amortization                         |  |                                | 102    |   |                               |   | 209    |      |  |   | 335    |   |  |   | 719    |  
|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Total operating expenses                              |  |                                | 4,029  |   |                               |   | 3,723  |      |  |   | 11,416 |   |  |   | 11,233 |  
|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Operating income                                      |  |                                | 2,180  |   |                               |   | 756    |      |  |   | 2,967  |   |  |   | 2,883  |  
|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Other income (expense), net                           |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|                                                      |  |                                |        |  
|Interest expense, net                                 |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Debt, net                                             |  |                                | (1,369 | ) |                               |   | (43    | )    |  |   | (3,790 | ) |  |   | (103   | )
|Dividends on mandatorily redeemable preferred stock   |  |                                | (725   | ) |                               |   |       |      |  |   | (2,124 | ) |  |   |       |  
|Other, net                                            |  |                                | 166    |   |                               |   | 22     |      |  |   | 151    |   |  |   | 76     |  
|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Total other income (expense), net                     |  |                                | (1,928 | ) |                               |   | (21    | )    |  |   | (5,763 | ) |  |   | (27    | )
|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Income (loss) before provision for income taxes       |  |                                | 252    |   |                               |   | 735    |      |  |   | (2,796 | ) |  |   | 2,856  |  
|                                                      |  |                                |        |  
|Provision for income taxes                            |  |                                | 332    |   |                               |   | 222    |      |  |   | (229   | ) |  |   | 943    |  
|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Net income (loss) before preferred stock adjustments  |  |                                | (80    | ) |                               |   | 513    |      |  |   | (2,567 | ) |  |   | 1,913  |  
|                                                      |  |                                |        |  
|Preferred stock adjustments                           |  |                                |       |   |                               |   | (75    | )    |  |   |       |   |  |   | (221   | )
|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Net income (loss) attributable to common shareholders |  | $                              | (80    | ) |                               | $ | 438    |      |  | $ | (2,567 | ) |  | $ | 1,692  |  
|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Earnings per share                                    |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|                                                      |  |                                |        |  
|Basic income (loss) per share                         |  | $                              | (0.00  | ) |                               | $ | 0.01   |      |  | $ | (0.04  | ) |  | $ | 0.02   |  
|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Diluted income (loss) per share                       |  | $                              | (0.00  | ) |                               | $ | 0.01   |      |  | $ | (0.04  | ) |  | $ | 0.02   |  
|                                                      |  |                                |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Weighted average common shares outstanding - basic    |  |                                | 70,153 |   |                               |   | 70,153 |      |  |   | 70,153 |   |  |   | 70,153 |  
|                                                      |  |                                |        |  
|Weighted average common shares outstanding - diluted  |  |                                | 70,153 |   |                               |   | 71,736 |      |  |   | 70,153 |   |  |   | 72,021 |  



The accompanying notes
are an integral part of these condensed consolidated statements.



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FIREARMS TRAINING SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS



|                                                                                                           |  |                   |             |   |                |   |          |  
|---------------------------------------------------------------------------------------------------------- |  | ----------------- | ----------- | - | -------------- | - | -------- | -
|                                                                                                           |  | December 31, 2003 |             |   | March 31, 2003 |  
|                                                                                                           |  | (in thousands)    |            
|ASSETS                                                                                                     |  |                   | (unaudited) |   |                |   |          |  
|Current assets                                                                                             |  |                   |             |   |                |   |          |  
|Cash and cash equivalents                                                                                  |  | $                 | 2,726       |   |                | $ | 3,457    |  
|Restricted cash                                                                                            |  |                   | 2,558       |   |                |   | 1,439    |  
|Accounts receivable, net of allowance of $350 and $362 in December and March 2003, respectively            |  |                   | 12,420      |   |                |   | 18,469   |  
|Income taxes receivable                                                                                    |  |                   | 310         |   |                |   | 647      |  
|Costs and estimated earnings in excess of billings on uncompleted contracts                                |  |                   | 6,410       |   |                |   | 4,697    |  
|Unbilled receivables                                                                                       |  |                   | 139         |   |                |   | 103      |  
|Inventories, net                                                                                           |  |                   | 12,914      |   |                |   | 10,059   |  
|Prepaid expenses and other current assets                                                                  |  |                   | 1,577       |   |                |   | 1,643    |  
|                                                                                                           |  |                   |             |   |                |   |          |  
|Total current assets                                                                                       |  |                   | 39,054      |   |                |   | 40,514   |  
|Property and equipment, net                                                                                |  |                   | 2,299       |   |                |   | 2,018    |  
|Other noncurrent assets                                                                                    |  |                   | 273         |   |                |   | 98       |  
|                                                                                                           |  |                   |             |   |                |   |          |  
|Total assets                                                                                               |  | $                 | 41,626      |   |                | $ | 42,630   |  
|                                                                                                           |  |                   |             |   |                |   |          |  
|LIABILITIES AND STOCKHOLDERS DEFICIT                                                                      |  |                   |             |   |                |   |          |  
|Current liabilities                                                                                        |  |                   |             |   |                |   |          |  
|Long-term debt due within one year                                                                         |  | $                 | 41,013      |   |                | $ | 457      |  
|Manditorily redeemable preferred stock                                                                     |  |                   | 29,741      |   |                |   |         |  
|Accounts payable                                                                                           |  |                   | 4,985       |   |                |   | 5,248    |  
|Accrued liabilities                                                                                        |  |                   | 4,330       |   |                |   | 4,826    |  
|Accrued interest                                                                                           |  |                   | 929         |   |                |   | 861      |  
|Billings in excess of costs and estimated earnings on uncompleted contracts                                |  |                   | 1,326       |   |                |   | 1,277    |  
|Deferred revenue                                                                                           |  |                   | 767         |   |                |   | 1,854    |  
|Warranty and contract cost provision reserve - current                                                     |  |                   | 1,364       |   |                |   | 2,015    |  
|                                                                                                           |  |                   |             |   |                |   |          |  
|Total current liabilities                                                                                  |  |                   | 84,455      |   |                |   | 16,538   |  
|Long-term debt                                                                                             |  |                   | 79          |   |                |   | 39,858   |  
|Warranty and contract cost provision reserve - noncurrent                                                  |  |                   | 1,075       |   |                |   | 615      |  
|Other noncurrent liabilities                                                                               |  |                   | 653         |   |                |   | 496      |  
|Manditorily redeemable preferred stock                                                                     |  |                   |            |   |                |   | 27,617   |  
|                                                                                                           |  |                   |             |   |                |   |          |  
|Total liabilities                                                                                          |  |                   | 86,262      |   |                |   | 85,124   |  
|                                                                                                           |  |                   |             |   |                |   |          |  
|Commitments and contingencies                                                                              |  |                   |             |   |                |   |          |  
|Stockholders deficit                                                                                      |  |                   |             |   |                |   |          |  
|Class A common stock, $0.000006 par value; 100,000 shares authorized, 70,153 shares issued and outstanding |  |                   |            |   |                |   |         |  
|Additional paid-in capital                                                                                 |  |                   | 123,215     |   |                |   | 123,215  |  
|Stock warrants                                                                                             |  |                   | 613         |   |                |   | 613      |  
|Accumulated deficit                                                                                        |  |                   | (168,786    | ) |                |   | (166,219 | )
|Accumulated other comprehensive income (loss)                                                              |  |                   | 322         |   |                |   | (103     | )
|                                                                                                           |  |                   |             |   |                |   |          |  
|Total stockholders deficit                                                                                |  |                   | (44,636     | ) |                |   | (42,494  | )
|                                                                                                           |  |                   |             |   |                |   |          |  
|Total liabilities and stockholders deficit                                                                |  | $                 | 41,626      |   |                | $ | 42,630   |  
|                                                                                                           |  |                   |             |   |                |   |          |  



The accompanying notes
are an integral part of these condensed consolidated statements.



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FIREARMS TRAINING SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited and in thousands)



|                                                                            |  |                                |        |   |      |   |        |  
|--------------------------------------------------------------------------- |  | ------------------------------ | ------ | - | ---- | - | ------ | -
|                                                                            |  | Nine Months Ended December 31, |       
|                                                                            |  | 2003                           |        |   | 2002 |  
|Cash flows from operating activities                                        |  |                                |        |   |      |   |        |  
|Net income (loss) attributable to common shareholders                       |  | $                              | (2,567 | ) |      | $ | 1,692  |  
|Adjustments for non-cash items                                              |  |                                |        |   |      |   |        |  
|Preferred stock adjustments to net income (loss)                            |  |                                | 2,124  |   |      |   | 221    |  
|Amortization of debt discount                                               |  |                                |       |   |      |   | (2,634 | )
|Non-cash interest                                                           |  |                                | 821    |   |      |   |       |  
|Depreciation and amortization                                               |  |                                | 855    |   |      |   | 853    |  
|Change in inventory reserve                                                 |  |                                | (513   | ) |      |   |       |  
|Change in warranty and contract cost provision reserve                      |  |                                | (191   | ) |      |   | (674   | )
|Loss on sale of assets                                                      |  |                                |       |   |      |   | 23     |  
|Changes in assets and liabilities                                           |  |                                |        |   |      |   |        |  
|Accounts receivable, net                                                    |  |                                | 6,049  |   |      |   | 1,575  |  
|Income taxes receivable                                                     |  |                                | 337    |   |      |   | 5,696  |  
|Costs and estimated earnings in excess of billings on uncompleted contracts |  |                                | (1,713 | ) |      |   | (1,726 | )
|Unbilled receivables                                                        |  |                                | (36    | ) |      |   | 578    |  
|Inventories                                                                 |  |                                | (2,342 | ) |      |   | (3,364 | )
|Prepaid expenses and other current assets                                   |  |                                | 66     |   |      |   | (188   | )
|Accounts payable                                                            |  |                                | (263   | ) |      |   | (80    | )
|Accrued liabilities                                                         |  |                                | (428   | ) |      |   | (763   | )
|Billings in excess of costs and estimated earnings on uncompleted contracts |  |                                | 49     |   |      |   | 423    |  
|Deferred revenue                                                            |  |                                | (1,087 | ) |      |   | 274    |  
|Noncurrent liabilities                                                      |  |                                | 157    |   |      |   | 157    |  
|                                                                            |  |                                |        |   |      |   |        |  
|Total adjustments                                                           |  |                                | 3,885  |   |      |   | 371    |  
|                                                                            |  |                                |        |   |      |   |        |  
|Net cash provided by operating activities                                   |  |                                | 1,318  |   |      |   | 2,063  |  
|                                                                            |  |                                |        |   |      |   |        |  
|Cash flows from investing activities                                        |  |                                |        |   |      |   |        |  
|Change in restricted cash                                                   |  |                                | (1,119 | ) |      |   | (319   | )
|Purchase of property and equipment                                          |  |                                | (902   | ) |      |   | (1,024 | )
|                                                                            |  |                                |        |   |      |   |        |  
|Net cash used by investing activities                                       |  |                                | (2,021 | ) |      |   | (1,343 | )
|                                                                            |  |                                |        |   |      |   |        |  
|Cash flows from financing activities                                        |  |                                |        |   |      |   |        |  
|Payments on long-term debt                                                  |  |                                | (44    | ) |      |   | (27    | )
|Payment of deferred financing costs                                         |  |                                | (409   | ) |      |   |       |  
|                                                                            |  |                                |        |   |      |   |        |  
|Net cash used by financing activities                                       |  |                                | (453   | ) |      |   | (27    | )
|                                                                            |  |                                |        |   |      |   |        |  
|Effect of exchange rate changes on cash                                     |  |                                | 425    |   |      |   | 198    |  
|                                                                            |  |                                |        |   |      |   |        |  
|Net increase (decrease) in cash and cash equivalents                        |  |                                | (731   | ) |      |   | 891    |  
|Cash and cash equivalents, beginning of period                              |  |                                | 3,457  |   |      |   | 4,252  |  
|                                                                            |  |                                |        |   |      |   |        |  
|Cash and cash equivalents, end of period                                    |  | $                              | 2,726  |   |      | $ | 5,143  |  
|                                                                            |  |                                |        |   |      |   |        |  
|Supplemental cash flow disclosures                                          |  |                                |        |   |      |   |        |  
|Cash paid (received) for                                                    |  |                                |        |   |      |   |        |  
|Interest                                                                    |  | $                              | 2,637  |   |      | $ | 1,075  |  
|Income taxes                                                                |  | $                              | 32     |   |      | $ | (4,766 | )
|Non-cash investing and financing activities                                 |  |                                |        |   |      |   |        |  
|Vehicles acquired through capital leases                                    |  | $                              |       |   |      | $ | 222    |  



The accompanying notes
are an integral part of these condensed consolidated statements.



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FIREARMS TRAINING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)



1. Basis of presentation and liquidity



The unaudited condensed consolidated financial statements of Firearms Training Systems, Inc. and subsidiaries (the Company) have been prepared
in accordance with accounting principles generally accepted in the United States of America and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included. Operating results for the three-month and nine-month periods ended December 31, 2003 are not necessarily indicative of the results that may be expected for the full year
ending March 31, 2004. We suggest that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and notes thereto for the year ended March 31, 2003, included in our 2003 Annual Report on
Form 10-K filed with the Securities and Exchange Commission (SEC).



The Company is currently in discussions with several parties to negotiate a refinancing of its Credit Agreement. The Company has received indications of interest from certain potential new lenders that would
substantially improve the Companys capital structure. However, there can currently be no assurance that the Company will either be successful in negotiating a refinancing with its existing lending group, or in finalizing an agreement with new
lenders under terms that would be favorable to the Company, if at all. The inability of the Company to satisfactorily address the concerns related to its capital structure prior to October 15, 2004 could have a severe adverse effect on the
Companys financial condition and future operations. As further discussed in Note 9 - Related party transactions, the current holders of the Companys debt and preferred stock are also major stockholders of the Company.



|2. | Revenue recognition
|-- | -------------------



A significant amount of the Companys revenue is derived from the sale of small and supporting arms training simulators and accessories. Revenue from
sales to commercial customers and small governmental agencies is primarily recognized upon shipment when title passes; as all material commitments have been fulfilled, the sales price is fixed or determinable and collectibility is reasonably
assured.



A large portion of the Companys small and
supporting arms training simulator revenue is derived from contracts with various large governmental agencies. Governmental contracts that involve high volume purchases of the Companys standard systems and related accessories are accounted for
as multiple-element arrangements. These contracts require little or no modifications to the existing proprietary platform, specify pricing terms by product and billings generally correspond to the underlying shipment schedule. Revenue under these
contracts is recognized upon delivery. Advanced billings related to these contracts are recorded as deferred revenue and are recognized ratably as units are delivered.



Other governmental contracts require significant customization of the Companys existing proprietary platform or
require the development of new systems to meet required customer specifications. These contracts are accounted for under the percentage of completion method, measured by the percentage of cost incurred to date to the estimated total cost for each
contract. Contract costs include all direct material, direct labor and other costs directly related to the contract. Selling, general, and administrative costs are charged to expense as incurred. Changes in job performance, job conditions, and
estimated profitability, including those arising from contract penalty provisions, and final contract settlements may result in revisions to costs and income and are recognized in the period in which the revisions are determined.



Provisions for estimated losses on uncompleted contracts accounted for under
both methods described above are made in the period in which such losses are determined.



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Revenue from extended warranty sales and customer logistics support sales are recorded as deferred
revenue and are recognized ratably as income over the lives of the related service agreements, which generally range from one to three years. Costs associated with these sales are recorded in the period incurred.



3. Stock-based compensation



The Company has elected to account for its stock-based compensation plans
under APB No. 25; however, the Company has computed for pro forma disclosure purposes the value of all options using the Black-Scholes option pricing model as prescribed by SFAS No. 123 using the following assumptions:



|                          |  |                               |   |  |     
|------------------------- |  | ----------------------------- | - |  | ----
|                          |  | Nine MonthsEnded December 31,
|                          |  | 2003                          |   |  | 2002
|Risk-free interest rate   |  | 2.28                          | % |  | N/A 
|Expected dividend yield   |  | 0                             |   |  | N/A 
|Expected lives (in years) |  | 3.5                           |   |  | N/A 
|Expected volatility       |  | 221.58                        | % |  | N/A 



The Company issued
options to purchase a total of 5.8 million shares of its common stock under its option plan on May 1, 2003, with an exercise price equal to the $0.40 per share market value of the stock on that date. No options were granted during the nine-month
period ended December 31, 2002, and accordingly, the assumptions are not applicable for that period.



The weighted-average grant-date fair value of options granted during the nine months ended December 31, 2003 was computed as approximately $2.2 million or
$0.38 per share under option. That value and the value computed for unvested options granted in prior years is being amortized on a pro forma basis over the vesting period of the options. Pro forma information (in thousands, except per share
amounts) regarding net earnings (loss) and earnings (loss) per share as if the Company had accounted for options using the fair value method is as follows:



|                                                              |  |                                          |       |   |                                |   |      |      |  |   |        |   |  |   |       |  
|------------------------------------------------------------- |  | ---------------------------------------- | ----- | - | ------------------------------ | - | ---- | ---- |  | - | ------ | - |  | - | ----- | -
|                                                              |  | Three Months Ended December 31,          |       |   | Nine Months Ended December 31, |  
|                                                              |  | 2003                                     |       |   | 2002                           |   |      | 2003 |  |   | 2002   |  
|                                                              |  | (in thousands, except per share amounts) |      
|Net income (loss) applicable to common shareholders           |  |                                          |       |   |                                |   |      |      |  |   |        |   |  |   |       |  
|As reported                                                   |  | $                                        | (80   | ) |                                | $ | 438  |      |  | $ | (2,567 | ) |  | $ | 1,692 |  
|Fair value based compensation cost, net of taxes              |  |                                          | (47   | ) |                                |   | (7   | )    |  |   | (141   | ) |  |   | (22   | )
|                                                              |  |                                          |       |   |                                |   |      |      |  |   |        |   |  |   |       |  
|Pro forma net income (loss) applicable to common shareholders |  | $                                        | (127  | ) |                                | $ | 431  |      |  | $ | (2,708 | ) |  | $ | 1,670 |  
|                                                              |  |                                          |       |   |                                |   |      |      |  |   |        |   |  |   |       |  
|Basic income (loss) per share                                 |  |                                          |       |   |                                |   |      |      |  |   |        |   |  |   |       |  
|As reported                                                   |  | $                                        | (0.00 | ) |                                | $ | 0.01 |      |  | $ | (0.04  | ) |  | $ | 0.02  |  
|Pro forma                                                     |  | $                                        | (0.00 | ) |                                | $ | 0.01 |      |  | $ | (0.04  | ) |  | $ | 0.02  |  
|Diluted income (loss) per share                               |  |                                          |       |   |                                |   |      |      |  |   |        |   |  |   |       |  
|As reported                                                   |  | $                                        | (0.00 | ) |                                | $ | 0.01 |      |  | $ | (0.04  | ) |  | $ | 0.02  |  
|Pro forma                                                     |  | $                                        | (0.00 | ) |                                | $ | 0.01 |      |  | $ | (0.04  | ) |  | $ | 0.02  |  



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4. Inventory



Inventories consist primarily of simulators, computer hardware, projectors, and component parts. Inventories are valued at the lower of cost on a moving
weighted average or market basis. Cost includes materials, labor, and factory overhead. Market is defined as net realizable value.



Inventories consist of the following (in thousands):



|                                          |  |                   |        |   |                |   |        |  
|----------------------------------------- |  | ----------------- | ------ | - | -------------- | - | ------ | -
|                                          |  | December 31, 2003 |        |   | March 31, 2003 |  
|Raw materials                             |  | $                 | 7,170  |   |                | $ | 5,962  |  
|Work in process                           |  |                   | 3,540  |   |                |   | 2,436  |  
|Finished goods                            |  |                   | 2,900  |   |                |   | 2,870  |  
|                                          |  |                   |        |   |                |   |        |  
|Inventories, gross                        |  |                   | 13,610 |   |                |   | 11,268 |  
|Reserve for excess and obsolete inventory |  |                   | (696   | ) |                |   | (1,209 | )
|                                          |  |                   |        |   |                |   |        |  
|Inventories, net                          |  | $                 | 12,914 |   |                | $ | 10,059 |  
|                                          |  |                   |        |   |                |   |        |  



5. Long-term contracts



Costs and estimated earnings on uncompleted contracts and
related amounts billed as of December 31, and March 31, 2003, respectively, are as follows (in thousands):



|                                                                            |  |                   |         |   |                |   |         |  
|--------------------------------------------------------------------------- |  | ----------------- | ------- | - | -------------- | - | ------- | -
|                                                                            |  | December 31, 2003 |         |   | March 31, 2003 |  
|Costs incurred on uncompleted contracts                                     |  | $                 | 31,261  |   |                | $ | 26,727  |  
|Estimated earnings                                                          |  |                   | 12,566  |   |                |   | 12,087  |  
|                                                                            |  |                   |         |   |                |   |         |  
|                                                                            |  |                   | 43,827  |   |                |   | 38,814  |  
|Less: billings to date                                                      |  |                   | (38,743 | ) |                |   | (35,394 | )
|                                                                            |  |                   |         |   |                |   |         |  
|                                                                            |  | $                 | 5,084   |   |                | $ | 3,420   |  
|                                                                            |  |                   |         |   |                |   |         |  
|Such amounts are included in the following accounts (in thousands)          |  |                   |         |   |                |   |         |  
|Costs and estimated earnings in excess of billings on uncompleted contracts |  | $                 | 6,410   |   |                | $ | 4,697   |  
|Billings in excess of costs and estimated earnings on uncompleted contracts |  |                   | (1,326  | ) |                |   | (1,277  | )
|                                                                            |  |                   |         |   |                |   |         |  
|                                                                            |  | $                 | 5,084   |   |                | $ | 3,420   |  
|                                                                            |  |                   |         |   |                |   |         |  



6. Other noncurrent assets



Intangible assets consist of the following (in
thousands):



|                         |  |                   |      |   |                |   |      |  
|------------------------ |  | ----------------- | ---- | - | -------------- | - | ---- | -
|                         |  | December 31, 2003 |      |   | March 31, 2003 |  
|Non-compete agreement    |  | $                 | 33   |   |                | $ | 33   |  
|Deferred financing costs |  |                   | 659  |   |                |   | 250  |  
|                         |  |                   |      |   |                |   |      |  
|                         |  |                   | 692  |   |                |   | 283  |  
|Accumulated amortization |  |                   | (419 | ) |                |   | (185 | )
|                         |  |                   |      |   |                |   |      |  
|Intangible assets, net   |  | $                 | 273  |   |                | $ | 98   |  
|                         |  |                   |      |   |                |   |      |  



Deferred financing
costs as of December 31, 2003, includes approximately $409,000 relating to a June 26, 2003 amendment to the Companys credit agreement which extended the maturity date from September 30, 2003 to October 15, 2004.



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##### Table of Contents

Amortization expense for the three and nine-month periods ended December 31, 2003 was $87,000 and
$298,000, respectively. Estimated amortization expense for the year ending March 31, 2004 will be approximately $384,000.



7. Long-term debt



Long-term debt consists of the following (in thousands):



|                             |  |                   |         |   |                |   |        |  
|---------------------------- |  | ----------------- | ------- | - | -------------- | - | ------ | -
|                             |  | December 31, 2003 |         |   | March 31, 2003 |  
|Working capital - borrowings |  | $                 | 130     |   |                | $ | 130    |  
|Long-term debt - Senior      |  |                   | 12,000  |   |                |   | 12,000 |  
|Long-term debt - Junior      |  |                   | 28,831  |   |                |   | 28,010 |  
|Capital lease obligations    |  |                   | 131     |   |                |   | 175    |  
|                             |  |                   |         |   |                |   |        |  
|                             |  |                   | 41,092  |   |                |   | 40,315 |  
|Due within one year          |  |                   | (41,013 | ) |                |   | (457   | )
|                             |  |                   |         |   |                |   |        |  
|Long-term debt               |  | $                 | 79      |   |                | $ | 39,858 |  
|                             |  |                   |         |   |                |   |        |  



Prior to March 31,
2003, interest expense on the Companys credit agreement was substantially offset by amortization of debt discount that was established in a previous debt restructuring. As of March 31, 2003, the debt discount was fully amortized, and interest
expense is currently being reported without the offsetting amortization.



On June 26, 2003, the Company and its lenders agreed to amend the Companys credit agreement extending the maturity date of the Senior and Junior Secured Loans and the Revolving Loans and Letters of Credit from
September 30, 2003 to October 15, 2004, and eliminating further extension options.



Under the terms of the amendment, the Company paid an amendment fee of approximately $409,000 in July 2003 and reduced the outstanding balance of the Senior Secured Loans by approximately $400,000 as of December 31,
2003 (paid January 5, 2004), and by an additional amount of approximately $1,100,000 on June 30, 2004. The interest rate on the Senior Secured Loans increased from prime plus 1% to prime plus 2.5% for the period from June 2, 2003 through December
31, 2003, and to prime plus 3.5% for the period from January 1, 2004 until the maturity date. The interest rate on the Junior Secured Loans increased from 10% to 15% for the period from June 2, 2003 through the maturity date, with 10% payable in
cash and 5% payable in additional notes with the same terms. All other terms and conditions of the Companys credit agreement remain unchanged.



8. Mandatorily redeemable preferred stock



In August 2000 the Company issued 21,361.113 shares of Series B preferred stock with a liquidation value of $1,000 per share (approximately $21.4 million)
in conjunction with a debt restructuring. Holders of the Series B preferred stock are entitled to receive cumulative dividends equal to 10% of the liquidation preference payable quarterly in additional shares of Series B preferred stock. The
preferred stock is subject to mandatory redemption on the latest maturity date (October 15, 2004, as of December 31, 2003) of the Senior Secured Loans (Note 7) at the liquidation value thereof. Accrual of dividends prior to March 31, 2003 was
substantially offset by amortization of a restructuring liability allocated to the preferred stock, which was fully amortized on March 31, 2003.



During the three months ended June 30, 2003, the Company adopted the provisions of Statement of Financial Accounting Standards No. 150, Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and Equities. Accordingly, the mandatorily redeemable preferred stock has been subsequently classified as a liability, which became a current liability as of October 15,
2003, in the balance sheet, and has been reclassified in the March 31, 2003 balance sheet for comparative purposes. The $725,000 and $2,124,000 dividends on the preferred stock have been included in operations as additional interest expense for the
three and nine-month periods ended December 31, 2003, respectively. In periods prior to April 1, 2003, dividends on preferred stock were reported as an adjustment to net income to arrive at net income attributable to common stockholders.



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##### Table of Contents

9. Related party transactions



A group of entities affiliated with Centre Partners Management LLC (the Centre Entities) are among the Companys
largest stockholders, owning collectively approximately 48.2% of our common stock. The Centre Entities hold a seat on the Companys Board of Directors. In addition, the Centre Entities, and other institutional lenders who are also major
stockholders as a result of a previously reported restructuring transaction, were party to the amendment to the credit agreement discussed in Note 7. These entities continue to be the Companys primary lenders. As a result of the share
ownership of the Centre Entities and their representation on the Board of Directors, the Centre Entities have the ability to influence the operations of the Company.



The Company entered into a consulting agreement, dated October 4, 2000, with Sugarman & Company, LLP, a company in which
Randy Sugarman is the managing partner and has an 80% ownership interest. Under the agreement and in accordance with the terms of the Companys restructuring in fiscal year 2001, Mr. Sugarman was engaged by the Company to evaluate its financial
position and operations and make recommendations to senior management regarding changes that need to be made to improve profitability and liquidity. Mr. Sugarmans services were performed on an hourly basis, plus out-of-pocket expenses, and the
Company was billed accordingly. From May 16, 2001 until August 9, 2002, Mr. Sugarman served as Interim Chief Executive Officer and President of the Company. Mr. Sugarman ceased to be an officer of the Company on August 9, 2002, in connection with
the conclusion of the Companys engagement of Sugarman & Company LLP. The Company incurred fees of $211,000 plus expenses of $47,000 for consulting services under the agreement during the nine-month period ended December 31, 2002.



10. Net income per common share



Net income (loss) per share was calculated as follows for the three and six
month periods ended September 30, 2003 and 2002

(in thousands except per share amounts):



|                                                                                               |  |                                 |        |                                |      |   |        |  |   |        |   |  |   |       
|---------------------------------------------------------------------------------------------- |  | ------------------------------- | ------ | ------------------------------ | ---- | - | ------ |  | - | ------ | - |  | - | ------
|                                                                                               |  | Three Months Ended December 31, |        | Nine Months Ended December 31,
|                                                                                               |  | 2003                            |        |                                | 2002 |   | 2003   |  |   | 2002  
|Basic:                                                                                         |  |                                 |        |                                |      |   |        |  |   |        |   |  |   |       
|Net income (loss) attributable to common shareholders                                          |  | $                               | (80    | )                              |      | $ | 438    |  | $ | (2,567 | ) |  | $ | 1,692 
|                                                                                               |  |                                 |        |                                |      |   |        |  |   |        |   |  |   |       
|Weighted average common shares outstanding                                                     |  |                                 | 70,153 |                                |      |   | 70,153 |  |   | 70,153 |   |  |   | 70,153
|Per share amount                                                                               |  | $                               | (0.00  | )                              |      | $ | 0.01   |  | $ | (0.04  | ) |  | $ | 0.02  
|                                                                                               |  |                                 |        |                                |      |   |        |  |   |        |   |  |   |       
|Diluted:                                                                                       |  |                                 |        |                                |      |   |        |  |   |        |   |  |   |       
|Net income (loss) attributable to common shareholders                                          |  | $                               | (80    | )                              |      | $ | 438    |  | $ | (2,567 | ) |  | $ | 1,692 
|                                                                                               |  |                                 |        |                                |      |   |        |  |   |        |   |  |   |       
|Weighted average common shares outstanding - basic                                             |  |                                 | 70,153 |                                |      |   | 70,153 |  |   | 70,153 |   |  |   | 70,153
|Shares assumed issued upon exercise of dilutive stock options using the treasury stock method  |  |                                 |       |                                |      |   | 625    |  |   |       |   |  |   | 711   
|Shares assumed issued upon exercise of dilutive stock warrants using the treasury stock method |  |                                 |       |                                |      |   | 958    |  |   |       |   |  |   | 1,157 
|                                                                                               |  |                                 |        |                                |      |   |        |  |   |        |   |  |   |       
|Weighted average common shares outstanding - diluted                                           |  |                                 | 70,153 |                                |      |   | 71,736 |  |   | 70,153 |   |  |   | 72,021
|                                                                                               |  |                                 |        |                                |      |   |        |  |   |        |   |  |   |       
|Per share amount                                                                               |  | $                               | (0.00  | )                              |      | $ | 0.01   |  | $ | (0.04  | ) |  | $ | 0.02  
|                                                                                               |  |                                 |        |                                |      |   |        |  |   |        |   |  |   |       



The number of stock
options assumed to be bought back by the Company for computation of diluted earnings per share purposes has been calculated by dividing gross proceeds from all weighted average stock options outstanding during the period, as if exercised, by the
average common share market price during the period. The average common share market price used in the above calculation was $0.48 and $0.59 respectively, for the three and nine-month periods ended December 31, 2002.



Options to purchase 2,092,777 and 1,552,077 shares of common stock
respectively, as well as warrants to purchase 3,246,164 shares of common stock were not included in the computation of diluted earnings per share for the three and nine-month periods ended December 31, 2002 because the exercise price of the options
and warrants was greater than the average market value of the common shares and their effect would have been anti-dilutive.



Options to purchase 6,834,038 shares of common stock and warrants to purchase 5,246,164 shares of common stock were outstanding as of December 31, 2003
but were not included in the computation of the 2003 diluted EPS because their effect would have been anti-dilutive, thereby decreasing net loss per share.



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##### Table of Contents

11. Contingencies and commitments



Product Warranty Reserve



The Companys product warranty accrual reflects managements best estimate of probable liability under its product
warranties. Management determines the warranty reserve based on known product failures (if any), historical experience, and other currently available evidence.



Changes in the product warranty accrual for the three and nine-month periods ended December 31, 2003 and 2002 were as follows (in thousands):



|                                                            |  |                                 |      |                               |      |   |      |  |   |      |   |  |   |    
|----------------------------------------------------------- |  | ------------------------------- | ---- | ----------------------------- | ---- | - | ---- |  | - | ---- | - |  | - | ---
|                                                            |  | Three Months Ended December 31, |      | Nine MonthsEnded December 31,
|                                                            |  | 2003                            |      |                               | 2002 |   | 2003 |  |   | 2002
|Balance - beginning of period                               |  | $                               | 702  |                               |      | $ | 553  |  | $ | 704  |   |  | $ | 550
|Change in liability for warranties issued during the period |  |                                 | 13   |                               |      |   |     |  |   | 123  |   |  |   | 3  
|Change in liabilities for preexisting warranties            |  |                                 | (100 | )                             |      |   |     |  |   | (212 | ) |  |   |    
|                                                            |  |                                 |      |                               |      |   |      |  |   |      |   |  |   |    
|Balance - end of period                                     |  | $                               | 615  |                               |      | $ | 553  |  | $ | 615  |   |  | $ | 553
|                                                            |  |                                 |      |                               |      |   |      |  |   |      |   |  |   |    



12. Comprehensive income (loss)



The components of comprehensive income (loss) consists of
the following (in thousands):



|                                         |  |                                |     |                                |      |   |      |  |   |        |   |  |   |      
|---------------------------------------- |  | ------------------------------ | --- | ------------------------------ | ---- | - | ---- |  | - | ------ | - |  | - | -----
|                                         |  | Three MonthsEnded December 31, |     | Nine Months Ended December 31,
|                                         |  | 2003                           |     |                                | 2002 |   | 2003 |  |   | 2002  
|Net income (loss)                        |  | $                              | (80 | )                              |      | $ | 513  |  | $ | (2,567 | ) |  | $ | 1,913
|Foreign currrency translation adjustment |  |                                | 181 |                                |      |   | 84   |  |   | 425    |   |  |   | 219  
|                                         |  |                                |     |                                |      |   |      |  |   |        |   |  |   |      
|Comprehensive income (loss)              |  | $                              | 101 |                                |      | $ | 597  |  | $ | (2,142 | ) |  | $ | 2,132
|                                         |  |                                |     |                                |      |   |      |  |   |        |   |  |   |      



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|ITEM  2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|-------- | -------------------------------------------------------------------------------------



This Managements Discussion and Analysis of Financial Condition and Results of Operations should be read in
conjunction with the Managements Discussion and Analysis of Financial Condition and Results of Operations contained in the Companys most recently filed Form 10-K for the fiscal year ended March 31, 2003.



In this Quarterly Report, we state our expectations as to future events and
our future financial performance. In some cases, you can identify those so-called forward-looking statements by words such as may, will, should, expects, plans,
anticipates, believes, estimates, predicts, potential, or continue or the negative of those words and other comparable words. You should be aware that those statements are only
our predictions, which are being made as of the date hereof. Actual events or results may differ materially. In evaluating those statements, you should specifically consider various factors, including the risks outlined below. Those factors may
cause our actual results to differ materially from any of our forward-looking statements. We undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.



Factors that may cause our actual results to differ materially from any of
our forward-looking statements presented in this Quarterly Report include, but are not limited to:



| |  | Changes in laws and regulations, both domestically and in the international markets in which we compete,
| | - | --------------------------------------------------------------------------------------------------------



| |  | Changes in the competitive environment, including the introduction of competitors attracted by the prospect of increased government spending on security,
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Changes in technology,
| | - | ----------------------



| |  | Disruptions in scheduled development of new products, such as our FATS V platform,
| | - | ----------------------------------------------------------------------------------



| |  | Lack of market acceptance of existing products,
| | - | -----------------------------------------------



| |  | Currency fluctuations,
| | - | ----------------------



| |  | The ability to realize cost reductions and operating efficiencies in a manner that does not unduly disrupt business operations,
| | - | -------------------------------------------------------------------------------------------------------------------------------



| |  | Industry consolidation and mergers,
| | - | -----------------------------------



| |  | Market conditions that may adversely affect the availability of debt and equity financing for working capital, capital expenditures or other purposes,
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The ability to restructure our debt and equity facilities on terms that will be satisfactory to the Company, and
| | - | ----------------------------------------------------------------------------------------------------------------



| |  | General economic conditions.
| | - | ----------------------------



Critical Accounting Policies and Estimates



The following discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles
generally accepted in the United States of America. The preparation of these financial statements requires us to make judgments regarding estimates that affect the reported amounts of assets, liabilities, revenues and expenses, and related
disclosures. We base our judgments on historical experience and on various assumptions that we believe are reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. We believe our
judgments and related estimates regarding the following accounting policies are critical in the preparation of our consolidated financial statements.





12



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##### Table of Contents

Revenue Recognition



Customer contracts that require significant customization of the Companys existing proprietary platform or require the
development of new systems to meet required customer specifications are accounted for under the percentage of completion method, measured by the percentage of cost incurred to date to the estimated total cost for each contract. Accounting for such
contracts is essentially a process of measuring the results of relatively long-term events and allocating those results to relatively short-term accounting periods. This involves considerable use of estimates in determining costs and profits and
thereby estimating the timing of revenue recognition and in assigning the amounts to accounting periods. The process is complicated by the need to evaluate continually the uncertainties inherent in the performance of contracts and by the need to
rely on estimates of revenues, costs, and the extent of progress toward completion. The Company continually monitors each of these estimates based on the most current information available from the project managers and project engineers assigned to
the programs. Changes in job performance, job conditions, and estimated profitability, including those arising from contract penalty provisions, and final contract settlements may result in revisions to costs and income and are recognized in the
period in which the revisions are determined. These revisions could materially increase or decrease profit margins on particular contracts in future periods.



Inventory Reserve



Inventories are valued at the lower of cost on a moving weighted average or market, cost being determined on the first-in, first-out basis and market
being defined as net realizable value. Management periodically reviews Company inventory for items that may be deemed obsolete, damaged or for amounts on hand in excess of anticipated future demand. The underlying assumptions utilized in assessing
the Companys inventory change from time to time due to changes in the underlying sales mix, the release of new versions of the Companys proprietary system and overall changes in technology and the marketplace. As the Company develops new
product lines, future charges against income may be necessary to reduce inventory to its net realizable value.



Contract Cost Provision Reserve



Management routinely assesses the Companys performance and estimated cost to complete ongoing sales contracts. Changes in job performance, job
conditions, and estimated profitability, including those arising from contract penalty provisions, and final contract settlements may result in revisions to costs and income. In the event management anticipates incurring costs in excess of contract
revenues, the Company records a contract cost provision reserve in an amount equal to the estimated costs in excess of contracted revenues in the period in which such information becomes apparent.



Warranty Cost Provision Reserve



Management periodically estimates expected warranty costs under the
Companys standard product warranty. In determining the estimate, management analyzes the relationship of historical standard warranty costs incurred on historical sales and the underlying product mix comprising the historical sales.
Management, in turn, utilizes this historical information to estimate expected warranty costs on recent sales within the standard warranty time frame. Due to the inherent limitations in the estimation process, the potential for product defects and
other unforeseen circumstances by the Company, the possibility exists that the recorded warranty provision reserve will be inadequate to offset actual warranty costs incurred resulting in additional charges against income. Also, actual warranty
costs may be significantly lower than expected resulting in the reduction of the Companys warranty provision reserve generating an addition to income in future periods.



13



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##### Table of Contents

RESULTS OF OPERATIONS



The following table sets forth the operations of the Company as a percentage of net revenues for the periods indicated:



FIREARMS TRAINING SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS



|                                                      |  |                                 |    |  |                               |   |  |        |    |  |        |  
|----------------------------------------------------- |  | ------------------------------- | -- |  | ----------------------------- | - |  | ------ | -- |  | ------ | -
|                                                      |  | Three Months Ended December 31, |    |  | Nine Months EndedDecember 31, |  
|                                                      |  | 2003                            |    |  | 2002                          |   |  | 2003   |    |  | 2002   |  
|Revenue                                               |  | 100.00                          | %  |  | 100.00                        | % |  | 100.00 | %  |  | 100.00 | %
|Cost of revenue                                       |  | 62.32                           |    |  | 64.06                         |   |  | 68.06  |    |  | 66.91  |  
|                                                      |  |                                 |    |  |                               |   |  |        |    |  |        |  
|Gross Margin                                          |  | 37.68                           |    |  | 35.94                         |   |  | 31.94  |    |  | 33.09  |  
|                                                      |  |                                 |    |  |                               |   |  |        |    |  |        |  
|Operating expenses                                    |  |                                 |    |  |                               |   |  |        |    |  |        |  
|Selling, general and administrative                   |  | 19.18                           |    |  | 20.12                         |   |  | 20.14  |    |  | 18.65  |  
|Research and development                              |  | 4.65                            |    |  | 8.08                          |   |  | 4.47   |    |  | 5.99   |  
|Depreciation and amortization                         |  | 0.62                            |    |  | 1.68                          |   |  | 0.74   |    |  | 1.69   |  
|                                                      |  |                                 |    |  |                               |   |  |        |    |  |        |  
|Total operating expenses                              |  | 24.45                           |    |  | 29.88                         |   |  | 25.35  |    |  | 26.33  |  
|                                                      |  |                                 |    |  |                               |   |  |        |    |  |        |  
|Operating income                                      |  | 13.23                           |    |  | 6.06                          |   |  | 6.59   |    |  | 6.76   |  
|                                                      |  |                                 |    |  |                               |   |  |        |    |  |        |  
|Other income (expense), net                           |  |                                 |    |  |                               |   |  |        |    |  |        |  
|Interest expense                                      |  |                                 |    |  |                               |   |  |        |    |  |        |  
|Debt, net                                             |  | (8.31                           | )  |  | (0.35                         | ) |  | (8.42  | )  |  | (0.24  | )
|Dividends on mandatorily redeemable preferred stock   |  | (4.40                           | )  |  |                              |   |  | (4.72  | )  |  |       |  
|Other, net                                            |  | 1.01                            |    |  | 0.18                          |   |  | 0.34   |    |  | 0.18   |  
|                                                      |  |                                 |    |  |                               |   |  |        |    |  |        |  
|Total other income (expense), net                     |  | (11.70                          | )  |  | (0.17                         | ) |  | (12.80 | )  |  | (0.06  | )
|                                                      |  |                                 |    |  |                               |   |  |        |    |  |        |  
|Income (loss) before provision for income taxes       |  | 1.53                            |    |  | 5.89                          |   |  | (6.21  | )  |  | 6.70   |  
|Provision for income taxes                            |  | 2.01                            |    |  | 1.78                          |   |  | (0.51  | )  |  | 2.21   |  
|                                                      |  |                                 |    |  |                               |   |  |        |    |  |        |  
|Net income (loss) before preferred stock adjustments  |  | (0.48                           | )  |  | 4.11                          |   |  | (5.70  | )  |  | 4.49   |  
|Accretion of preferred stock                          |  |                                |    |  | (0.60                         | ) |  |       |    |  | (0.52  | )
|                                                      |  |                                 |    |  |                               |   |  |        |    |  |        |  
|Net income (loss) attributable to common shareholders |  | (0.48                           | )% |  | 3.51                          | % |  | (5.70  | )% |  | 3.97   | %
|                                                      |  |                                 |    |  |                               |   |  |        |    |  |        |  



Three Months Ended December 31,
2003 and 2002:



Net Revenues: Revenues increased $4.0
million, or 32.2%, to $16.5 million for the three months ended December 31, 2003 as compared to $12.5 million for the three months ended December 31, 2002. Sales to U.S. military customers for the three months ended December 31, 2003 increased $4.4
million, or 115.5%, to $8.2 million. The increase in U.S. military sales is due to deliveries made during the 2003 period of contracts that were delayed during the first and second quarters of fiscal year 2004 due to the militarys
concentration on the war effort along with some increased end of year spending by the military. Sales to U.S. law enforcement customers for the three months ended December 31, 2003 increased $0.6 million, or 30.9%, to $2.4 million reflecting an
increased emphasis on law enforcement sales by the Company. Sales to international customers for the three months ended December 31, 2003 decreased $0.9 million, or 13.2%, to $5.9 million reflecting a major contract delivery and installation during
the 2002 period that was not replaced during the current three-month period.



Cost of Revenues: Cost of revenues increased $2.3 million, or 28.6%, to $10.3 million for the three months ended December 31, 2003 as compared to $8.0 million for the three months ended December 31, 2002. As a
percentage of revenues, cost of revenues for the three months ended December 31, 2003 decreased to 62.3% as compared to 64.1% for the three months ended December 31, 2002. The decrease in cost of revenues as a percentage of revenues is attributable
primarily to increased revenues and the positive results of previously undertaken cost control initiatives.



Gross Margin: As a result of the foregoing, gross margin increased $1.7 million, or 38.6%, to $6.2 million, or 37.7% of revenues, for the three months
ended December 31, 2003 as compared to $4.5 million, or 35.9% of revenues, for the three months ended December 31, 2002.



14



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##### Table of Contents

Total Operating Expenses: Total operating expenses increased $0.3 million, or 8.2%, for the three months
ended December 31, 2003. Because of the increased revenue base, as a percentage of revenues, total operating expenses decreased to 24.5% for the three months ended December 31, 2003 as compared to 29.9% for the three months ended December 31, 2002.
The increase in the amount of operating expenses is primarily due to increased bid and proposal activities partially offset by a reduction in depreciation and amortization and in net research and development expenses (R&D). While the portion of
the R & D costs funded by the Company has been decreasing, the Companys total R & D costs have been increasing with the portion funded under contracts by customers increasing at a greater rate.



Operating Income: As a result of the foregoing, operating income increased
$1.4 million to $2.2 million, or 13.2% of revenues, for the three months ended December 31, 2003 as compared to $0.8 million, or 6.1% of revenues, for the three months ended December 31, 2002.



Other Income (Expense), net: Net interest expense totaled ($2.1 million), or
(13.1%) of revenues, for the three months ended December 31, 2003 as compared to ($43,000), or (0.4%) of revenues, for the three months ended December 31, 2002. The increase in interest expense is attributable to the following factors:



| | 1. | Interest expense for the three months ended December 31, 2002 was reduced by $878,000 in amortization of debt discount related to a prior debt restructuring that became fully
amortized as of March 31, 2003.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 2. | Interest expense for the three months ended December 31, 2003 includes amortization of the additional $409,000 in fees related to the Fifth Amendment to the Companys credit
agreement, which extended the maturity date of the credit agreement from September 30, 2003 to October 15, 2004.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 3. | Under the Fifth Amendment to the Companys credit agreement, the interest rate on the Companys Senior Secured Loans increased from prime plus 1% to prime plus 2.5% for
the period from June 2, 2003 through December 31, 2003, and the interest rate on the Companys Junior Secured Loans increased from 10% to 15% for the period from June 2, 2003. As of January 1, 2004, the interest rate on the Senior Secured Loans
increased again to prime plus 3.5% where it will remain until the maturity date.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 4. | Interest expense for the three months ended December 31, 2003 includes $725,000 in accrual of mandatorily redeemable preferred stock dividends due to the Companys adoption of
the provisions of Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equities(FAS 150) during the three-month period ended June 30, 2003. The accrual
of preferred stock dividends was previously reported as an adjustment to Net Income to arrive at Net Income Attributable to Common Stockholders. The provisions of FAS 150 preclude the restatement of prior year financial statements.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 5. | Accrued mandatorily redeemable preferred stock dividends, which were previously reported as an adjustment to Net Income to arrive at Net Income Attributable to Common Stockholders,
for the three months ended December 31, 2002 were reduced by approximately $582,000 amortization of a debt restructuring liability that became fully amortized as of March 31, 2003.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Provision for Income Taxes: The effective tax rate increased to 131.8% of
income before taxes for the three months ended December 31, 2003 as compared to 30.2% for the three months ended December 31, 2002. The increase in the effective tax rate is primarily due to the non-deductibility of dividends on preferred stock that
are now included in, and are in excess of, income before the tax provision for the 2003 period. The Company has not recorded a tax benefit for the majority of its deferred tax assets due to uncertainty of future realization.



Net Income (Loss) Before Preferred Stock Adjustments: As a result of the
foregoing, net income (loss) declined from net income of $513,000, or 4.1% of revenue, for the three months ended December 31, 2002 to a net loss of ($80,000), or (0.5%) of revenue, for the three months ended December 31, 2003.



15



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##### Table of Contents

Preferred Stock Adjustments: Accretion of mandatorily redeemable preferred stock dividends was $75,000
for the three months ended December 31, 2002, which was reduced by approximately $582,000 of debt restructuring liability amortization. As noted above, the total accrual of mandatorily redeemable preferred stock dividends is included in interest
expense for the three months ended December 31, 2003, since the debt restructuring liability was fully amortized as of March 31, 2003.



Net Income (Loss) Attributable to Common Stockholders: As a result of the foregoing, net income (loss) attributable to common stockholders decreased by
$518,000 from income of $438,000, or $0.01 per share, for the three months ended December 31, 2002 to a net loss of ($80,000), or ($0.00) per share, for the three months ended December 31, 2003.



Nine Months Ended December 31, 2003 and 2002:



Net Revenues: Revenues increased $2.4 million, or 5.6%, to $45.0 million for
the nine months ended December 31, 2003 as compared to $42.7 million for the nine months ended December 31, 2002. Sales to U.S. military customers for the nine months ended December 31, 2003, decreased by $0.5 million, or 2.5%, to $19.6 million. The
decrease in U.S. military sales is due to delays during the first two quarters of deliveries due to military concentration on the war effort and the completion during the 2002 period of a substantial military contract. Sales to U.S. law enforcement
customers for the nine months ended December 31, 2003 increased $1.6 million, or 34.0%, to $6.4 million reflecting an increased emphasis on law enforcement sales by the Company. Sales to international customers for the nine months ended December 31,
2003 increased $1.5 million, or 8.3%, to $19.0 million reflecting increased profits on certain percentage of completion contracts and customer contract delivery and installation schedules during the first quarter of the period offset somewhat by the
completion of a substantial contract during the 2002 period.



Cost of Revenues: Cost of revenues increased $2.1 million, or 7.4%, to $30.6 million for the nine months ended December 31, 2003 as compared to $28.5 million for the nine months ended December 31, 2002. As a percentage of revenues, cost of
revenues for the nine months ended December 31, 2003 increased to 68.1% as compared to 66.9% for the nine months ended December 31, 2002. The increase in cost of revenues as a percentage of revenues is attributable primarily to a higher portion of
lower margin revenues during the 2003 period partially offset by the positive results of previously undertaken cost control initiatives.



Gross Margin: As a result of the foregoing, the amount of gross margin increased to $14.4 million for the nine months ended December 31,2003 as compared
to $14.1 million during the comparable period in 2002, and the gross margin percentage decreased from 33.1% of revenues for the nine months ended December 31, 2002 to 31.9% for the nine months ended December 31, 2003.



Total Operating Expenses: Total operating expenses increased $0.2 million, or
1.9%, for the nine months ended December 31, 2003. Because of the increased revenue base, as a percentage of revenues, total operating expenses decreased to 25.4% for the nine months ended December 31, 2003 as compared to 26.3% for the nine months
ended December 31, 2002. The increase in the amount of operating expenses is primarily due to increased bid and proposal activities partially offset by a reduction in depreciation and amortization costs and in net R & D costs. While the portion
of the R & D costs funded by the Company has been decreasing, the Companys total R & D costs have been increasing with the portion funded under contracts by customers increasing at a greater rate.



Operating Income: As a result of the foregoing, operating income increased
$0.1 million to $3.0 million, or 6.6% of revenues, for the nine months ended December 31, 2003 as compared to $2.9 million, or 6.8% of revenues, for the nine months ended December 31, 2002.



16



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##### Table of Contents

Other Income (Expense), net: Net interest expense totaled ($5.9 million), or (13.1%) of revenues, for the
nine months ended December 31, 2003 as compared to ($103,000), or (0.2%) of revenues, for the nine months ended December 31, 2002. The increase in interest expense is attributable to the following factors:



| | 1. | Interest expense for the nine months ended December 31, 2002 was reduced by $2.6 million in amortization of debt discount related to a prior debt restructuring that became fully
amortized as of March 31, 2003.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 2. | Interest expense for the nine months ended December 31, 2003 includes amortization of the additional $409,000 in fees related to the Fifth Amendment to the Companys credit
agreement, which extended the maturity date of the credit agreement from September 30, 2003 to October 15, 2004.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 3. | Under the Fifth Amendment to the Companys credit agreement, the interest rate on the Companys Senior Secured Loans increased from prime plus 1% to prime plus 2.5% for
the period from June 2, 2003 through December 31, 2003, and the interest rate on the Companys Junior Secured Loans increased from 10% to 15% for the period from June 2, 2003. As of January 1, 2004, the interest rate on the Senior Secured Loans
increased again to prime plus 3.5% where it will remain until the maturity date.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 4. | Interest expense for the nine months ended December 31, 2003 includes $2.1 million in accrual of mandatorily redeemable preferred stock dividends due to the Companys adoption
of the provisions of Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equities(FAS 150) during the three-month period ended June 30, 2003. The
accrual of preferred stock dividends was previously reported as an adjustment to Net Income to arrive at Net Income Attributable to Common Stockholders. The provisions of FAS 150 preclude the restatement of prior year financial statements.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 5. | Accrued mandatorily redeemable preferred stock dividends, which were previously reported as an adjustment to Net Income to arrive at Net Income Attributable to Common Stockholders,
for the nine months ended December 31, 2002 was reduced by approximately $1.7 million amortization of a debt restructuring liability that became fully amortized as of March 31, 2003.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Provision for Income Taxes: The effective tax rate decreased to 8.2% of loss
before taxes for the nine months ended December 31, 2003 due to the non-deductibility of $2.1 million in dividends on preferred stock that are now included in the loss before the tax provision. The effective tax rate for the nine months ended
December 31, 2002 was standard at approximately 33% without including the preferred stock dividends in income before the tax provision. The Company has not recorded a tax benefit for the majority of its deferred tax assets due to uncertainty of
future realization.



Net Income (Loss) Before Preferred Stock
Adjustments: As a result of the foregoing, net income (loss) declined from net income of $1.9 million, or 4.5% of revenue, for the nine months ended December 31, 2002 to a net loss of ($2.6 million), or (5.7%) of revenue, for the nine months ended
December 31, 2003.



Preferred Stock Adjustments: Accretion of
mandatorily redeemable preferred stock dividends was $221,000 for the nine months ended December 30, 2002, which was reduced by approximately $1.7 million of debt restructuring liability amortization. As noted above, the total accrual of mandatorily
redeemable preferred stock dividends is included in interest expense for the nine months ended December 31, 2003, since the debt restructuring liability was fully amortized as of March 31, 2003.



Net Income (Loss) Attributable to Common Stockholders: As a result of the
foregoing, net income (loss) attributable to common stockholders decreased by $4.3 million from income of $1.7 million, or $0.02 per share, for the nine months ended December 31, 2002 to a loss of ($2.6 million), or ($0.04) per share, for the nine
months ended December 31, 2003.



17



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##### Table of Contents

ANALYSIS OF BACKLOG



Backlog represents customer orders that have been contracted for future delivery. Accordingly, these orders have not yet been recognized as revenue, but
represent potential revenue. As of December 31, 2003 and 2002, the Company had a backlog of approximately $62.3 and $79.0 million, respectively. As of December 31, 2003 the backlog is comprised of $50.5 million from international customers and $11.8
million from U.S. military and law enforcement customers. Approximately $26.9 million of the contracted orders are scheduled for delivery during the fourth quarter of fiscal year 2004.



A summary of changes in the Companys backlog for the three and nine-month periods ended December 31, 2003 and 2002, is
as follows (in thousands):



|                              |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|----------------------------- |  | ------------------------------- | ------- | - | ------------------------------ | - | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                              |  | Three Months Ended December 31, |         |   | Nine Months Ended December 31, |  
|                              |  | 2003                            |         |   | 2002                           |   |         | 2003 |  |   | 2002    |  
|Backlog - beginning of period |  | $                               | 65,118  |   |                                | $ | 67,440  |      |  | $ | 64,346  |   |  | $ | 59,618  |  
|New bookings                  |  |                                 | 13,648  |   |                                |   | 23,982  |      |  |   | 42,968  |   |  |   | 62,001  |  
|Revenue                       |  |                                 | (16,479 | ) |                                |   | (12,463 | )    |  |   | (45,027 | ) |  |   | (42,660 | )
|                              |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Backlog - end of period       |  | $                               | 62,287  |   |                                | $ | 78,959  |      |  | $ | 62,287  |   |  | $ | 78,959  |  
|                              |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  



LIQUIDITY AND CAPITAL RESOURCES



In August 2000, the Company entered into a Second Amended
and Restated Credit Agreement (the New Credit Agreement) and Partial Exchange Agreement with its lenders. In accordance with the New Credit Agreement, the unpaid principal and accrued interest under the old facility was converted into shares of
Common Stock, shares of Series B mandatory redeemable preferred stock, Senior Secured Loans, and Junior Secured Loans. The New Credit Agreement also provides for a New Revolving Credit Commitment comprised of available Revolving Loans and Letters of
Credit. Aggregate borrowings under the New Revolving Credit Commitment are limited to $882,000, with borrowings under the Letters of Credit subject to a sub limit of $828,000. During March, 2002, the Company and its lenders further amended the New
Credit Agreement to, among other amendments, provide a $2,200,000 Support Letter of Credit Facility and extend the maturity date of the Senior Secured Loans, Junior Secured Loans and New Revolving Loans from March 31, 2003 to September 30, 2003.



On June 26, 2003, the Company and its lenders amended the New
Credit Agreement extending the maturity date of the Senior and Junior Secured Loans and the Revolving Loans and Letters of Credit from September 30, 2003 to October 15, 2004, and eliminating further extension options. The extension also extends to
October 15, 2004, the date on which the Companys mandatorily redeemable preferred stock becomes redeemable by the holders.



Under the terms of the most recent amendment, the Company paid an amendment fee of approximately $409,000 and reduced the outstanding balance of the
Senior Secured Loans by approximately $400,000 on January 5, 2004, and will reduce the outstanding balance by an additional amount of approximately $1,100,000 on June 30, 2004. The interest rate on the Senior Secured Loans increased from prime plus
1% to prime plus 2.5% for the period from June 2, 2003 through December 31, 2003 and increased again to prime plus 3.5% for the period from January 1, 2004 until the maturity date. The interest rate on the Junior Secured Loans increased from 10% to
15% for the period from June 2, 2003 through the maturity date, with 10% payable in cash and 5% payable in additional notes with the same terms. All other terms and conditions of the New Credit Agreement remain unchanged.



As of December 31, 2003, the Company had a working capital deficit of ($45.4
million) compared to a deficit of ($21.0 million) as of December 31, 2002. The net $24.4 million increase in working capital deficit is primarily due to the classification as a current liability of $29.7 million in mandatorily redeemable preferred
stock and additional Junior Secured Loans issued in payment of interest; offset somewhat by increased accounts receivable and costs and estimated earnings in excess of billings on uncompleted contracts.



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##### Table of Contents

The Companys capital expenditures for the nine months ended December 31, 2003 were $0.8 million.
Such expenditures include leasehold improvements, computer equipment and software, marketing product demonstration equipment, and manufacturing machinery. As of December 31, 2003, the Company was in compliance with all covenants within its debt
agreements.



The Company had a net decrease in cash and cash
equivalents of ($0.7 million) for the nine months ended December 31, 2003 compared to a net increase of $0.9 million for the nine months ended December 31, 2002. For the period ended December 31, 2003, the Companys operating activities
generated cash of approximately $1.3 million compared to $2.1 million for the nine months ended December 31, 2002. Cash flow from operations for the 2003 period were produced primarily by the collection of accounts receivable offset by reductions of
accounts payable, accrued liabilities and deferred revenue and increases in costs and estimated earnings in excess of billings on uncompleted contracts and inventories. The receipt of a $4.9 million tax refund significantly increased cash flow from
operations for the nine months ended December 31, 2002.



The
Companys principal liquidity and capital needs are to fund working capital, provide debt service, and make capital expenditures necessary to support and grow its business. Since August of 2000, the Company has financed its operations and
growth primarily through internally generated funds and income tax refunds. However, with the maturity of the Companys Senior and Junior Secured Loans and Revolving Loans and Letters of Credit on October 15, 2004, and with the Companys
preferred stock becoming mandatorily redeemable on October 15, 2004, as discussed above, funds provided by operations will not be sufficient to fund these payments. As further discussed under the caption Related Parties and Transactions,
the current holders of the Companys debt and preferred stock are also major stockholders of the Company.



The Company is currently in discussions with several parties to negotiate a refinancing of its New Credit Agreement. The Company has received indications
of interest from certain potential new lenders that would substantially improve the Companys capital structure. However, there can currently be no assurance that the Company will either be successful in negotiating a refinancing with its
existing lending group, or in finalizing an agreement with new lenders under terms that would be favorable to the Company, if at all. The inability of the Company to satisfactorily address the concerns related to its capital structure prior to
October 15, 2004 would have a severe adverse effect on the Companys financial condition and future operations.



The Company is subject to several business and market risks. The Company must continue to achieve its revenue targets and cost reduction objectives in
order to generate adequate cash flow to fund working capital needs and to service debt requirements; the Company must receive new contracts for production to be delivered in the current fiscal year to meet its revenue targets and to replenish
existing backlog to sustain the revenue targets in future periods. The Company must also negotiate favorable repayment terms under the New Credit Agreement, which is currently scheduled to mature in October 2004.



CONCENTRATION OF CREDIT RISK



As of December 31, 2003, approximately $8.4 million in accounts receivable,
or 67.7% of total accounts receivable, net, was due from the Companys top ten customers, $0.3 million of which was secured by performance letters of credit for foreign receivables. The remaining $8.1 million is due from U.S., U.K., Singapore
and Swedish government contracts and subcontracts.



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##### Table of Contents

COMMITMENTS AND OTHER CONTRACTURAL OBLIGATIONS



Disclosure of Commitments and Other Contractual Obligations

December 31, 2003

(amounts in thousands)



|                                       |  |       |        |                  |   |                   |  |                   |       |               |   |     |  |   |  
|-------------------------------------- |  | ----- | ------ | ---------------- | - | ----------------- |  | ----------------- | ----- | ------------- | - | --- |  | - | -
|                                       |  | Total |        | Less than 1 year |   | Within1 - 3 years |  | Within4 - 5 years |       | After 5 years
|Long-term debt                         |  |       |        |                  |   |                   |  |                   |       |               |   |     |  |   |  
|Working capital - borrowings           |  | $     | 130    |                  | $ | 130               |  | $                 |      |               | $ |    |  | $ | 
|Long-term debt - Senior                |  |       | 12,000 |                  |   | 12,000            |  |                   |      |               |   |    |  |   | 
|Long-term debt - Junior                |  |       | 28,831 |                  |   | 28,831            |  |                   |      |               |   |    |  |   | 
|Capital lease obligations              |  |       | 131    |                  |   | 52                |  |                   | 79    |               |   |    |  |   | 
|Mandatorily Redeemable Preferred Stock |  |       | 29,741 |                  |   | 29,741            |  |                   |      |               |   |    |  |   | 
|Other                                  |  |       |        |                  |   |                   |  |                   |       |               |   |     |  |   |  
|Open purchase orders                   |  |       | 4,602  |                  |   | 3,984             |  |                   | 618   |               |   |     |  |   |  
|Operating lease obligations            |  |       | 3,391  |                  |   | 937               |  |                   | 1,601 |               |   | 853 |  |   | 
|                                       |  |       |        |                  |   |                   |  |                   |       |               |   |     |  |   |  
|Total                                  |  | $     | 78,826 |                  | $ | 75,675            |  | $                 | 2,298 |               | $ | 853 |  | $ | 
|                                       |  |       |        |                  |   |                   |  |                   |       |               |   |     |  |   |  



RELATED PARTIES AND TRANSACTIONS



A group of entities affiliated with Centre Partners
Management LLC (the Centre Entities) are among the Companys largest stockholders, owning collectively approximately 48.2% of our common stock. The Centre Entities hold a seat on the Companys Board of Directors. In addition, the Centre
Entities, and other institutional lenders who are also major stockholders, as a result of a previously reported restructuring transaction, were party to the amendments to the New Credit Agreement discussed in Note 7 to the financial statements and
in the section Liquidity and Capital Resources. These entities continue to be the Companys primary lenders. As a result of the share ownership of the Centre Entities and their representation on the Board of Directors, the Centre
Entities have the ability to influence the operations of the Company.



The Company entered into a consulting agreement, dated October 4, 2000, with Sugarman & Company, LLP, a company in which Randy Sugarman is the managing partner and has an 80% ownership interest. Under the agreement and in accordance
with the terms of the Companys restructuring in fiscal year 2001, Mr. Sugarman was engaged by the Company to evaluate its financial position and operations and make recommendations to senior management regarding changes that need to be made to
improve profitability and liquidity. Mr. Sugarmans services were performed on an hourly basis, plus out-of-pocket expenses, and the Company was billed accordingly. From May 16, 2001 until August 9, 2002, Mr. Sugarman served as Interim Chief
Executive Officer and President of the Company. Mr. Sugarman ceased to be an officer of the Company on August 9, 2002, in connection with the conclusion of the Companys engagement of Sugarman & Company LLP. The Company incurred fees of
$211,000 plus expenses of $47,000 for consulting services under the agreement during the nine-month period ended December 31, 2002.



20



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##### Table of Contents

|ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|------- | ----------------------------------------------------------



The Companys major market risk exposure arises from changes in interest rates and its impact on variable rate debt instruments. In addition, the
Company has interest rate risk associated with fixed rate debt at maturity. The Companys objectives in interest rate risk management are to limit the impact of interest rate changes on earnings and cash flows, and to lower overall borrowing
costs. To achieve its objectives, the Company borrows at fixed rates when it believes it is in its best interests to do so, and may enter into derivative financial instruments, such as interest rate swaps and caps, in order to limit its exposure to
interest rate fluctuations. The Company does not enter into derivative or interest rate transactions for speculative purposes. There were no derivative contracts in effect at December 31, 2003.



As of December 31, 2003, the Company had a total of approximately $28.8
million in fixed rate debt at an interest rate of 15% and a total of approximately $29.7 million in mandatorily redeemable preferred stock bearing dividends at 10%, both of which will mature on October 15, 2004. The company also has a total of
approximately $12.0 million in variable rate debt at an interest rate of prime plus 2.5%, (6.5% as of December 31, 2003) through December 31, 2003, and then increasing to prime plus 3.5% for the period from January 1, 2004 through the maturity date
of October 15, 2004. If interest rates on the Companys existing variable rate debt were to increase by 10% over the next twelve months, management believes there would be no material adverse impact on the Companys results of operations.



|ITEM 4. | CONTROLS AND PROCEDURES
|------- | -----------------------



Within the 90-day period prior to the filing date of this report, the Companys management, including its Chief Executive Officer and Chief Financial
Officer, carried out an evaluation of the effectiveness of the Companys disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934. Based upon that evaluation, the Companys Chief Executive Officer
and Chief Financial Officer concluded that the Companys disclosure controls and procedures are reasonably effective in timely alerting them to material information required to be included in the Companys SEC filings. There has been no
change in the Companys internal control over financial reporting that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Companys internal control over
financial reporting.



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##### Table of Contents

|PART II. | OTHER INFORMATION
|-------- | -----------------



|ITEM 1. | LEGAL PROCEEDINGS
|------- | -----------------



The Company is involved in legal proceedings in the ordinary course of its business, which in the opinion of management will not have a materially adverse
effect on the Companys financial position, liquidity, or results of operation.



|ITEM 6. | EXHIBITS AND REPORTS ON FORM 8-K
|------- | --------------------------------



|(a) | Exhibits
|--- | --------



|                |  |                                                                                                                                   
|--------------- |  | ----------------------------------------------------------------------------------------------------------------------------------
|                | 
|Exhibit 10.1*-  |  | Amendment to Employment agreement between the Company and John A. Morelli (for the purpose of extending the term of the agreement)
|                | 
|Exhibit 31.1 -  |  | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                
|                | 
|Exhibit 31.2 -  |  | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                
|                | 
|Exhibit 32.1**- |  | Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                
|                | 
|Exhibit 32.2**- |  | Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                

---

|* | Indicates a management contract or compensatory arrangement
|- | -----------------------------------------------------------

|** | Pursuant to Commission Release No. 33-8238, this certification will be treated as accompanying this Quarterly Report on Form 10-Q and not filed as part of
such report for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of Section 18 of the Exchange Act and this certification will not be deemed to be incorporated by reference into any filing under the Securities Act of
1933, as amended, or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(b) | Reports on Form 8-K filed during the quarter ended December 31, 2003
|--- | --------------------------------------------------------------------



On October 31, 2003, the Company filed a press release announcing financial results for the second quarter of the fiscal year ending March 31, 2004.



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SIGNATURES



Pursuant to the
requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



DATED: February 10, 2004



FIREARMS TRAINING SYSTEMS, INC./S/ John A. MorelliJohn A. MorelliChief Financial Officer and Treasurer(Principal Financial Officer and Duly Authorized Officer)






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