##### Table of Contents

---

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549



---



FORM 10-Q



---



(Mark One)

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



FOR THE QUARTERLY PERIOD ENDED June 30, 2005



OR



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



COMMISSION FILE NUMBER: 333-13105



---



FIREARMS TRAINING SYSTEMS, INC.

(Exact name of registrant as specified in its charter)



---



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|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)



---



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 August 9, 2005, there were 75,945,337 shares of the Registrants
Class A Common Stock outstanding.



---



---

##### Table of Contents

FIREARMS TRAINING SYSTEMS, INC.

INDEX



|         |  |                                                                                                                                                        |  |     
|-------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ----
|         |  |                                                                                                                                                        |  | PAGE
|PART I.  |  | FINANCIAL INFORMATION                                                                                                                                  |  |     
|         |  |                                                                                                                                                       
|ITEM 1.  |  | CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:                                                                                                           |  |     
|         |  |                                                                                                                                                       
|         |  | Condensed Consolidated Statements of Operations Three months ended June 30, 2005 (unaudited), restated 2004 (unaudited), and restated 2003 (unaudited) |  | 3   
|         |  |                                                                                                                                                       
|         |  | Condensed Consolidated Balance Sheets June 30, 2005 (unaudited), March 31, 2005, and restated June 30, 2004 (unaudited)                                |  | 4   
|         |  |                                                                                                                                                       
|         |  | Condensed Consolidated Statements of Cash Flows Three months ended June 30, 2005 (unaudited), restated 2004 (unaudited), and restated 2003 (unaudited) |  | 5   
|         |  |                                                                                                                                                       
|         |  | Notes to Condensed Consolidated Financial Statements (unaudited)                                                                                       |  | 6   
|         |  |                                                                                                                                                       
|ITEM 2.  |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                                                                  |  | 13  
|         |  |                                                                                                                                                       
|ITEM 3.  |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                                                             |  | 19  
|         |  |                                                                                                                                                       
|ITEM 4.  |  | CONTROLS AND PROCEDURES                                                                                                                                |  | 19  
|         |  |                                                                                                                                                       
|PART II. |  | OTHER INFORMATION                                                                                                                                      |  |     
|         |  |                                                                                                                                                       
|ITEM 1.  |  | LEGAL PROCEEDINGS                                                                                                                                      |  | 20  
|         |  |                                                                                                                                                       
|ITEM 6.  |  | EXHIBITS                                                                                                                                               |  | 20  
|         |  |                                                                                                                                                       
|         |  | SIGNATURES                                                                                                                                             |  | 21  





2



---

##### 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 for per share
amounts)



|                                                     |  |                             |        |   |            |   |        |            |  |   |        |  
|---------------------------------------------------- |  | --------------------------- | ------ | - | ---------- | - | ------ | ---------- |  | - | ------ | -
|                                                     |  | Three Months Ended June 30, |       
|                                                     |  | 2005                        |        |   | 2004       |   |        | 2003       | 
|                                                     |  |                             |        |   | (Restated) |   |        | (Restated) | 
|Revenue                                              |  | $                           | 16,539 |   |            | $ | 18,365 |            |  | $ | 15,823 |  
|Cost of revenue                                      |  |                             | 10,872 |   |            |   | 11,866 |            |  |   | 11,347 |  
|                                                     |  |                             |        |   |            |   |        |            |  |   |        |  
|Gross margin                                         |  |                             | 5,667  |   |            |   | 6,499  |            |  |   | 4,476  |  
|                                                     |  |                             |        |   |            |   |        |            |  |   |        |  
|Operating expenses:                                  |  |                             |        |   |            |   |        |            |  |   |        |  
|Selling, general and administrative                  |  |                             | 3,715  |   |            |   | 3,451  |            |  |   | 3,022  |  
|Research and development                             |  |                             | 1,403  |   |            |   | 1,018  |            |  |   | 523    |  
|                                                     |  |                             |        |   |            |   |        |            |  |   |        |  
|Total operating expenses                             |  |                             | 5,118  |   |            |   | 4,469  |            |  |   | 3,545  |  
|                                                     |  |                             |        |   |            |   |        |            |  |   |        |  
|Operating income                                     |  |                             | 549    |   |            |   | 2,030  |            |  |   | 931    |  
|                                                     |  |                             |        |   |            |   |        |            |  |   |        |  
|Other income (expense), net                          |  |                             |        |   |            |   |        |            |  |   |        |  
|Interest expense on debt                             |  |                             | (902   | ) |            |   | (1,399 | )          |  |   | (1,071 | )
|Dividends on mandatorily redeemable preferred stock  |  |                             |       |   |            |   | (762   | )          |  |   | (690   | )
|Other, net                                           |  |                             | 236    |   |            |   | (85    | )          |  |   | 53     |  
|                                                     |  |                             |        |   |            |   |        |            |  |   |        |  
|Total other income (expense)                         |  |                             | (666   | ) |            |   | (2,246 | )          |  |   | (1,708 | )
|                                                     |  |                             |        |   |            |   |        |            |  |   |        |  
|Loss before provision (benefit) for income taxes     |  |                             | (117   | ) |            |   | (216   | )          |  |   | (777   | )
|Provision (benefit) for income taxes                 |  |                             | (126   | ) |            |   | 123    |            |  |   | (35    | )
|                                                     |  |                             |        |   |            |   |        |            |  |   |        |  
|Net income (loss)                                    |  | $                           | 9      |   |            | $ | (339   | )          |  | $ | (742   | )
|                                                     |  |                             |        |   |            |   |        |            |  |   |        |  
|Income (loss) per share                              |  |                             |        |   |            |   |        |            |  |   |        |  
|Basic income (loss) per share                        |  | $                           | 0.00   |   |            | $ | (0.01  | )          |  | $ | (0.01  | )
|                                                     |  |                             |        |   |            |   |        |            |  |   |        |  
|Diluted income (loss) per share                      |  | $                           | 0.00   |   |            | $ | (0.01  | )          |  | $ | (0.01  | )
|                                                     |  |                             |        |   |            |   |        |            |  |   |        |  
|Weighted average common shares outstanding  basic   |  |                             | 75,945 |   |            |   | 70,154 |            |  |   | 70,153 |  
|                                                     |  |                             |       
|Weighted average common shares outstanding  diluted |  |                             | 80,693 |   |            |   | 70,154 |            |  |   | 70,153 |  



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



3



---

##### Table of Contents

FIREARMS TRAINING SYSTEMS, INC. AND SUBSIDIARIES



CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except for shares authorized, issued and
outstanding and per share value)



|                                                                                                                                                   |  |               |          |   |                |   |          |                          |  |   |          |  
|-------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | -------- | - | -------------- | - | -------- | ------------------------ |  | - | -------- | -
|                                                                                                                                                   |  | June 30, 2005 |          |   | March 31, 2005 |   |          | June 30, 2004            | 
|                                                                                                                                                   |  | (unaudited)   |          |   |                |   |          | (Restated and unaudited) | 
|ASSETS                                                                                                                                             |  |               |          |   |                |   |          |                          |  |   |          |  
|Current assets:                                                                                                                                    |  |               |          |   |                |   |          |                          |  |   |          |  
|Cash and cash equivalents                                                                                                                          |  | $             | 3,726    |   |                | $ | 6,456    |                          |  | $ | 2,321    |  
|Restricted cash                                                                                                                                    |  |               | 3,194    |   |                |   | 3,209    |                          |  |   | 2,484    |  
|Accounts receivable, net of allowance of $350                                                                                                      |  |               | 15,245   |   |                |   | 14,707   |                          |  |   | 22,759   |  
|Costs and estimated earnings in excess of billings on incomplete contracts                                                                         |  |               | 7,810    |   |                |   | 9,937    |                          |  |   | 7,809    |  
|Unbilled receivables                                                                                                                               |  |               | 386      |   |                |   | 543      |                          |  |   | 1,816    |  
|Inventories                                                                                                                                        |  |               | 14,602   |   |                |   | 12,565   |                          |  |   | 11,102   |  
|Income taxes receivable                                                                                                                            |  |               | 253      |   |                |   | 98       |                          |  |   | 189      |  
|Deferred income taxes                                                                                                                              |  |               | 385      |   |                |   | 412      |                          |  |   | 770      |  
|Prepaid expenses and other current assets                                                                                                          |  |               | 2,409    |   |                |   | 1,813    |                          |  |   | 2,991    |  
|                                                                                                                                                   |  |               |          |   |                |   |          |                          |  |   |          |  
|Total current assets                                                                                                                               |  |               | 48,010   |   |                |   | 49,740   |                          |  |   | 52,241   |  
|                                                                                                                                                   |  |               |         
|Property and equipment, net                                                                                                                        |  |               | 2,037    |   |                |   | 2,051    |                          |  |   | 2,288    |  
|                                                                                                                                                   |  |               |         
|Other noncurrent assets:                                                                                                                           |  |               |          |   |                |   |          |                          |  |   |          |  
|Deferred income taxes                                                                                                                              |  |               | 989      |   |                |   | 989      |                          |  |   | 1,492    |  
|Intangible assets, net                                                                                                                             |  |               | 1,247    |   |                |   | 1,305    |                          |  |   | 504      |  
|                                                                                                                                                   |  |               |          |   |                |   |          |                          |  |   |          |  
|Total assets                                                                                                                                       |  | $             | 52,283   |   |                | $ | 54,085   |                          |  | $ | 56,525   |  
|                                                                                                                                                   |  |               |          |   |                |   |          |                          |  |   |          |  
|LIABILITIES AND STOCKHOLDERS DEFICIT                                                                                                              |  |               |          |   |                |   |          |                          |  |   |          |  
|Current Liabilities:                                                                                                                               |  |               |          |   |                |   |          |                          |  |   |          |  
|Long-term debt due within one year                                                                                                                 |  | $             | 4,312    |   |                | $ | 4,584    |                          |  | $ | 3,555    |  
|Accounts payable                                                                                                                                   |  |               | 3,562    |   |                |   | 5,328    |                          |  |   | 5,008    |  
|Accrued liabilities                                                                                                                                |  |               | 5,098    |   |                |   | 6,760    |                          |  |   | 6,824    |  
|Accrued interest                                                                                                                                   |  |               | 270      |   |                |   | 294      |                          |  |   | 958      |  
|Income taxes payable                                                                                                                               |  |               | 1,552    |   |                |   | 1,442    |                          |  |   | 425      |  
|Billings in excess of cost and estimated earnings on incomplete contracts                                                                          |  |               | 1,281    |   |                |   | 3,000    |                          |  |   | 1,142    |  
|Deferred revenue                                                                                                                                   |  |               | 3,843    |   |                |   | 3,200    |                          |  |   | 4,044    |  
|Contract cost reserve                                                                                                                              |  |               | 640      |   |                |   | 639      |                          |  |   | 976      |  
|Warranty cost reserve                                                                                                                              |  |               | 399      |   |                |   | 283      |                          |  |   | 167      |  
|                                                                                                                                                   |  |               |          |   |                |   |          |                          |  |   |          |  
|Total current liabilities                                                                                                                          |  |               | 20,957   |   |                |   | 25,530   |                          |  |   | 23,099   |  
|                                                                                                                                                   |  |               |         
|Long-term debt                                                                                                                                     |  |               | 27,766   |   |                |   | 24,469   |                          |  |   | 37,689   |  
|                                                                                                                                                   |  |               |         
|Other noncurrent liabilities                                                                                                                       |  |               | 507      |   |                |   | 562      |                          |  |   | 645      |  
|                                                                                                                                                   |  |               |         
|Manditorily redeemable preferred stock                                                                                                             |  |               |         |   |                |   |         |                          |  |   | 31,247   |  
|                                                                                                                                                   |  |               |          |   |                |   |          |                          |  |   |          |  
|Total liabilities                                                                                                                                  |  |               | 49,230   |   |                |   | 50,561   |                          |  |   | 92,680   |  
|                                                                                                                                                   |  |               |          |   |                |   |          |                          |  |   |          |  
|Commitments and contingencies                                                                                                                      |  |               |          |   |                |   |          |                          |  |   |          |  
|                                                                                                                                                   |  |               |         
|Preferred stock, 3,500 shares authorized; 3,203, 3,203, and zero shares issued and outstanding; liquidation value of $10,769 and $10,506 per
share |  |               | 32,028   |   |                |   | 32,028   |                          |  |   |         |  
|                                                                                                                                                   |  |               |          |   |                |   |          |                          |  |   |          |  
|Stockholders deficit:                                                                                                                             |  |               |          |   |                |   |          |                          |  |   |          |  
|Class A common stock, $0.000006 par value; 100 million shares authorized, 75,945,337, 75,945,337, and 70,205,639 shares issued and
outstanding     |  |               |         |   |                |   |         |                          |  |   |         |  
|Additional paid-in capital                                                                                                                         |  |               | 127,980  |   |                |   | 127,980  |                          |  |   | 123,244  |  
|Stock warrants                                                                                                                                     |  |               |         |   |                |   |         |                          |  |   | 613      |  
|Accumulated deficit                                                                                                                                |  |               | (157,584 | ) |                |   | (157,593 | )                        |  |   | (160,531 | )
|Accumulated other comprehensive income                                                                                                             |  |               | 629      |   |                |   | 1,109    |                          |  |   | 519      |  
|                                                                                                                                                   |  |               |          |   |                |   |          |                          |  |   |          |  
|Total stockholders deficit                                                                                                                        |  |               | (28,975  | ) |                |   | (28,504  | )                        |  |   | (36,155  | )
|                                                                                                                                                   |  |               |          |   |                |   |          |                          |  |   |          |  
|Total liabilities and stockholders deficit                                                                                                        |  | $             | 52,283   |   |                | $ | 54,085   |                          |  | $ | 56,525   |  
|                                                                                                                                                   |  |               |          |   |                |   |          |                          |  |   |          |  



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



4



---

##### Table of Contents

FIREARMS TRAINING SYSTEMS, INC. AND SUBSIDIARIES



CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited and in thousands)



|                                                                            |  |                             |        |   |            |   |        |            |  |   |        |  
|--------------------------------------------------------------------------- |  | --------------------------- | ------ | - | ---------- | - | ------ | ---------- |  | - | ------ | -
|                                                                            |  | Three Months Ended June 30, |       
|                                                                            |  | 2005                        |        |   | 2004       |   |        | 2003       | 
|                                                                            |  |                             |        |   | (Restated) |   |        | (Restated) | 
|Cash flows from operating activities:                                       |  |                             |        |   |            |   |        |            |  |   |        |  
|Net income (loss)                                                           |  | $                           | 9      |   |            | $ | (339   | )          |  | $ | (742   | )
|                                                                            |  |                             |        |   |            |   |        |            |  |   |        |  
|Adjustments for non-cash items                                              |  |                             |        |   |            |   |        |            |  |   |        |  
|Non-cash interest and financing costs                                       |  |                             | 132    |   |            |   | 1,212  |            |  |   | 799    |  
|Depreciation and amortization                                               |  |                             | 270    |   |            |   | 237    |            |  |   | 269    |  
|Change in inventory reserve                                                 |  |                             | 63     |   |            |   | 104    |            |  |   | 96     |  
|Change in warranty cost and contract loss reserve                           |  |                             | 117    |   |            |   | (287   | )          |  |   | (288   | )
|Gain (loss) on disposal of assets                                           |  |                             | 13     |   |            |   | 1      |            |  |   | (5     | )
|Deferred income taxes                                                       |  |                             |       |   |            |   | 38     |            |  |   | (103   | )
|Changes in assets and liabilities                                           |  |                             |        |   |            |   |        |            |  |   |        |  
|Accounts receivable, net                                                    |  |                             | (538   | ) |            |   | 558    |            |  |   | 6,602  |  
|Income taxes receivable                                                     |  |                             | (155   | ) |            |   | (75    | )          |  |   | 566    |  
|Costs and estimated earnings in excess of billings on uncompleted contracts |  |                             | 2,127  |   |            |   | (1,851 | )          |  |   | (1,656 | )
|Unbilled receivables                                                        |  |                             | 157    |   |            |   | (1,754 | )          |  |   | 45     |  
|Inventories                                                                 |  |                             | (2,100 | ) |            |   | 1,015  |            |  |   | 40     |  
|Prepaid expenses and other current assets                                   |  |                             | (596   | ) |            |   | (1,971 | )          |  |   | 213    |  
|Accounts payable                                                            |  |                             | (1,766 | ) |            |   | 1,329  |            |  |   | (2,134 | )
|Accrued liabilities                                                         |  |                             | (1,686 | ) |            |   | (169   | )          |  |   | (159   | )
|Income taxes payable                                                        |  |                             | 110    |   |            |   | 116    |            |  |   | (93    | )
|Billings in excess of costs and estimated earnings on uncompleted contracts |  |                             | (1,719 | ) |            |   | (208   | )          |  |   | 58     |  
|Deferred revenue                                                            |  |                             | 643    |   |            |   | 2,805  |            |  |   | (1,029 | )
|Noncurrent liabilities                                                      |  |                             | (55    | ) |            |   | 58     |            |  |   | 27     |  
|                                                                            |  |                             |        |   |            |   |        |            |  |   |        |  
|Total adjustments                                                           |  |                             | (4,983 | ) |            |   | 1,158  |            |  |   | 3,248  |  
|                                                                            |  |                             |        |   |            |   |        |            |  |   |        |  
|Net cash provided by (used in) operating activities                         |  |                             | (4,974 | ) |            |   | 819    |            |  |   | 2,506  |  
|                                                                            |  |                             |        |   |            |   |        |            |  |   |        |  
|Cash flows from investing activities                                        |  |                             |        |   |            |   |        |            |  |   |        |  
|Change in restricted cash                                                   |  |                             | 15     |   |            |   | 18     |            |  |   | (1,607 | )
|Purchase of property and equipment                                          |  |                             | (278   | ) |            |   | (146   | )          |  |   | (293   | )
|Proceeds from disposal of property and equipment                            |  |                             |       |   |            |   | 1      |            |  |   | 5      |  
|                                                                            |  |                             |        |   |            |   |        |            |  |   |        |  
|Net cash provided by (used in) investing activities                         |  |                             | (263   | ) |            |   | (127   | )          |  |   | (1,895 | )
|                                                                            |  |                             |        |   |            |   |        |            |  |   |        |  
|Cash flows from financing activities                                        |  |                             |        |   |            |   |        |            |  |   |        |  
|Proceeds from long-term debt                                                |  |                             | 3,500  |   |            |   | 295    |            |  |   |       |  
|Payments on long-term debt                                                  |  |                             | (532   | ) |            |   | (534   | )          |  |   | (19    | )
|Payment of deferred financing costs                                         |  |                             | (17    | ) |            |   | (405   | )          |  |   | (409   | )
|Exercise of stock options                                                   |  |                             |       |   |            |   | 29     |            |  |   |       |  
|                                                                            |  |                             |        |   |            |   |        |            |  |   |        |  
|Net cash provided by (used in) financing activities                         |  |                             | 2,951  |   |            |   | (615   | )          |  |   | (428   | )
|                                                                            |  |                             |        |   |            |   |        |            |  |   |        |  
|Effect of exchange rate changes on cash                                     |  |                             | (444   | ) |            |   | (123   | )          |  |   | 300    |  
|                                                                            |  |                             |        |   |            |   |        |            |  |   |        |  
|Net increase (decrease) in cash and cash equivalents                        |  |                             | (2,730 | ) |            |   | (46    | )          |  |   | 483    |  
|Cash and cash equivalents, beginning of period                              |  |                             | 6,456  |   |            |   | 2,367  |            |  |   | 3,457  |  
|                                                                            |  |                             |        |   |            |   |        |            |  |   |        |  
|Cash and cash equivalents, end of period                                    |  | $                           | 3,726  |   |            | $ | 2,321  |            |  | $ | 3,940  |  
|                                                                            |  |                             |        |   |            |   |        |            |  |   |        |  



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



5



---

##### Table of Contents

FIREARMS TRAINING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)



1. Basis of presentation



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 months ended June 30, 2005, are not necessarily indicative of the results that may be expected for the full year ending March 31, 2006. 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, 2005, included in our 2005 Annual Report on Form 10-K filed with the
Securities and Exchange Commission (SEC).



2. Restatement of
Previously Issued Financial Statements



The Company has
restated its previously issued consolidated financial statements for fiscal years ended March 31, 2004 and 2003. The restatements relate to correcting the accounting treatment previously used with respect to two percentage-of-completion contracts
entered into by foreign subsidiaries denominated in foreign currencies, which were accounted for incorrectly. In the past, the Company deferred the impact of foreign currency fluctuations until the period in which each contract was completed. The
Company determined that its method of deferring the recognition of foreign currency fluctuations on these percentage-of-completion contracts was incorrect and that a restatement was necessary. The Company has restated its financial statements to
recognize the effects of foreign currency transactions and translations in accordance with SFAS 52, Foreign Currency Translation. Revenues and operations recorded by each foreign subsidiary and each foreign subsidiaries assets and
liabilities should have been translated in accordance with SFAS 52. Gain and loss associated with assets and liabilities held by the Company and each subsidiary not held in each entities functional currency should have been recorded into
income. The effect of these adjustments increased revenues and operating income by $353,000 and $205,000 for the three months ended June 30, 2004 and 2003, respectively, and decreased net loss by $275,000 and $148,000 for those periods.



The effect of the restatement on certain line items of the Companys
consolidated statements of income and balance sheet is as follows (in thousands):



|                                                                              |  |                                                 |         |   |                                          |   |       |             |  |   |                        |   |  |            |        |             |  |   |     |  |   |        |  
|----------------------------------------------------------------------------- |  | ----------------------------------------------- | ------- | - | ---------------------------------------- | - | ----- | ----------- |  | - | ---------------------- | - |  | ---------- | ------ | ----------- |  | - | --- |  | - | ------ | -
|                                                                              |  | For the Three months Ended and At June 30, 2004 |         |   | For the Three months Ended June 30, 2003 |  
|                                                                              |  | As Previously Reported                          |         |   | Adjustment                               |   |       | As Restated |  |   | As Previously Reported |   |  | Adjustment |        | As Restated | 
|Consolidated income statement:                                                |  |                                                 |         |   |                                          |   |       |             |  |   |                        |   |  |            |        |             |  |   |     |  |   |        |  
|Revenue                                                                       |  | $                                               | 18,012  |   |                                          | $ | 353   |             |  | $ | 18,365                 |   |  | $          | 15,618 |             |  | $ | 205 |  | $ | 15,823 |  
|Gross margin                                                                  |  |                                                 | 6,146   |   |                                          |   | 353   |             |  |   | 6,499                  |   |  |            | 4,271  |             |  |   | 205 |  |   | 4,476  |  
|Operating income                                                              |  |                                                 | 1,677   |   |                                          |   | 353   |             |  |   | 2,030                  |   |  |            | 726    |             |  |   | 205 |  |   | 931    |  
|Other income (expense), net                                                   |  |                                                 | (2,251  | ) |                                          |   | 5     |             |  |   | (2,246                 | ) |  |            | (1,719 | )           |  |   | 11  |  |   | (1,708 | )
|Loss before provision for income taxes                                        |  |                                                 | (574    | ) |                                          |   | 358   |             |  |   | (216                   | ) |  |            | (993   | )           |  |   | 216 |  |   | (777   | )
|Provision (benefit) for income taxes                                          |  |                                                 | 40      |   |                                          |   | 83    |             |  |   | 123                    |   |  |            | (103   | )           |  |   | 68  |  |   | (35    | )
|Net loss                                                                      |  |                                                 | (614    | ) |                                          |   | 275   |             |  |   | (339                   | ) |  |            | (890   | )           |  |   | 148 |  |   | (742   | )
|Basic and diluted income per share                                            |  |                                                 | 0.01    |   |                                          |   |      |             |  |   | 0.01                   |   |  |            | 0.01   |             |  |   |    |  |   | 0.01   |  
|                                                                              |  |                                                 |         |   |                                          |  
|Consolidated balance sheet:                                                   |  |                                                 |         |   |                                          |   |       |             |  |   |                        |   |  |            |        |             |  |   |     |  |   |        |  
|Cost and estimated earnings in excess of billings on incomplete contracts     |  | $                                               | 5,891   |   |                                          | $ | 1,918 |             |  | $ | 7,809                  |   |  |            |        |             |  |   |     |  |   |        |  
|Income taxes receivable                                                       |  |                                                 | 91      |   |                                          |   | 98    |             |  |   | 189                    |   |  |            |        |             |  |   |     |  |   |        |  
|Deferred income taxes                                                         |  |                                                 | 2,711   |   |                                          |   | (449  | )           |  |   | 2,262                  |   |  |            |        |             |  |   |     |  |   |        |  
|Income taxes payable                                                          |  |                                                 | 158     |   |                                          |   | 267   |             |  |   | 425                    |   |  |            |        |             |  |   |     |  |   |        |  
|Billings in excess of cost and and estimated earnings on incomplete contracts |  |                                                 | 1,322   |   |                                          |   | (180  | )           |  |   | 1,142                  |   |  |            |        |             |  |   |     |  |   |        |  
|Total stockholders deficit                                                   |  |                                                 | (37,635 | ) |                                          |   | 1,480 |             |  |   | (36,155                | ) |  |            |        |             |  |   |     |  |   |        |  



6



---

##### Table of Contents

3. 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 governmental agencies is recognized upon shipment when title passes, because at the time title passes, all material commitments will have been fulfilled, the sales price is fixed and determinable and
collectibility is reasonably assured. Some contracts contain acceptance clauses giving customers a right to test products. In these instances, revenue is not recognized until the customer accepts the products or the acceptance clause lapses. A large
portion of the Companys small and supporting arms training simulator revenue is derived from contracts with large governmental agencies. Governmental contracts that involve high volume purchases of the Companys standard systems and
related accessories are accounted for as multiple-deliverable arrangements, in accordance with EITF 00-21, Revenue Arrangements with Multiple Deliverables, based on the relative fair values of the deliverables specified in the contract. These
contracts require little or no modifications to the existing proprietary platform and specify pricing terms by product, with billings generally corresponding 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 in accordance with SOP 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts,
measured by the percentage of cost incurred to date to the total costs 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.



Revenues 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.



4. Stock-based compensation



The Company accounts for stock incentives available to employees and
non-employee directors under its stock-based compensation plans using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, as allowed under FAS No. 123, Accounting
for Stock-Based Compensation. The Company has adopted the provisions of FAS No. 123 and FAS 148, Accounting for Stock-Based Compensation-Transition and Disclosure, which require disclosure of the pro forma effects on earnings and earnings
per share as if SFAS No. 123 had been adopted.



In December
2004, FASB issued SFAS No. 123 (revised 2004), Share Based Payment (SFAS 123R), which is a revision of SFAS Statement No. 123. This statement supercedes APB Opinion 25, and amends SFAS Statement No. 95, Statement of Cash Flows.
Generally, the approach in SFAS 123R is similar to the approach described in SFAS 123; however, SFAS 123R requires all share-based payment to employees, including grants of employee stock options, to be recognized in the income statement based on
their fair values. Pro forma disclosure is no longer an alternative. The effective date of this statement for the Company is April 1, 2006.



The adoption of SFAS 123R fair value method is expected to result in non-cash charges that will increase the Companys operating expenses; however,
it will have no impact on its cash flows. The amount of the impact of adoption of SFAS 123R has not been determined at this time.



7



---

##### Table of Contents

The Company did not issue options during the three months ended June 30, 2005 and 2004.



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 income (loss) and income (loss) per share as if the Company had accounted for options using the fair
value method is as follows:



|                                                       |  |                                          |       |   |            |   |       |            |  |   |       |  
|------------------------------------------------------ |  | ---------------------------------------- | ----- | - | ---------- | - | ----- | ---------- |  | - | ----- | -
|                                                       |  | Three Months Ended June 30,              |      
|                                                       |  | (in thousands, except per share amounts) |      
|                                                       |  | 2005                                     |       |   | 2004       |   |       | 2003       | 
|                                                       |  |                                          |       |   | (Restated) |   |       | (Restated) | 
|Net income (loss)                                      |  |                                          |       |   |            |   |       |            |  |   |       |  
|As reported                                            |  | $                                        | 9     |   |            | $ | (339  | )          |  | $ | (742  | )
|Fair value based compensation cost, net of taxes       |  |                                          | (32   | ) |            |   | (88   | )          |  |   | (43   | )
|                                                       |  |                                          |       |   |            |   |       |            |  |   |       |  
|Pro forma net loss attributable to common stockholders |  | $                                        | (23   | ) |            | $ | (427  | )          |  | $ | (785  | )
|                                                       |  |                                          |       |   |            |   |       |            |  |   |       |  
|Basic and diluted income (loss) per share              |  |                                          |       |   |            |   |       |            |  |   |       |  
|As reported                                            |  | $                                        | 0.00  |   |            | $ | (0.01 | )          |  | $ | (0.01 | )
|Pro forma                                              |  | $                                        | (0.00 | ) |            | $ | (0.01 | )          |  | $ | (0.01 | )



5. 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):



|                                          |  |               |        |   |                |   |        |               |  |   |        |  
|----------------------------------------- |  | ------------- | ------ | - | -------------- | - | ------ | ------------- |  | - | ------ | -
|                                          |  | June 30, 2005 |        |   | March 31, 2005 |   |        | June 30, 2004 | 
|Raw materials                             |  | $             | 7,781  |   |                | $ | 7,177  |               |  | $ | 6,471  |  
|Work in process                           |  |               | 3,068  |   |                |   | 3,883  |               |  |   | 3,082  |  
|Finished goods                            |  |               | 4,454  |   |                |   | 2,143  |               |  |   | 2,346  |  
|                                          |  |               |        |   |                |   |        |               |  |   |        |  
|Inventories, gross                        |  |               | 15,303 |   |                |   | 13,203 |               |  |   | 11,899 |  
|Reserve for excess and obsolete inventory |  |               | (701   | ) |                |   | (638   | )             |  |   | (797   | )
|                                          |  |               |        |   |                |   |        |               |  |   |        |  
|Inventories                               |  | $             | 14,602 |   |                | $ | 12,565 |               |  | $ | 11,102 |  
|                                          |  |               |        |   |                |   |        |               |  |   |        |  



8



---

##### Table of Contents

6. Long-term contracts



Costs and estimated earnings on uncompleted contracts and related amounts billed are as follows (in thousands):



|                                                                            |  |               |         |   |                |   |         |               |  |   |         |  
|--------------------------------------------------------------------------- |  | ------------- | ------- | - | -------------- | - | ------- | ------------- |  | - | ------- | -
|                                                                            |  | June 30, 2005 |         |   | March 31, 2005 |   |         | June 30, 2004 | 
|                                                                            |  |               |         |   |                |   |         | (Restated)    | 
|Costs incurred on uncompleted contracts                                     |  | $             | 41,582  |   |                | $ | 37,219  |               |  | $ | 36,325  |  
|Estimated earnings                                                          |  |               | 19,419  |   |                |   | 17,749  |               |  |   | 16,051  |  
|                                                                            |  |               |         |   |                |   |         |               |  |   |         |  
|                                                                            |  |               | 61,001  |   |                |   | 54,968  |               |  |   | 52,376  |  
|Less: billings to date                                                      |  |               | (54,472 | ) |                |   | (48,031 | )             |  |   | (45,709 | )
|                                                                            |  |               |         |   |                |   |         |               |  |   |         |  
|                                                                            |  | $             | 6,529   |   |                | $ | 6,937   |               |  | $ | 6,667   |  
|                                                                            |  |               |         |   |                |   |         |               |  |   |         |  
|Such amounts are included in the following accounts (in thousands):         |  |               |         |   |                |   |         |               |  |   |         |  
|                                                                            |  |               |        
|Costs and estimated earnings in excess of billings on uncompleted contracts |  | $             | 7,810   |   |                | $ | 9,937   |               |  | $ | 7,809   |  
|Billings in excess of costs and estimated earnings on uncompleted contracts |  |               | (1,281  | ) |                |   | (3,000  | )             |  |   | (1,142  | )
|                                                                            |  |               |         |   |                |   |         |               |  |   |         |  
|                                                                            |  | $             | 6,529   |   |                | $ | 6,937   |               |  | $ | 6,667   |  
|                                                                            |  |               |         |   |                |   |         |               |  |   |         |  



7. Long-term debt



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



|                             |  |               |        |   |                |   |        |               |  |   |        |  
|---------------------------- |  | ------------- | ------ | - | -------------- | - | ------ | ------------- |  | - | ------ | -
|                             |  | June 30, 2005 |        |   | March 31, 2005 |   |        | June 30, 2004 | 
|Working capital - borrowings |  | $             | 3,500  |   |                | $ |       |               |  | $ | 525    |  
|Long-term debt  Loan A      |  |               | 13,406 |   |                |   | 13,938 |               |  |   |       |  
|Long-term debt  Loan B      |  |               | 15,000 |   |                |   | 15,000 |               |  |   |       |  
|Accrued PIK                  |  |               | 172    |   |                |   | 115    |               |  |   |       |  
|Long-term debt  Senior      |  |               |       |   |                |   |       |               |  |   | 11,061 |  
|Long-term debt  Junior      |  |               |       |   |                |   |       |               |  |   | 29,552 |  
|Capital lease obligations    |  |               |       |   |                |   |       |               |  |   | 106    |  
|                             |  |               |        |   |                |   |        |               |  |   |        |  
|                             |  |               | 32,078 |   |                |   | 29,053 |               |  |   | 41,244 |  
|Due within one year          |  |               | (4,312 | ) |                |   | (4,584 | )             |  |   | (3,555 | )
|                             |  |               |        |   |                |   |        |               |  |   |        |  
|Long-term debt               |  | $             | 27,766 |   |                | $ | 24,469 |               |  | $ | 37,689 |  
|                             |  |               |        |   |                |   |        |               |  |   |        |  



On September 30, 2004,
the Company and its operating subsidiary, FATS, Inc., entered into a Revolving Credit, Term Loan and Security Agreement (the New Credit Agreement) with CapitalSource Finance LLC (CapitalSource), a related party as described
in Note 10, as administrative, payment and collateral agent for the lenders named therein. The New Credit Agreement permits a maximum borrowing capacity of $42 million and matures on September 30, 2009.



The New Credit Agreement provides for a revolving credit facility pursuant to
which up to $12,000,000 in principal may be drawn (subject to adjustment based on letter of credit usage and compliance with identified leverage ratios), a $15,000,000 Term A loan and a $15,000,000 Term B loan. The revolving
credit facility requires the Company to pay interest on a monthly basis in cash at an annual rate equal to the prime rate plus .5% subject to a floor of 4.75% (6.75% at June 30, 2005). At June 30, 2005, the amount available on the
revolving credit facility was $8,034,000, which includes $466,000 related to a letter of credit. Any amounts outstanding under the revolving credit facility are due in full on September 30, 2009. For the three months ended June 30, 2005, interest
expense on the revolving credit facility was approximately $17,000.



9



---

##### Table of Contents

The Term A loan requires the Company to pay interest on a monthly basis in cash at an annual rate equal
to the prime rate plus 3% subject to a floor of 7.25% (9.25% at June 30, 2005). The Company must also make scheduled quarterly payments of principal under the Term A loan. The quarterly principal payments required are in the amount of
$531,250 for the first year of the term, $750,000 for the second through fourth years of the term, and $968,750 in the fifth year of the term. For the three months ended June 30, 2005, interest expense on the Term A loan was approximately $314,000.



The Term B loan requires the Company to pay interest on a
monthly basis in cash at an annual rate equal to the prime rate plus 6% subject to a floor of 10.25% (12.25% at June 30, 2005). The Company is also required to pay interest payable-in-kind (PIK interest), which accrues
monthly at an annual rate of 1.5%. The PIK interest is due and payable on the earlier to occur of (i) the Companys early redemption or termination of the Term B loan, (ii) the lenders demand as a result of a default or (iii) September
30, 2009. The Company has the option at any time to pay the PIK interest in cash. Outstanding principal under the Term B loan is due in full at the maturity date. For the three months ended June 30, 2005, interest expense on the Term B loan,
including PIK interest, was approximately $513,000.



Borrowings
under the New Credit Agreement are collateralized by substantially all of the Companys assets. The Company has also pledged all of the stock of its operating subsidiary, FATS, Inc., and 65% of the stock of its foreign subsidiaries. The Company
generally will be required to apply all proceeds it receives from transactions in which it sells any material assets, sells equity securities or incurs indebtedness for borrowed money as a mandatory prepayment on the outstanding obligations under
the New Credit Agreement. In addition, subject to certain availability exceptions, the Company will be required to apply 50% of its excess cash flow each year as a mandatory prepayment. Among other restrictions, the New Credit Agreement includes
certain restrictive covenants, including covenants related to future indebtedness, asset acquisitions and dispositions, investments and maintenance of required leverage ratios, minimum EBITDA, as defined, and fixed charge coverage ratios. In
addition, the New Credit Agreement requires the Company to pay a number of lender fees including: (i) an unused credit line fee equal to 0.0417% per month of the difference between average outstanding revolving loans and the revolving loan cap; (ii)
a monthly collateral management fee equal to 0.0417% per month of the average outstanding revolving loans; (iii) a monthly float day fee calculated in accordance with a specified formula; (iv) a letter of credit fee equal to 3% of the undrawn face
amount of outstanding letters of credit; and (v) a termination fee (ranging from 1% to 2% of the amount prepaid as to the Term A loan, and either a yield maintenance fee calculated in accordance with a specified formula or up to 2% of the amount
prepaid depending on the timing of the prepayment as to the Term B loan) in the event the term loans are prepaid prior to the second anniversary of the closing. For the three months ended June 30, 2005, the expense associated with these lenders fees
was approximately $29,000.



As of June 30, 2005, $32,078,000
was outstanding under the New Credit Agreement.



As of June 30,
2004, the amounts outstanding for working capital and senior and junior long-term debt were under a credit agreement different than the New Credit Agreement described above. Terms of this previous agreement, which was not outstanding at June 30 or
March 31, 2005, are described in the Form 10-K for the fiscal year ended March 31, 2004.



8. Mandatorily redeemable preferred stock (Series B)



In August 2000, the board of directors approved an amendment to the Companys certificate of incorporation to change the number of authorized shares of preferred stock to 100,000. The board of directors then
created a new class of Series B preferred stock with 50,000 authorized shares. Holders of the Series B preferred stock were entitled to receive cumulative dividends equal to 10% of the liquidation preference payable quarterly in additional shares of
Series B preferred stock.



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 August 2000 in conjunction with its debt restructuring. The increase in debt related to dividends earned on the Series B during the years ended
March 31, 2002, 2003 and 2004 was approximately $2,353,000, $2,597,000 and $2,867,000, respectively. These amounts were previously offset by the reduction of approximately $2,083,000 and $2,299,000 in the debt restructuring liability allocated to
the preferred stock, resulting in a net increase of approximately $270,000 and $298,000 for the years ended March 31, 2002 and 2003, respectively. As of March 31, 2003, the debt restructuring liability related to the preferred stock was fully
amortized and, therefore, for the year ended March 31, 2004, the total $2,867,000 of preferred stock dividends was reported without the related offsetting amortization.



The Company adopted the classification provisions of SFAS No. 150, Accounting for Certain Liabilities with
Characteristics of both Liabilities and Equity, as of the beginning of the year ended March 31, 2004. Those provisions required the Company to include the mandatorily redeemable preferred stock as a liability in its balance sheet and to include
the dividends on the preferred stock as a component of interest expense in its income statement. The provisions also



10



---

##### Table of Contents

prohibited reclassification of prior year amounts. Accordingly, the net accrued additional liabilities resulting from the
Series B preferred stock dividends was reported as an adjustment to net income to arrive at net income attributable to common stockholders for the years ended March 31, 2002 and 2003, and the total preferred stock dividends was reported as interest
expense in the income statement for the year ended March 31, 2004.



The Series B preferred stock was subject to mandatory redemption on October 15, 2005 at its liquidation value. Accordingly, the Series B preferred stock was not classified as a current liability as of March 31, 2004. All of the shares of
Series B preferred stock were exchanged for shares of Series C preferred stock in connection with the debt restructuring as described in Note 9 below.



9. Preferred stock (Series C)



In September 2004, the board of directors created a new class of Series C preferred stock with 3,500 authorized shares. Holders of the Series C preferred
stock are entitled to receive, if declared by the board, cumulative dividends equal to (i) 10% of the liquidation preference per year through March 31, 2006; (ii) 12% of the liquidation preference per year through September 30, 2006 and (iii) 14% of
the liquidation preference per year thereafter, payable in cash. Dividends are cumulative and compound quarterly whether or not there are funds available for the payment of dividends.



The Company issued 3,202.78 shares of Series C preferred stock with a liquidation value of $10,000 (subject to adjustment to
reflect any stock split, combination, reclassification or similar event involving the Series C Preferred) per share (approximately $32.03 million) in September 2004 in exchange for the then outstanding 32,027.80 shares of the Series B preferred
stock. No gain or loss was recognized as a result of this exchange as the fair value of the Series C preferred stock approximated the fair value of the Series B preferred stock. The fair values were obtained by a third-party valuation. At June 30,
2005, the liquidation value for the Series C preferred stock was $10,769 per share.



The Company may redeem the shares of Series C preferred stock at any time and from time to time at a redemption price equal to the liquidation preference plus the amount of all accrued and unpaid dividends, whether or
not earned or declared. The shares of Series C preferred stock are required to be redeemed upon the occurrence of a change of control (which includes the sale of all or substantially all of the Companys assets, merger,
consolidation or similar event in which more than 50% of the voting stock of the Company is transferred). In the event the Company is legally prohibited from redeeming the shares when required (or the Company materially breaches any of its other
obligations relating to the Series C preferred stock), the applicable dividend rate payable on the Series C preferred stock will be increased by 2% per annum.



The Series C preferred stock ranks prior to all other classes of preferred and common stock as to payment of dividends and the distribution of amounts
upon liquidation, dissolution or winding up. Holders of shares of the Series C preferred stock generally do not have any voting rights other than those provided by law. The Company must obtain the consent from holders of at least a majority of the
outstanding shares of Series C preferred stock in order to: (i) enter into any plan of liquidation or dissolution (unless prior written notice of any such plan is given to the Series C preferred holders and, as a result of such liquidation or
dissolution, the Company is able to satisfy in full the liquidation preferences together with all accrued and unpaid dividends on the shares); (ii) enter into any agreement which by its terms would violate or conflict with the rights of the Series C
preferred holders; (iii) subject to certain exceptions, amend or waive any provision of the Series C Designations or the Companys certificate of incorporation. Any amendment that would decrease the dividend rate payable on the Series C
preferred stock requires the consent of all holders of Series C preferred stock. Any amendment that would increase the authorized number of Series C preferred shares or that would result in the issuance of capital stock ranking senior to or on
parity with the Series C preferred stock as to dividends or rights upon liquidation requires the consent of at least two holders who are not affiliates of each other and who hold, in the aggregate, at least a majority of the Series C preferred
shares.



10. Related party transactions



Special Situations Opportunity Fund I, LLC, one of the Term A lenders under
the New Credit Agreement described in Note 7, is an affiliate of First Source Financial, Inc. First Source is one of the Companys Series C preferred stockholders and an affiliate of First Source owns approximately 12.5% of the Companys
outstanding common stock. In addition, the primary lenders under the credit facility that was paid in full in connection with the New Credit Agreement included Centre Capital Investors II, L.P., Centre Capital Tax-Exempt Investors II, L.P., Centre
Capital Offshore Investors II, L.P., Centre Partners Coinvestment, L.P. (collectively, the Centre Entities). The Centre Entities are among the Companys largest stockholders. Three of the Companys six directors are affiliates
with the Centre Entities.



11



---

##### Table of Contents

On September 30, 2004, the Company entered into an Exchange Agreement with the Centre Entities, U.S. Bank
National Association and First Source Financial LLP. As reflected in Note 8, in accordance with an Exchange Agreement, executed in connection with the New Credit Agreement, the Company issued 3,202.78 shares of its Series C preferred stock to these
entities in exchange for 32,027.80 shares of its Series B preferred stock previously held by them. As a result of the exchange, all of the previously issued shares of Series B preferred stock were cancelled.



11. Net income (loss) per common share



Basic and diluted net income (loss) per share was calculated by dividing net
income (loss) by the weighted average common shares outstanding for the three months ended June 30, 2005 and 2004.



Options to purchase 6,690,737 shares of common stock were outstanding at June 30, 2005 and were included in the computation of diluted EPS for the three
months ended June 30, 2005.



Options to purchase 6,692,333
shares of common stock and warrants to purchase 5,246,164 shares of common stock were outstanding at June 30, 2004, but were not included in the computation of diluted EPS for the three months ended June 30, 2004, because their effect would not have
been dilutive, thereby decreasing net loss per share.



12. Contingencies and
commitments



Product Warranty Cost Reserve



The Companys product warranty accrual reflects
managements best estimate of probable liability under its product warranties. Management determines the warranty based on known product failures (if any), historical experience, and other currently available evidence. Changes in the product
warranty accrual for the three months ended June 30, 2005 and 2004 were as follows (in thousands):



|                                         |  |                             |      |   |                |   |      |               |  |   |      |  
|---------------------------------------- |  | --------------------------- | ---- | - | -------------- | - | ---- | ------------- |  | - | ---- | -
|                                         |  | June 30, 2005               |      |   | March 31, 2005 |   |      | June 30, 2004 | 
|Balance  beginning                      |  | $                           | 283  |   |                | $ | 214  |               |  | $ | 214  |  
|Claims paid                              |  |                             | (180 | ) |                |   | (332 | )             |  |   | (13  | )
|Warranties issued/(expired), net         |  |                             | 296  |   |                |   | 401  |               |  |   | (34  | )
|                                         |  |                             |      |   |                |   |      |               |  |   |      |  
|Balance - ending                         |  | $                           | 399  |   |                | $ | 283  |               |  | $ | 167  |  
|                                         |  |                             |      |   |                |   |      |               |  |   |      |  
|                                        
|13. Supplemental cash flow disclosures   | 
|                                         | 
|                                         |  | Three Months Ended June 30, |     
|                                         |  | 2005                        |      |   | 2004           |   |      | 2003          | 
|Cash paid (received) for (in thousands): |  |                             |      |   |                |   |      |               |  |   |      |  
|Interest                                 |  | $                           | 267  |   |                | $ | 940  |               |  | $ | 836  |  
|Income taxes                             |  |                             | (48  | ) |                |   | 75   |               |  |   | (358 | )
|                                        
|14. Comprehensive income (loss)          | 
|                                         | 
|                                         |  | Three Months Ended June 30, |     
|                                         |  | 2005                        |      |   | 2004           |   |      | 2003          | 
|                                         |  |                             |      |   | (Restated)     |   |      | (Restated)    | 
|Net income (loss)                        |  | $                           | 9    |   |                | $ | (339 | )             |  | $ | (742 | )
|Foreign currency translation adjustment  |  |                             | (480 | ) |                |   | (164 | )             |  |   | 300  |  
|                                         |  |                             |      |   |                |   |      |               |  |   |      |  
|Comprehensive income (loss)              |  | $                           | (471 | ) |                | $ | (503 | )             |  | $ | (442 | )
|                                         |  |                             |      |   |                |   |      |               |  |   |      |  



12



---

##### Table of Contents

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, 2005.



You should carefully review the information contained in this Report and should particularly consider any risks and other
factors that we set forth in this Report and in other reports or documents that we file from time to time with the SEC. Except for historical information contained herein, this Report contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements of 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
Report include, but are not limited to:



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



| |  |  | diversion of funds that otherwise might be spent on our products in support of the war on terror,
| | - |  | -------------------------------------------------------------------------------------------------



| |  |  | changes in the competitive environment, including the introduction of competitors attracted by the prospect of increased government spending on security, especially with respect to
large defense contractors,
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | changes in technology which may affect our existing and future product offerings,
| | - |  | ---------------------------------------------------------------------------------



| |  |  | disruptions in scheduled development of new products,
| | - |  | -----------------------------------------------------



| |  |  | decline in 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 that involve our competitors, especially with respect to large defense contractors,
| | - |  | ----------------------------------------------------------------------------------------------------------------------



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



| |  |  | general economic conditions including changes in customer budgets and spending profiles,
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | the fact that our U.S. and other government customers may generally terminate our contracts for convenience if termination is deemed by them to be in their best interests,
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the fact that a significant portion of our revenues are derived from international sales, which are subject to political and economic risks, including political instability,
currency controls, exchange rate fluctuations and changes in import/export regulations and tariff rates, and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the other risks identified in Managements Discussion and Analysis of Financial Condition and Results of Operations  Risk Factors set forth in our Annual Report on
Form 10-K for the fiscal year ended March 31, 2005.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



13



---

##### Table of Contents

For these forward-looking statements, we claim the protection of the safe harbor for forward-looking
statements in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.



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.



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 governmental agencies is recognized upon shipment when title passes, because at the time title passes, all material commitments will
have been fulfilled, the sales price is fixed and determinable and collectibility is reasonably assured. Some contracts contain acceptance clauses giving customers a right to test products. In these instances, revenue is not recognized until the
customer accepts the products or the acceptance clause lapses. A large portion of the Companys small and supporting arms training simulator revenue is derived from contracts with large governmental agencies. Governmental contracts that involve
high volume purchases of the Companys standard systems and related accessories are accounted for as multiple-deliverable arrangements, in accordance with EITF 00-21, Revenue Arrangements with Multiple Deliverables, based on the relative
fair values of the deliverables specified in the contract. 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 in accordance with SOP 81-1, Accounting
for Performance of Construction-Type and Certain Production-Type Contracts, measured by the percentage of cost incurred to date to the total costs 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.



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.



Inventory Valuation



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 the Companys 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
systems 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.



14



---

##### Table of Contents

Contract Loss Reserve



Management assesses the Companys performance and estimated costs 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 loss reserve in an amount equal to the estimated costs in excess of contracted revenues in the period in which the possibility of contract loss becomes apparent.



Warranty Cost 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 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 reserve will be inadequate to offset actual warranty costs incurred resulting in additional charges against income in the period such information is
determined. Also, actual warranty costs may be significantly lower than expected resulting in the reduction of the Companys warranty reserve generating an addition to income in future periods.



RESULTS OF OPERATIONS



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



|                                                          |  |                             |   |  |            |        |   |            |   |        |  
|--------------------------------------------------------- |  | --------------------------- | - |  | ---------- | ------ | - | ---------- | - | ------ | -
|                                                          |  | Three Months Ended June 30, |  
|                                                          |  | 2005                        |   |  | 2004       |        |   | 2003       |  
|                                                          |  |                             |   |  | (Restated) |        |   | (Restated) |  
|Revenue                                                   |  | 100.00                      | % |  |            | 100.00 | % |            |   | 100.00 | %
|Cost of revenue                                           |  | 65.74                       |   |  |            | 64.61  |   |            |   | 71.71  |  
|                                                          |  |                             |   |  |            |        |   |            |   |        |  
|Gross Margin                                              |  | 34.26                       |   |  |            | 35.39  |   |            |   | 28.29  |  
|                                                          |  |                             |   |  |            |        |   |            |   |        |  
|Operating expenses                                        |  |                             |   |  |            |        |   |            |   |        |  
|Selling, general and administrative                       |  | 22.46                       |   |  |            | 18.79  |   |            |   | 19.10  |  
|Research and development                                  |  | 8.48                        |   |  |            | 5.54   |   |            |   | 3.31   |  
|                                                          |  |                             |   |  |            |        |   |            |   |        |  
|Total operating expenses                                  |  | 30.94                       |   |  |            | 24.33  |   |            |   | 22.41  |  
|                                                          |  |                             |   |  |            |        |   |            |   |        |  
|Operating income                                          |  | 3.32                        |   |  |            | 11.06  |   |            |   | 5.88   |  
|                                                          |  |                             |   |  |            |        |   |            |   |        |  
|Other income (expense), net                               |  |                             |   |  |            |        |   |            |   |        |  
|Interest expense on debt                                  |  | (5.45                       | ) |  |            | (7.62  | ) |            |   | (6.77  | )
|Dividends on mandatorily redeemable preferred stock       |  |                            |   |  |            | (4.15  | ) |            |   | (4.36  | )
|Other, net                                                |  | 1.43                        |   |  |            | (0.46  | ) |            |   | 0.34   |  
|                                                          |  |                             |   |  |            |        |   |            |   |        |  
|Total other income (expense)                              |  | (4.02                       | ) |  |            | (12.23 | ) |            |   | (10.79 | )
|                                                          |  |                             |   |  |            |        |   |            |   |        |  
|Income (loss) before provision (benefit) for income taxes |  | (0.70                       | ) |  |            | (1.17  | ) |            |   | (4.91  | )
|Provision (benefit) for income taxes                      |  | (0.76                       | ) |  |            | 0.68   |   |            |   | (0.22  | )
|                                                          |  |                             |   |  |            |        |   |            |   |        |  
|Net income (loss)                                         |  | 0.06                        |   |  | $          | (1.85  | ) |            | $ | (4.69  | )
|                                                          |  |                             |   |  |            |        |   |            |   |        |  



15



---

##### Table of Contents

Three Months Ended June 30, 2005 Compared to Three Months Ended June 30, 2004 (restated):



Net Revenues: Revenues decreased $1.9 million, or 10.3%, to $16.5
million for the three months ended June 30, 2005, as compared to $18.4 million for the three months ended June 30, 2004. Sales to international customers for the three months ended June 30, 2005 decreased $1.1 million, or 12.4%, to $7.8 million. The
international sales decrease is due primarily to large long-term percentage-of-completion contracts nearing completion. Sales to U.S. military customers for the three months ended June 30, 2005 decreased $0.6 million, or 7.2%, to $7.8 million. Sales
to U.S. law enforcement customers for the three months ended June 30, 2005 decreased $0.2 million, or 18.2%, to $0.9 million reflecting state and municipality budgeting shortfalls associated with diversion of funds to offset operational costs.



Cost of Revenues: Cost of revenues decreased $1.0
million, or 8.4%, to $10.9 million for the three months ended June 30, 2005, as compared to $11.9 million for the three months ended June 30, 2004. As a percentage of revenues, cost of revenues for the three months ended June 30, 2005 increased
slightly to 65.7%, as compared to 64.6% for the three months ended June 30, 2004. The increase in cost of revenues as a percentage of revenues is attributed primarily to a higher portion of lower margin revenues during the period.



Gross Profit: As a result of the foregoing, gross profit decreased
$0.8 million, or 12.3%, to $5.7 million, or 34.3% of revenues for the three months ended June 30, 2005, as compared to $6.5 million, or 35.4% of revenues, for the three months ended June 30, 2004.



Total Operating Expenses: Total operating expenses increased $0.6
million, or 13.3%, to $5.1 million for the three months ended June 30, 2005, as compared to $4.5 million for the three months ended June 30, 2004. As a percentage of revenues, total operating expenses increased to 30.9% for the three months ended
June 30, 2005, as compared to 24.3% for the three months ended June 30, 2004. Selling, general and administrative (SG&A) expenses, which include bid and proposal activities, increased from $3.5 million for the three months ended June
30, 2004 to $3.7 million for the three months ended June 30, 2005. In addition, as a percentage of revenues, SG&A increased from 18.8% at June 30, 2004 to 22.5% at June 30, 2005. Research and development costs increased from $1.0 million for the
three months ended June 30, 2004 to $1.4 million for the three months ended June 30, 2005 due to increases in developmental efforts in improving our standard product.



Operating Income: As a result of the foregoing, operating income decreased $1.4 million to $0.6 million for the three
months ended June 30, 2005, as compared to $2.0 million for the three months ended June 30, 2004. As a percentage of revenues, operating income was 3.3% of revenues for the three months ended June 30, 2005, as compared to 11.1% of revenues for the
three months ended June 30, 2004.



Other Income (Expense),
net: Other income (expense), net totaled $(0.7) million, or (4.0%) of revenues, for the three months ended June 30, 2005, as compared to $(2.3) million, or (12.2%) of revenues, for the three months ended June 30, 2004. Interest on debt decreased
$0.5 million, or 35.7%, due primarily to lower interest rates on the New Credit Agreement. Dividends on mandatorily redeemable preferred stock decreased $0.8 million due to the exchange of the mandatorily redeemable preferred stock (Series B) for
our new Series C preferred stock. In addition, due to the stronger US dollar, the foreign currency exchange gain was $0.2 million for the three months ended June 30, 2005, as compared to a $41,000 loss for the three months ended June 30, 2004.



Loss Before Provision (Benefit) for Income Taxes: As a
result of the foregoing, the loss before provision (benefit) for income taxes decreased by $0.1 from a loss of $0.2 million for the three months ended June 30, 2004 to a loss of $0.1 million for the three months ended June 30, 2005.



Provision (Benefit) for Income Taxes: Net taxable loss for the three
months ended June 30, 2005 resulted in a tax benefit of $126,000, while the net taxable loss for the three months ended June 30, 2004 resulted in a tax provision of $123,000. The tax provision for the three months ended June 30, 2004 is primarily
the result of nondeductible dividends on our Series B preferred stock in excess of the loss before income taxes.



Net Income (Loss): As a result of the foregoing, net loss decreased by $0.3 million to net income of $9,000, or $0.00 diluted income per share, for
the three months ended June 30, 2005 from a net loss of $339,000, or $0.01 diluted loss per share, for the three months ended June 30, 2004.



16



---

##### Table of Contents

Three Months Ended June 30, 2004 (restated) Compared to Three Months Ended June 30, 2003 (restated):



Net Revenues: Revenues increased $2.6 million, or 16.5%, to $18.4
million for the three months ended June 30, 2004, as compared to $15.8 million for the three months ended June 30, 2003. Sales to international customers for the three months ended June 30, 2004 increased $1.1 million, or 12.7%, to $9.0 million
largely due to increased sales in Europe and the Middle East offset slightly by reductions in sales in the Pacific and Latin America. Sales to U.S. military customers for the three months ended June 30, 2004 increased by $1.7 million, or 26.4%, to
$8.3 million. The increase in U.S. military sales is due primarily to the completion during the three months ended June 30, 2004 of two major military sales contracts. Sales to U.S. law enforcement customers for the three months ended June 30, 2004
decreased $0.2 million, or (16.0)%, to $1.1 million reflecting the law enforcement markets current concentration on Homeland Security efforts and delays in orders pending final development of our Bluefire weapons systems.



Cost of Revenues: Cost of revenues increased $0.6 million, or 5.3%, to
$11.9 million for the three months ended June 30, 2004, as compared to $11.3 million for the three months ended June 30, 2003. As a percentage of revenues, cost of revenues for the three months ended June 30, 2004 decreased to 64.6%, as compared to
71.7% for the three months ended June 30, 2003. The decrease in cost of revenues as a percentage of revenues is attributable primarily to the completion of certain international and military contracts during the quarter with higher profit margins
and the positive results of previously undertaken cost control initiatives.



Gross Profit: As a result of the foregoing, gross profit increased $2.0 million, or 44.4%, to $6.5 million, or 35.4% of revenues for the three months ended June 30, 2004, as compared to $4.5 million, or 28.3%
of revenues, for the three months ended June 30, 2003.



Total Operating Expenses: Total operating expenses increased $0.9 million, or 25.0%, to $4.5 million for the three months ended June 30, 2004, as compared to $3.6 million for the three months ended June 30, 2003. As a percentage of
revenues, total operating expenses increased to 24.3% for the three months ended June 30, 2004, as compared to 22.4% for the three months ended June 30, 2003. Selling, general and administrative expenses (SG&A), which include bid and proposal
activities, increased from $3.0 million for the three months ended June 30, 2003 to $3.5 million for the three months ended June 30, 2004. This increase in SG&A is due primarily to costs associated with the capture of new business. Research and
development (R&D) costs increased $0.5 million, or 100.00%, to $1.0 million for the three months ended June 30, 2004, as compared to $0.5 million for the three months ended June 30, 2003, due primarily to increases in developmental efforts
related to Bluefire weapons and enhancements to our I-FACT product.



Operating Income: As a result of the foregoing, operating income increased $1.1 million, or 122.2%, to $2.0 million for the three months ended June 30, 2004, as compared to $0.9 million for the three months ended June 30, 2003. As a
percentage of revenues, operating income was 11.1% of revenues for the three months ended June 30, 2004, as compared to 5.9% of revenues for the three months ended June 30, 2003.



Other Income (Expense), net: Interest on debt increased $328,000, or 30.6%, due primarily to the increased rates and
amortization of financing costs related to the extension of the debt maturity date from September 15, 2003 to October 15, 2004. Dividends on our Series B mandatorily redeemable preferred stock increased $72,000, or 10.4%, due to the compounding
effect of the 10% dividends, which are paid in additional shares of the Series B preferred stock.



Loss Before Provision (Benefit) for Income Taxes: As a result of the foregoing, the loss before provision for income taxes decreased by $0.5
million from a loss of $0.7 million for the three months ended June 30, 2003 to a loss of $0.2 million for the three months ended June 30, 2004.



Provision (Benefit) for Income Taxes: The net taxable loss for the three months ended June 30, 2003 produced a tax benefit of $35,000, while the
net taxable loss for the three months ended June 30, 2004 resulted in a tax provision of $123,000. The tax provision for the three months ended June 30, 2004 is primarily the result of nondeductible dividends on our Series B preferred stock in
excess of the loss before income taxes.



Net Loss: As a
result of the foregoing, net loss decreased by $403,000, from a loss of $742,000, or $0.01 diluted loss per share, for the three months ended June 30, 2003 to a loss of $339,000, or $0.01 diluted loss per share, for the three months ended June 30,
2004.



17



---

##### Table of Contents

ANALYSIS OF BACKLOG



As of June 30, 2005, the Company had a backlog of approximately $50.9 million compared with $53.1 million as of June 30, 2004. Our backlog as of June 30,
2005 consisted of $32.6 million from international customers, $17.3 million from U.S. military customers and $1.0 million from U.S. law enforcement customers. Management expects that approximately $34.7 million of backlog will be delivered during
the remainder of fiscal 2006. The U.S. and other government customers may generally terminate contracts, in whole or in part, for default or convenience if such termination would be in the best interest of the customer. However, these contracts
generally provide for reimbursement of actual costs incurred plus a reasonable profit through the date of termination.



A summary of changes in the Companys backlog for the years ended June 30, 2005 and 2004 is as follows (in thousands):



|                              |  |                             |         |   |            |   |         |            |  |   |         |  
|----------------------------- |  | --------------------------- | ------- | - | ---------- | - | ------- | ---------- |  | - | ------- | -
|                              |  | Three Months Ended June 30, |        
|                              |  | 2005                        |         |   | 2004       |   |         | 2003       | 
|                              |  |                             |         |   | (Restated) |   |         | (Restated) | 
|Backlog  beginning of period |  | $                           | 58,411  |   |            | $ | 59,310  |            |  | $ | 64,346  |  
|New bookings                  |  |                             | 9,070   |   |            |   | 12,128  |            |  |   | 11,845  |  
|Revenue                       |  |                             | (16,539 | ) |            |   | (18,365 | )          |  |   | (15,823 | )
|                              |  |                             |         |   |            |   |         |            |  |   |         |  
|Backlog  end of period       |  | $                           | 50,942  |   |            | $ | 53,073  |            |  | $ | 60,368  |  
|                              |  |                             |         |   |            |   |         |            |  |   |         |  



LIQUIDITY AND CAPITAL RESOURCES



As of June 30, 2005, we had working capital of $27.1
million compared to a working capital of $29.1 million as of June 30, 2004. The net $2.0 million decrease in working capital is due primarily to a $7.5 million decrease in accounts receivable, offset by a $3.5 million increase in inventories and a
$2.0 million decrease in accounts payable and various accrued liability accounts.



We had a net decrease in cash and cash equivalents of $2.7 million for the three months ended June 30, 2005, as compared to a net decrease of cash and cash equivalents of $46,000 for the three months ended June 30,
2004. For the period ended June 30, 2005, the Companys operating activities used cash of approximately $5.0 million compared to the providing of cash of $0.8 million for the three months ended June 30, 2004. Cash flow from operations decreased
primarily due to the outlay of cash for inventory purchases and accounts payable and various accrued liability payments. The use of cash for operating activities was partially offset by $3.5 million of long-term debt proceeds.



Our primary capital requirements are for working capital, debt service, and
capital expenditures. Since August of 2000, we have financed our operations and growth primarily through internally generated funds and income tax refunds. With the issuance of the New Credit Agreement, which decreased debt and provided lower
interest rates, management believes that funds provided by operations will be sufficient to fund our cash needs and anticipated capital expenditures through the year ending March 31, 2006. As previously disclosed, however, the Company has retained
Houlihan Lokey Howard & Zukin Capital, Inc. as its exclusive financial advisor to assist the company in evaluating various strategic alternatives, including recapitalization, sale of stock, merger or asset disposition possibilities, all with the
goal of maximizing shareholder value. The Company expects to complete its review of strategic alternatives and take any actions arising from this review during the next several months. However, there can be no assurance that this process will result
in a transaction, any proposal or agreement for a transaction, or any other action by the Company.



CONCENTRATION OF CREDIT RISK



As of June 30, 2005, approximately $9.9 million in accounts receivable, or 64.7% of total net accounts receivable, was due from five of the Companys customers.



18



---

##### Table of Contents

COMMITMENTS AND OTHER CONTRACTURAL OBLIGATIONS



Disclosure of Commitments and Other Obligations

June 30, 2005

(amounts in thousands)



|                             |  |       |        |                  |   |                  |  |                  |        |               |   |        |  |   |  
|---------------------------- |  | ----- | ------ | ---------------- | - | ---------------- |  | ---------------- | ------ | ------------- | - | ------ |  | - | -
|                             |  | Total |        | Less than 1 year |   | Within 1-3 years |  | Within 4-5 years |        | After 5 years
|Long-term debt               |  |       |        |                  |   |                  |  |                  |        |               |   |        |  |   |  
|Working capital  borrowings |  | $     | 3,500  |                  | $ |                 |  | $                |       |               | $ | 3,500  |  | $ | 
|Long-term debt  Term A      |  |       | 13,406 |                  |   | 4,312            |  |                  | 8,243  |               |   | 851    |  |   | 
|Long-term debt  Term B      |  |       | 15,000 |                  |   |                 |  |                  |       |               |   | 15,000 |  |   | 
|Accrued PIK                  |  |       | 172    |                  |   |                 |  |                  |       |               |   | 172    |  |   | 
|Other                        |  |       |        |                  |   |                  |  |                  |        |               |   |        |  |   |  
|Other purchase orders        |  |       | 5,135  |                  |   | 3,813            |  |                  | 1,322  |               |   |       |  |   | 
|Operating lease obligations  |  |       | 2,751  |                  |   | 1,063            |  |                  | 1,548  |               |   | 140    |  |   | 
|                             |  |       |        |                  |   |                  |  |                  |        |               |   |        |  |   |  
|Total                        |  | $     | 39,964 |                  | $ | 9,188            |  | $                | 11,113 |               | $ | 19,663 |  | $ | 
|                             |  |       |        |                  |   |                  |  |                  |        |               |   |        |  |   |  



OFF-BALANCE SHEET ARRANGEMENTS



As of June 30, 2005, the Company did not have any
off-balance sheet financing transactions or arrangements other than disclosed in the table above.



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



Our major market risk exposure arises from changes in interest rates and its impact on variable rate debt instruments. Our 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 these objectives, we borrow at fixed rates when we have the opportunity and believe it is in the
Companys best interests to do so, and may enter into derivative financial instruments, such as interest rate swaps and caps, in order to limit our exposure to interest rate fluctuations. We do not enter into derivative or interest rate
transactions for speculative purposes. There were no derivative contracts in effect at June 30, 2005.



As of June 30, 2005, we had a total of approximately $32.1 million in variable rate debt at differing interest rates tied to the prime rate. 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 or cash flow.



ITEM 4. CONTROLS AND PROCEDURES



We maintain disclosure controls and procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, that are designed to provide reasonable assurance that information required to be disclosed in the reports that we file
or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and that such information is accumulated and communicated to the
Companys management, including its chief executive and chief financial officers, as appropriate, to allow timely decisions regarding required disclosure. It should be noted, however, that because of inherent limitations, the Companys
disclosure controls and procedures, however well designed and operated, can provide only reasonable assurance that the objectives of the disclosure controls and procedures are met.



The Company carried out an evaluation, under the supervision and with the participation of its management, including its
chief executive and chief financial officer, of the effectiveness of the design and operation of its disclosure controls and procedures as of the end of the period covered by this Report. Based on the evaluation of these disclosure controls and
procedures, the chief executive and chief financial officer of the Company concluded that the Companys disclosure controls and procedures as of the end of the period covered by this Report were effective at a reasonable assurance level.



19



---

##### Table of Contents

Other than as described below, there were no changes in the Companys internal control over
financial reporting during the Companys fiscal quarter ended June 30, 2005, that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting. However, due to errors
identified in the accounting for certain percentage-of-completion contracts denominated in foreign currencies giving rise to the restatements identified elsewhere in this Report, management has concluded that it had a material weakness in controls
over the application of generally accepted accounting principles with respect to these contracts. This weakness was mitigated by annual closing controls, which identified the error. During the Companys fiscal quarter ended June 30, 2005, the
Company implemented additional controls to review on a monthly basis all percentage-of-completion contracts denominated in foreign currencies to ensure that they are being accounted for in accordance with generally accepted accounting principles.



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



|     |  |                                                                                                                                                                  
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.1 |  | Employment agreement, dated as of June 27, 2005, between the Company and David W. McGrane (Filed as Exhibit 10.2 to the Companys Form 8-K dated June 27, 2005)  
|     | 
|10.2 |  | Employment agreement, dated as of June 27, 2005, between the Company and Ronavan R. Mohling (Filed as Exhibit 10.1 to the Companys Form 8-K dated June 27, 2005)
|     | 
|31.1 |  | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                               
|     | 
|31.2 |  | Certificate of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                 
|     | 
|32.1 |  | Certificate of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                 
|     | 
|32.2 |  | Certificate of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                 



20



---

##### Table of Contents

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: August 15, 2005



FIREARMS TRAINING SYSTEMS, INC./S/ Gregory A. TonGregory A. TonChief Financial Officer and Treasurer(Principal Financial Officer and Duly Authorized Officer)




21