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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549



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FORM 10-Q



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(Mark One)

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



FOR THE QUARTERLY PERIOD ENDED December 31, 2005



OR



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



COMMISSION FILE NUMBER: 333-13105



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FIREARMS TRAINING SYSTEMS, INC.

(Exact name of registrant as specified in its charter)



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



7340 MCGINNIS FERRY
ROAD

SUWANEE, GEORGIA 30024

(Address of principal executive offices)



TELEPHONE NUMBER (770) 813-0180

(Registrants telephone number, including area code)



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



Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.

Large accelerated filer ̈Accelerated filer ̈Non-accelerated filer  x



Indicate by checkmark whether the registrant is a shell company (as defined in Rule 126-2 of the Exchange
Act)    Yes ̈No  x



As of February 7, 2006, there were 75,994,502 shares of the
Registrants Class A Common Stock outstanding.



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##### Table of Contents

FIREARMS TRAINING SYSTEMS, INC.

INDEX



|         |  |                                                                                                                                                                    |  |     
|-------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ----
|         |  |                                                                                                                                                                    |  | PAGE
|PART I.  |  | FINANCIAL INFORMATION                                                                                                                                              |  |     
|         |  |                                                                                                                                                                   
|ITEM 1.  |  | CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:                                                                                                                       |  |     
|         |  |                                                                                                                                                                   
|         |  | Condensed Consolidated Statements of OperationsThree and Nine months ended December 31, 2005 (unaudited), restated 2004 (unaudited), and restated 2003 (unaudited) |  | 3   
|         |  |                                                                                                                                                                   
|         |  | Condensed Consolidated Balance SheetsDecember 31, 2005 (unaudited), March 31, 2005, and restated December 31, 2004 (unaudited)                                     |  | 4   
|         |  |                                                                                                                                                                   
|         |  | Condensed Consolidated Statements of Cash FlowsNine months ended December 31, 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                                                                              |  | 14  
|         |  |                                                                                                                                                                   
|ITEM 3.  |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                                                                         |  | 22  
|         |  |                                                                                                                                                                   
|ITEM 4.  |  | CONTROLS AND PROCEDURES                                                                                                                                            |  | 22  
|         |  |                                                                                                                                                                   
|PART II. |  | OTHER INFORMATION                                                                                                                                                  |  |     
|         |  |                                                                                                                                                                   
|ITEM 1.  |  | LEGAL PROCEEDINGS                                                                                                                                                  |  | 23  
|         |  |                                                                                                                                                                   
|ITEM 1A. |  | RISK FACTORS                                                                                                                                                       |  | 23  
|         |  |                                                                                                                                                                   
|ITEM 4.  |  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                                                                |  | 25  
|         |  |                                                                                                                                                                   
|ITEM 6.  |  | EXHIBITS                                                                                                                                                           |  | 25  
|         |  |                                                                                                                                                                   
|         |  | SIGNATURES                                                                                                                                                         |  | 26  



2



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##### Table of Contents

PART I. FINANCIAL INFORMATION



ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



FIREARMS TRAINING SYSTEMS, INC. AND SUBSIDIARIES



CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited and in thousands, except for per share
amounts)



|                                                          |  |                                 |        |   |                                |   |        |            |  |   |        |   |  |            |        |   |            |   |        |   |  |   |        |  
|--------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---------- |  | - | ------ | - |  | ---------- | ------ | - | ---------- | - | ------ | - |  | - | ------ | -
|                                                          |  | Three Months Ended December 31, |        |   | Nine Months Ended December 31, |  
|                                                          |  | 2005                            |        |   | 2004                           |   |        | 2003       |  |   | 2005   |   |  | 2004       |        |   | 2003       |  
|                                                          |  |                                 |        |   | (Restated)                     |   |        | (Restated) |  |   |        |   |  | (Restated) |        |   | (Restated) |  
|Revenue                                                   |  | $                               | 16,632 |   |                                | $ | 21,521 |            |  | $ | 16,800 |   |  | $          | 55,871 |   |            | $ | 60,361 |   |  | $ | 45,758 |  
|Cost of revenue                                           |  |                                 | 11,176 |   |                                |   | 14,080 |            |  |   | 10,270 |   |  |            | 37,152 |   |            |   | 39,710 |   |  |   | 30,645 |  
|                                                          |  |                                 |        |   |                                |   |        |            |  |   |        |   |  |            |        |   |            |   |        |   |  |   |        |  
|Gross margin                                              |  |                                 | 5,456  |   |                                |   | 7,441  |            |  |   | 6,530  |   |  |            | 18,719 |   |            |   | 20,651 |   |  |   | 15,113 |  
|                                                          |  |                                 |        |   |                                |   |        |            |  |   |        |   |  |            |        |   |            |   |        |   |  |   |        |  
|Operating expenses:                                       |  |                                 |        |   |                                |   |        |            |  |   |        |   |  |            |        |   |            |   |        |   |  |   |        |  
|Selling, general and administrative                       |  |                                 | 3,572  |   |                                |   | 3,437  |            |  |   | 3,263  |   |  |            | 10,983 |   |            |   | 10,692 |   |  |   | 9,404  |  
|Research and development                                  |  |                                 | 1,132  |   |                                |   | 948    |            |  |   | 766    |   |  |            | 3,530  |   |            |   | 2,690  |   |  |   | 2,012  |  
|                                                          |  |                                 |        |   |                                |   |        |            |  |   |        |   |  |            |        |   |            |   |        |   |  |   |        |  
|Total operating expenses                                  |  |                                 | 4,704  |   |                                |   | 4,385  |            |  |   | 4,029  |   |  |            | 14,513 |   |            |   | 13,382 |   |  |   | 11,416 |  
|                                                          |  |                                 |        |   |                                |   |        |            |  |   |        |   |  |            |        |   |            |   |        |   |  |   |        |  
|Operating income                                          |  |                                 | 752    |   |                                |   | 3,056  |            |  |   | 2,501  |   |  |            | 4,206  |   |            |   | 7,269  |   |  |   | 3,697  |  
|                                                          |  |                                 |        |   |                                |   |        |            |  |   |        |   |  |            |        |   |            |   |        |   |  |   |        |  
|Other income (expense), net                               |  |                                 |        |   |                                |   |        |            |  |   |        |   |  |            |        |   |            |   |        |   |  |   |        |  
|Interest expense on debt                                  |  |                                 | (977   | ) |                                |   | (935   | )          |  |   | (1,369 | ) |  |            | (2,800 | ) |            |   | (3,945 | ) |  |   | (3,790 | )
|Dividends on mandatorily redeemable preferred stock       |  |                                 |       |   |                                |   |       |            |  |   | (725   | ) |  |            |       |   |            |   | (1,543 | ) |  |   | (2,123 | )
|Other, net                                                |  |                                 | (48    | ) |                                |   | (274   | )          |  |   | 161    |   |  |            | 7      |   |            |   | (676   | ) |  |   | 152    |  
|                                                          |  |                                 |        |   |                                |   |        |            |  |   |        |   |  |            |        |   |            |   |        |   |  |   |        |  
|Total other income (expense)                              |  |                                 | (1,025 | ) |                                |   | (1,209 | )          |  |   | (1,933 | ) |  |            | (2,793 | ) |            |   | (6,164 | ) |  |   | (5,761 | )
|                                                          |  |                                 |        |   |                                |   |        |            |  |   |        |   |  |            |        |   |            |   |        |   |  |   |        |  
|Income (loss) before provision (benefit) for income taxes |  |                                 | (273   | ) |                                |   | 1,847  |            |  |   | 568    |   |  |            | 1,413  |   |            |   | 1,105  |   |  |   | (2,064 | )
|Provision (benefit) for income taxes                      |  |                                 | (175   | ) |                                |   | 711    |            |  |   | 462    |   |  |            | 418    |   |            |   | 905    |   |  |   | 39     |  
|                                                          |  |                                 |        |   |                                |   |        |            |  |   |        |   |  |            |        |   |            |   |        |   |  |   |        |  
|Net income (loss)                                         |  | $                               | (98    | ) |                                | $ | 1,136  |            |  | $ | 106    |   |  | $          | 995    |   |            | $ | 200    |   |  | $ | (2,103 | )
|                                                          |  |                                 |        |   |                                |   |        |            |  |   |        |   |  |            |        |   |            |   |        |   |  |   |        |  
|Income (loss) per share                                   |  |                                 |        |   |                                |   |        |            |  |   |        |   |  |            |        |   |            |   |        |   |  |   |        |  
|Basic income (loss) per share                             |  | $                               | (0.00  | ) |                                | $ | 0.02   |            |  | $ | 0.00   |   |  | $          | 0.01   |   |            | $ | 0.00   |   |  | $ | (0.03  | )
|                                                          |  |                                 |        |   |                                |   |        |            |  |   |        |   |  |            |        |   |            |   |        |   |  |   |        |  
|Diluted income (loss) per share                           |  | $                               | (0.00  | ) |                                | $ | 0.02   |            |  | $ | 0.00   |   |  | $          | 0.01   |   |            | $ | 0.00   |   |  | $ | (0.03  | )
|                                                          |  |                                 |        |   |                                |   |        |            |  |   |        |   |  |            |        |   |            |   |        |   |  |   |        |  
|Weighted average common shares outstanding  basic        |  |                                 | 75,976 |   |                                |   | 70,313 |            |  |   | 70,153 |   |  |            | 75,958 |   |            |   | 70,313 |   |  |   | 70,153 |  
|                                                          |  |                                 |        |   |                                |  
|Weighted average common shares outstanding  diluted      |  |                                 | 75,976 |   |                                |   | 76,112 |            |  |   | 70,153 |   |  |            | 80,175 |   |            |   | 70,313 |   |  |   | 70,153 |  



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



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##### 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)



|                                                                                                                                               |  |                  |          |   |               |   |          |                         |  |   |          |  
|---------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------- | -------- | - | ------------- | - | -------- | ----------------------- |  | - | -------- | -
|                                                                                                                                               |  | December 31,2005 |          |   | March 31,2005 |   |          | December 31,2004        | 
|                                                                                                                                               |  | (unaudited)      |          |   |               |   |          | (Restated andunaudited) | 
|ASSETS                                                                                                                                         |  |                  |          |   |               |   |          |                         |  |   |          |  
|                                                                                                                                               |  |                  |         
|Current assets:                                                                                                                                |  |                  |          |   |               |   |          |                         |  |   |          |  
|Cash and cash equivalents                                                                                                                      |  | $                | 1,031    |   |               | $ | 6,456    |                         |  | $ | 3,668    |  
|Restricted cash                                                                                                                                |  |                  | 2,960    |   |               |   | 3,209    |                         |  |   | 2,280    |  
|Accounts receivable, net of allowance of $350                                                                                                  |  |                  | 12,569   |   |               |   | 14,707   |                         |  |   | 16,675   |  
|Costs and estimated earnings in excess of billings on incomplete contracts                                                                     |  |                  | 10,006   |   |               |   | 9,937    |                         |  |   | 6,442    |  
|Unbilled receivables                                                                                                                           |  |                  | 446      |   |               |   | 543      |                         |  |   | 4,799    |  
|Inventories                                                                                                                                    |  |                  | 12,923   |   |               |   | 12,565   |                         |  |   | 11,951   |  
|Income taxes receivable                                                                                                                        |  |                  | 8        |   |               |   | 98       |                         |  |   | 152      |  
|Deferred income taxes                                                                                                                          |  |                  | 385      |   |               |   | 412      |                         |  |   | 770      |  
|Prepaid expenses and other current assets                                                                                                      |  |                  | 2,129    |   |               |   | 1,813    |                         |  |   | 2,102    |  
|                                                                                                                                               |  |                  |          |   |               |   |          |                         |  |   |          |  
|Total current assets                                                                                                                           |  |                  | 42,457   |   |               |   | 49,740   |                         |  |   | 48,839   |  
|                                                                                                                                               |  |                  |         
|Property and equipment, net                                                                                                                    |  |                  | 1,948    |   |               |   | 2,051    |                         |  |   | 2,137    |  
|                                                                                                                                               |  |                  |         
|Other noncurrent assets:                                                                                                                       |  |                  |          |   |               |   |          |                         |  |   |          |  
|Other                                                                                                                                          |  |                  | 158      |   |               |   |         |                         |  |   |         |  
|Deferred income taxes                                                                                                                          |  |                  | 1,023    |   |               |   | 989      |                         |  |   | 1,571    |  
|Intangible assets, net                                                                                                                         |  |                  | 1,130    |   |               |   | 1,305    |                         |  |   | 1,421    |  
|                                                                                                                                               |  |                  |          |   |               |   |          |                         |  |   |          |  
|Total assets                                                                                                                                   |  | $                | 46,716   |   |               | $ | 54,085   |                         |  | $ | 53,968   |  
|                                                                                                                                               |  |                  |          |   |               |   |          |                         |  |   |          |  
|LIABILITIES AND STOCKHOLDERS DEFICIT                                                                                                          |  |                  |          |   |               |   |          |                         |  |   |          |  
|                                                                                                                                               |  |                  |         
|Current Liabilities:                                                                                                                           |  |                  |          |   |               |   |          |                         |  |   |          |  
|Long-term debt due within one year                                                                                                             |  | $                | 2,552    |   |               | $ | 4,584    |                         |  | $ | 2,344    |  
|Accounts payable                                                                                                                               |  |                  | 3,446    |   |               |   | 5,328    |                         |  |   | 4,716    |  
|Accrued liabilities                                                                                                                            |  |                  | 3,852    |   |               |   | 6,760    |                         |  |   | 5,383    |  
|Accrued interest                                                                                                                               |  |                  | 291      |   |               |   | 294      |                         |  |   | 281      |  
|Income taxes payable                                                                                                                           |  |                  | 221      |   |               |   | 1,442    |                         |  |   | 1,183    |  
|Billings in excess of cost and estimated earnings on incomplete contracts                                                                      |  |                  | 2,973    |   |               |   | 3,000    |                         |  |   | 1,149    |  
|Deferred revenue                                                                                                                               |  |                  | 1,074    |   |               |   | 3,200    |                         |  |   | 5,593    |  
|Contract cost reserve                                                                                                                          |  |                  | 496      |   |               |   | 639      |                         |  |   | 292      |  
|Warranty cost reserve                                                                                                                          |  |                  | 428      |   |               |   | 283      |                         |  |   | 236      |  
|                                                                                                                                               |  |                  |          |   |               |   |          |                         |  |   |          |  
|Total current liabilities                                                                                                                      |  |                  | 15,333   |   |               |   | 25,530   |                         |  |   | 21,177   |  
|                                                                                                                                               |  |                  |         
|Long-term debt                                                                                                                                 |  |                  | 26,665   |   |               |   | 24,469   |                         |  |   | 34,864   |  
|                                                                                                                                               |  |                  |         
|Other noncurrent liabilities                                                                                                                   |  |                  | 438      |   |               |   | 562      |                         |  |   | 625      |  
|                                                                                                                                               |  |                  |          |   |               |   |          |                         |  |   |          |  
|Total liabilities                                                                                                                              |  |                  | 42,436   |   |               |   | 50,561   |                         |  |   | 56,666   |  
|                                                                                                                                               |  |                  |          |   |               |   |          |                         |  |   |          |  
|Commitments and contingencies                                                                                                                  |  |                  |          |   |               |   |          |                         |  |   |          |  
|                                                                                                                                               |  |                  |         
|Preferred stock, 3,500 shares authorized; 3,203 shares issued and outstanding; liquidation value of $11,314, $10,506 and $10,250 per
share     |  |                  | 32,028   |   |               |   | 32,028   |                         |  |   | 32,028   |  
|                                                                                                                                               |  |                  |          |   |               |   |          |                         |  |   |          |  
|Stockholders deficit:                                                                                                                         |  |                  |          |   |               |   |          |                         |  |   |          |  
|Class A common stock, $0.000006 par value; 100 million shares authorized, 75,994,502, 75,945,337, and 70,694,173 shares issued and
outstanding |  |                  |         |   |               |   |         |                         |  |   |         |  
|Additional paid-in capital                                                                                                                     |  |                  | 128,000  |   |               |   | 127,980  |                         |  |   | 123,497  |  
|Stock warrants                                                                                                                                 |  |                  |         |   |               |   |         |                         |  |   | 613      |  
|Accumulated deficit                                                                                                                            |  |                  | (156,600 | ) |               |   | (157,593 | )                       |  |   | (159,988 | )
|Accumulated other comprehensive income                                                                                                         |  |                  | 852      |   |               |   | 1,109    |                         |  |   | 1,152    |  
|                                                                                                                                               |  |                  |          |   |               |   |          |                         |  |   |          |  
|Total stockholders deficit                                                                                                                    |  |                  | (27,748  | ) |               |   | (28,504  | )                       |  |   | (34,726  | )
|                                                                                                                                               |  |                  |          |   |               |   |          |                         |  |   |          |  
|Total liabilities and stockholders deficit                                                                                                    |  | $                | 46,716   |   |               | $ | 54,085   |                         |  | $ | 53,968   |  
|                                                                                                                                               |  |                  |          |   |               |   |          |                         |  |   |          |  



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



4



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##### Table of Contents

FIREARMS TRAINING SYSTEMS, INC. AND SUBSIDIARIES



CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited and in thousands)



|                                                                            |  |                                |         |   |            |   |         |            |  |   |        |  
|--------------------------------------------------------------------------- |  | ------------------------------ | ------- | - | ---------- | - | ------- | ---------- |  | - | ------ | -
|                                                                            |  | Nine Months Ended December 31, |        
|                                                                            |  | 2005                           |         |   | 2004       |   |         | 2003       | 
|                                                                            |  |                                |         |   | (Restated) |   |         | (Restated) | 
|Cash flows from operating activities:                                       |  |                                |         |   |            |   |         |            |  |   |        |  
|Net income (loss)                                                           |  | $                              | 995     |   |            | $ | 200     |            |  | $ | (2,103 | )
|                                                                            |  |                                |         |   |            |   |         |            |  |   |        |  
|Adjustments for non-cash items                                              |  |                                |         |   |            |   |         |            |  |   |        |  
|Non-cash interest and financing costs                                       |  |                                | 406     |   |            |   | 2,582   |            |  |   | 2,945  |  
|Depreciation and amortization                                               |  |                                | 810     |   |            |   | 738     |            |  |   | 855    |  
|Change in inventory reserve                                                 |  |                                | (131    | ) |            |   | (15     | )          |  |   | (513   | )
|Change in warranty cost and contract loss reserve                           |  |                                | 2       |   |            |   | (901    | )          |  |   | (191   | )
|(Gain) loss on disposal of assets                                           |  |                                | (48     | ) |            |   | (5      | )          |  |   |       |  
|Deferred income taxes                                                       |  |                                | (7      | ) |            |   | 17      |            |  |   |       |  
|Changes in assets and liabilities                                           |  |                                |         |   |            |   |         |            |  |   |        |  
|Accounts receivable, net                                                    |  |                                | 2,137   |   |            |   | 6,642   |            |  |   | 6,049  |  
|Income taxes receivable                                                     |  |                                | 90      |   |            |   | (38     | )          |  |   | 280    |  
|Costs and estimated earnings in excess of billings on uncompleted contracts |  |                                | (68     | ) |            |   | (484    | )          |  |   | (2,525 | )
|Unbilled receivables                                                        |  |                                | 96      |   |            |   | (4,737  | )          |  |   | (36    | )
|Inventories                                                                 |  |                                | (227    | ) |            |   | 286     |            |  |   | (2,342 | )
|Prepaid expenses and other current assets                                   |  |                                | (315    | ) |            |   | (1,083  | )          |  |   | 66     |  
|Noncurrent asset                                                            |  |                                | (158    | ) |            |   |        |            |  |   |       |  
|Accounts payable                                                            |  |                                | (1,881  | ) |            |   | 1,037   |            |  |   | (263   | )
|Accrued liabilities                                                         |  |                                | (2,911  | ) |            |   | (2,290  | )          |  |   | (428   | )
|Income taxes payable                                                        |  |                                | (1,222  | ) |            |   | 875     |            |  |   | 359    |  
|Billings in excess of costs and estimated earnings on uncompleted contracts |  |                                | (27     | ) |            |   | (200    | )          |  |   | 4      |  
|Deferred revenue                                                            |  |                                | (2,127  | ) |            |   | 4,354   |            |  |   | (1,087 | )
|Noncurrent liabilities                                                      |  |                                | (123    | ) |            |   | 38      |            |  |   | 157    |  
|                                                                            |  |                                |         |   |            |   |         |            |  |   |        |  
|Total adjustments                                                           |  |                                | (5,704  | ) |            |   | 6,816   |            |  |   | 3,330  |  
|                                                                            |  |                                |         |   |            |   |         |            |  |   |        |  
|Net cash provided by (used in) operating activities                         |  |                                | (4,709  | ) |            |   | 7,016   |            |  |   | 1,227  |  
|                                                                            |  |                                |         |   |            |   |         |            |  |   |        |  
|Cash flows from investing activities                                        |  |                                |         |   |            |   |         |            |  |   |        |  
|Change in restricted cash                                                   |  |                                | 249     |   |            |   | 222     |            |  |   | (1,119 | )
|Purchase of property and equipment                                          |  |                                | (694    | ) |            |   | (380    | )          |  |   | (902   | )
|Proceeds from disposal of property and equipment                            |  |                                | 48      |   |            |   | 4       |            |  |   |       |  
|                                                                            |  |                                |         |   |            |   |         |            |  |   |        |  
|Net cash used in investing activities                                       |  |                                | (397    | ) |            |   | (154    | )          |  |   | (2,021 | )
|                                                                            |  |                                |         |   |            |   |         |            |  |   |        |  
|Cash flows from financing activities                                        |  |                                |         |   |            |   |         |            |  |   |        |  
|Proceeds from long-term debt                                                |  |                                | 11,875  |   |            |   | 37,450  |            |  |   |       |  
|Payments on long-term debt                                                  |  |                                | (11,885 | ) |            |   | (42,150 | )          |  |   | (44    | )
|Payment of deferred financing costs                                         |  |                                | (57     | ) |            |   | (1,484  | )          |  |   | (409   | )
|Exercise of stock options                                                   |  |                                | 20      |   |            |   | 282     |            |  |   |       |  
|                                                                            |  |                                |         |   |            |   |         |            |  |   |        |  
|Net cash used in financing activities                                       |  |                                | (47     | ) |            |   | (5,902  | )          |  |   | (453   | )
|                                                                            |  |                                |         |   |            |   |         |            |  |   |        |  
|Effect of exchange rate changes on cash                                     |  |                                | (272    | ) |            |   | 341     |            |  |   | 516    |  
|                                                                            |  |                                |         |   |            |   |         |            |  |   |        |  
|Net increase (decrease) in cash and cash equivalents                        |  |                                | (5,425  | ) |            |   | 1,301   |            |  |   | (731   | )
|                                                                            |  |                                |        
|Cash and cash equivalents, beginning of period                              |  |                                | 6,456   |   |            |   | 2,367   |            |  |   | 3,457  |  
|                                                                            |  |                                |         |   |            |   |         |            |  |   |        |  
|Cash and cash equivalents, end of period                                    |  | $                              | 1,031   |   |            | $ | 3,668   |            |  | $ | 2,726  |  
|                                                                            |  |                                |         |   |            |   |         |            |  |   |        |  



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



5



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##### 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 and nine months ended December 31, 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
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 December 31, 2004 |         |   | For the Three Months Ended December 31, 2003 |  
|                                                                          |  | As PreviouslyReported                               |         |   | Adjustment                                   |   |        | As Restated |  |   | As Previously Reported |   |  | Adjustment |        |   | As Restated |  
|Consolidated income statement:                                            |  |                                                     |         |   |                                              |   |        |             |  |   |                        |   |  |            |        |   |             |   |     |   |  |   |        |  
|Revenue                                                                   |  | $                                                   | 21,029  |   |                                              | $ | 492    |             |  | $ | 21,521                 |   |  | $          | 16,479 |   |             | $ | 321 |   |  | $ | 16,800 |  
|Gross margin                                                              |  |                                                     | 6,949   |   |                                              |   | 492    |             |  |   | 7,441                  |   |  |            | 6,209  |   |             |   | 321 |   |  |   | 6,530  |  
|Operating income                                                          |  |                                                     | 2,564   |   |                                              |   | 492    |             |  |   | 3,056                  |   |  |            | 2,180  |   |             |   | 321 |   |  |   | 2,501  |  
|Other income (expense), net                                               |  |                                                     | (1,222  | ) |                                              |   | 13     |             |  |   | (1,209                 | ) |  |            | (1,928 | ) |             |   | (5  | ) |  |   | (1,933 | )
|Income before provision for income taxes                                  |  |                                                     | 1,342   |   |                                              |   | 505    |             |  |   | 1,847                  |   |  |            | 252    |   |             |   | 316 |   |  |   | 568    |  
|Provision (benefit) for income taxes                                      |  |                                                     | 569     |   |                                              |   | 142    |             |  |   | 711                    |   |  |            | 332    |   |             |   | 130 |   |  |   | 462    |  
|Net income (loss)                                                         |  |                                                     | 773     |   |                                              |   | 363    |             |  |   | 1,136                  |   |  |            | (80    | ) |             |   | 186 |   |  |   | 106    |  
|Diluted income (loss) per share                                           |  |                                                     | 0.01    |   |                                              |   | 0.01   |             |  |   | 0.02                   |   |  |            | (0.00  | ) |             |   |    |   |  |   | 0.00   |  
|                                                                          |  |                                                     |         |   |                                              |  
|Consolidated balance sheet:                                               |  |                                                     |         |   |                                              |   |        |             |  |   |                        |   |  |            |        |   |             |   |     |   |  |   |        |  
|Cost and estimated earnings in excess of billings on incomplete contracts |  | $                                                   | 6,242   |   |                                              | $ | 200    |             |  | $ | 6,442                  |   |  |            |        |   |             |   |     |   |  |   |        |  
|Income taxes receivable                                                   |  |                                                     | 110     |   |                                              |   | 42     |             |  |   | 152                    |   |  |            |        |   |             |   |     |   |  |   |        |  
|Deferred income taxes                                                     |  |                                                     | 2,790   |   |                                              |   | (449   | )           |  |   | 2,341                  |   |  |            |        |   |             |   |     |   |  |   |        |  
|Income taxes payable                                                      |  |                                                     | 707     |   |                                              |   | 476    |             |  |   | 1,183                  |   |  |            |        |   |             |   |     |   |  |   |        |  
|Billings in excess of cost and estimated earnings on incomplete contracts |  |                                                     | 4,084   |   |                                              |   | (2,935 | )           |  |   | 1,149                  |   |  |            |        |   |             |   |     |   |  |   |        |  
|Total stockholders deficit                                               |  |                                                     | (36,978 | ) |                                              |   | 2,252  |             |  |   | (34,726                | ) |  |            |        |   |             |   |     |   |  |   |        |  



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|                                                |  |                                             |        |   |                                             |   |             |  |   |                       |   |  |            |        |             |  |   |      |  |   |        |  
|----------------------------------------------- |  | ------------------------------------------- | ------ | - | ------------------------------------------- | - | ----------- |  | - | --------------------- | - |  | ---------- | ------ | ----------- |  | - | ---- |  | - | ------ | -
|                                                |  | For the Nine Months Ended December 31, 2004 |        |   | For the Nine Months Ended December 31, 2003 |  
|                                                |  | As PreviouslyReported                       |        |   | Adjustment                                  |   | As Restated |  |   | As PreviouslyReported |   |  | Adjustment |        | As Restated | 
|Consolidated income statement:                  |  |                                             |        |   |                                             |   |             |  |   |                       |   |  |            |        |             |  |   |      |  |   |        |  
|Revenue                                         |  | $                                           | 59,171 |   |                                             | $ | 1,190       |  | $ | 60,361                |   |  | $          | 45,028 |             |  | $ | 730  |  | $ | 45,758 |  
|Gross margin                                    |  |                                             | 19,461 |   |                                             |   | 1,190       |  |   | 20,651                |   |  |            | 14,383 |             |  |   | 730  |  |   | 15,113 |  
|Operating income                                |  |                                             | 6,079  |   |                                             |   | 1,190       |  |   | 7,269                 |   |  |            | 2,967  |             |  |   | 730  |  |   | 3,697  |  
|Other income (expense), net                     |  |                                             | (6,178 | ) |                                             |   | 14          |  |   | (6,164                | ) |  |            | (5,763 | )           |  |   | 2    |  |   | (5,761 | )
|Income (loss) before provision for income taxes |  |                                             | (99    | ) |                                             |   | 1,204       |  |   | 1,105                 |   |  |            | (2,796 | )           |  |   | 732  |  |   | (2,064 | )
|Provision (benefit) for income taxes            |  |                                             | 556    |   |                                             |   | 349         |  |   | 905                   |   |  |            | (229   | )           |  |   | 268  |  |   | 39     |  
|Net income (loss)                               |  |                                             | (655   | ) |                                             |   | 855         |  |   | 200                   |   |  |            | (2,567 | )           |  |   | 464  |  |   | (2,103 | )
|Basic and diluted income (loss) per share       |  |                                             | (0.01  | ) |                                             |   | 0.01        |  |   | 0.00                  |   |  |            | (0.04  | )           |  |   | 0.01 |  |   | (0.03  | )



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.



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##### Table of Contents

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.



The Company has computed for pro forma disclosure purposes the value of all options using the Black-Scholes option pricing model as prescribed by SFAS
No. 123 using the following assumptions:



|                          |  |                               |  |        |   |  |        |  
|------------------------- |  | ----------------------------- |  | ------ | - |  | ------ | -
|                          |  | Nine Months EndedDecember 31, | 
|                          |  | 2005                          |  | 2004   |   |  | 2003   |  
|Risk-free interest rate   |  | N/A                           |  | 3.27   | % |  | 2.28   | %
|Expected dividend yields  |  | N/A                           |  | 0      |   |  | 0      |  
|Expected lives (in years) |  | N/A                           |  | 3.5    |   |  | 3.5    |  
|Expected volatility       |  | N/A                           |  | 196.47 | % |  | 221.58 | %



The Company issued
options to purchase a total of 5.8 million shares of its common stock under its option plan on May 1, 2003, with an exercise price equal to the $.40 per share market value of the stock on that date.



The weighted average grant-date fair value of options granted during the nine
months ended December 31, 2003 was computed as approximately $2.2 million or $.38 per share under option.



The Company issued options to purchase a total of 750,000 shares of its common stock under its option plan on August 4, 2004, with an exercise price
equal to the $.64 per share market value of the stock on that date.



The weighted average grant-date fair value of options granted during the nine months ended December 31, 2004 was computed as approximately $450,000 or $.60 per share under option.



The Company did not issue options during the nine months ended
December 31, 2005.



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##### Table of Contents

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 EndedDecember 31, |       |   | Nine Months Ended December 31, |  
|                                                                |  | 2005                           |       |   | 2004                           |   |       | 2003       |  |   | 2005 |   |  | 2004       |      |   | 2003       |  
|                                                                |  |                                |       |   | (Restated)                     |   |       | (Restated) |  |   |      |   |  | (Restated) |      |   | (Restated) |  
|Net income (loss):                                              |  |                                |       |   |                                |   |       |            |  |   |      |   |  |            |      |   |            |   |       |   |  |   |        |  
|As reported                                                     |  | $                              | (98   | ) |                                | $ | 1,136 |            |  | $ | 106  |   |  | $          | 995  |   |            | $ | 200   |   |  | $ | (2,103 | )
|Fair value based compensation cost, net of taxes                |  |                                | (32   | ) |                                |   | (87   | )          |  |   | (47  | ) |  |            | (96  | ) |            |   | (262  | ) |  |   | (141   | )
|                                                                |  |                                |       |   |                                |   |       |            |  |   |      |   |  |            |      |   |            |   |       |   |  |   |        |  
|Pro forma net income (loss) attributable to common stockholders |  | $                              | (130  | ) |                                | $ | 1,049 |            |  | $ | 59   |   |  | $          | 899  |   |            | $ | (62   | ) |  | $ | (2,244 | )
|                                                                |  |                                |       |   |                                |   |       |            |  |   |      |   |  |            |      |   |            |   |       |   |  |   |        |  
|Basic and diluted income (loss) per share                       |  |                                |       |   |                                |   |       |            |  |   |      |   |  |            |      |   |            |   |       |   |  |   |        |  
|As reported                                                     |  | $                              | (0.00 | ) |                                | $ | 0.02  |            |  | $ | 0.00 |   |  | $          | 0.01 |   |            | $ | 0.00  |   |  | $ | (0.03  | )
|Pro forma                                                       |  | $                              | (0.00 | ) |                                | $ | 0.01  |            |  | $ | 0.00 |   |  | $          | 0.01 |   |            | $ | (0.00 | ) |  | $ | (0.03  | )



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):



|                                          |  |                  |        |   |               |   |        |                  |  |   |        |  
|----------------------------------------- |  | ---------------- | ------ | - | ------------- | - | ------ | ---------------- |  | - | ------ | -
|                                          |  | December 31,2005 |        |   | March 31,2005 |   |        | December 31,2004 | 
|Raw materials                             |  | $                | 7,893  |   |               | $ | 7,177  |                  |  | $ | 7,653  |  
|Work in process                           |  |                  | 2,719  |   |               |   | 3,883  |                  |  |   | 3,130  |  
|Finished goods                            |  |                  | 2,818  |   |               |   | 2,143  |                  |  |   | 1,846  |  
|                                          |  |                  |        |   |               |   |        |                  |  |   |        |  
|Inventories, gross                        |  |                  | 13,430 |   |               |   | 13,203 |                  |  |   | 12,629 |  
|Reserve for excess and obsolete inventory |  |                  | (507   | ) |               |   | (638   | )                |  |   | (678   | )
|                                          |  |                  |        |   |               |   |        |                  |  |   |        |  
|Inventories                               |  | $                | 12,923 |   |               | $ | 12,565 |                  |  | $ | 11,951 |  
|                                          |  |                  |        |   |               |   |        |                  |  |   |        |  



6. Long-term contracts



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



|                                                                            |  |                  |         |   |               |   |         |                  |  |   |         |  
|--------------------------------------------------------------------------- |  | ---------------- | ------- | - | ------------- | - | ------- | ---------------- |  | - | ------- | -
|                                                                            |  | December 31,2005 |         |   | March 31,2005 |   |         | December 31,2004 | 
|                                                                            |  |                  |         |   |               |   |         | (Restated)       | 
|Costs incurred on uncompleted contracts                                     |  | $                | 52,166  |   |               | $ | 37,219  |                  |  | $ | 40,014  |  
|Estimated earnings                                                          |  |                  | 23,220  |   |               |   | 17,749  |                  |  |   | 14,827  |  
|                                                                            |  |                  |         |   |               |   |         |                  |  |   |         |  
|                                                                            |  |                  | 75,386  |   |               |   | 54,968  |                  |  |   | 54,841  |  
|Less: billings to date                                                      |  |                  | (68,353 | ) |               |   | (48,031 | )                |  |   | (49,548 | )
|                                                                            |  |                  |         |   |               |   |         |                  |  |   |         |  
|                                                                            |  | $                | 7,033   |   |               | $ | 6,937   |                  |  | $ | 5,293   |  
|                                                                            |  |                  |         |   |               |   |         |                  |  |   |         |  
|                                                                            |  |                  |        
|Such amounts are included in the following accounts (in thousands):         |  |                  |         |   |               |   |         |                  |  |   |         |  
|                                                                            |  |                  |        
|Costs and estimated earnings in excess of billings on uncompleted contracts |  | $                | 10,006  |   |               | $ | 9,937   |                  |  | $ | 6,442   |  
|Billings in excess of costs and estimated earnings on uncompleted contracts |  |                  | (2,973  | ) |               |   | (3,000  | )                |  |   | (1,149  | )
|                                                                            |  |                  |         |   |               |   |         |                  |  |   |         |  
|                                                                            |  | $                | 7,033   |   |               | $ | 6,937   |                  |  | $ | 5,293   |  
|                                                                            |  |                  |         |   |               |   |         |                  |  |   |         |  



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7. Long-term debt



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



|                             |  |                  |        |   |               |   |        |                  |  |   |        |  
|---------------------------- |  | ---------------- | ------ | - | ------------- | - | ------ | ---------------- |  | - | ------ | -
|                             |  | December 31,2005 |        |   | March 31,2005 |   |        | December 31,2004 | 
|Working capital - borrowings |  | $                | 2,976  |   |               | $ |       |                  |  | $ | 7,681  |  
|Long-term debt  Loan A      |  |                  | 10,952 |   |               |   | 13,938 |                  |  |   | 14,469 |  
|Long-term debt  Loan B      |  |                  | 15,000 |   |               |   | 15,000 |                  |  |   | 15,000 |  
|Accrued PIK                  |  |                  | 289    |   |               |   | 115    |                  |  |   | 58     |  
|                             |  |                  |        |   |               |   |        |                  |  |   |        |  
|                             |  |                  | 29,217 |   |               |   | 29,053 |                  |  |   | 37,208 |  
|Due within one year          |  |                  | (2,552 | ) |               |   | (4,584 | )                |  |   | (2,344 | )
|                             |  |                  |        |   |               |   |        |                  |  |   |        |  
|Long-term debt               |  | $                | 26,665 |   |               | $ | 24,469 |                  |  | $ | 34,864 |  
|                             |  |                  |        |   |               |   |        |                  |  |   |        |  



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% (7.75% at December 31, 2005). At December 31, 2005, the amount
available on the revolving credit facility was $8,730,740, which includes $293,719 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 and nine months
ended December 31, 2005, interest expense on the revolving credit facility was approximately $63,000 and $139,000, respectively.



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% (10.25% at December 31, 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 $451,917 for the first year of the term,
$638,000 for the second through fourth years of the term, and $824,083 in the fifth year of the term. For the three and nine months ended December 31, 2005, interest expense on the Term A loan was approximately $279,000 and $867,000,
respectively.



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% (13.25% at December 31, 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 and nine months ended
December 31, 2005, interest expense on the Term B loan, including PIK interest, was approximately $564,000 and $1,618,000, respectively.



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



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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 and nine months ended December 31, 2005, the expense associated with these lenders fees was approximately $29,000 and $88,000, respectively.



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 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 December 31, 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 December 31, 2005, the liquidation value for the Series C preferred stock was $11,314 per share.



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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.



On September 30, 2004, the Company entered into an Exchange Agreement in
connection with the New Credit 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, 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 and nine months ended December 31, 2005 and 2004.



Options to purchase 6,468,522 shares of common stock were outstanding at December 31, 2005 and were included in the computation of diluted EPS for
the nine months ended December 31, 2005. However, for the three months ended December 31, 2005, the dilutive options were not included in the computation of diluted EPS because their effect would have been anti-dilutive, thereby decreasing
net loss per share.



Options to purchase 6,735,187 shares of
common stock and warrants to purchase 5,246,164 shares of common stock were outstanding at December 31, 2004, but were not included in the computation of diluted EPS for the nine months ended December 31, 2004 because their effect would
have been anti-dilutive, thereby decreasing net loss per share. However, for the three months ended December 31, 2004, the dilutive options and warrants were included in the computation of diluted EPS as the Company incurred net income.



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



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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 were as follows (in thousands):



|                                 |  |                                     |      |   |                           |   |      |                                     |  |   |      |  
|-------------------------------- |  | ----------------------------------- | ---- | - | ------------------------- | - | ---- | ----------------------------------- |  | - | ---- | -
|                                 |  | Nine Months Ended December 31, 2005 |      |   | Year Ended March 31, 2005 |   |      | Nine Months Ended December 31, 2004 | 
|Balance  beginning              |  | $                                   | 283  |   |                           | $ | 214  |                                     |  | $ | 214  |  
|Claims paid                      |  |                                     | (330 | ) |                           |   | (332 | )                                   |  |   | (197 | )
|Warranties issued/(expired), net |  |                                     | 475  |   |                           |   | 401  |                                     |  |   | 219  |  
|                                 |  |                                     |      |   |                           |   |      |                                     |  |   |      |  
|Balance - ending                 |  | $                                   | 428  |   |                           | $ | 283  |                                     |  | $ | 236  |  
|                                 |  |                                     |      |   |                           |   |      |                                     |  |   |      |  



13. Supplemental cash flow
disclosures



|                                         |  |                                |       |      |   |        |  |   |      
|---------------------------------------- |  | ------------------------------ | ----- | ---- | - | ------ |  | - | -----
|                                         |  | Nine Months Ended December 31,
|                                         |  | 2005                           |       | 2004 |   | 2003  
|Cash paid (received) for (in thousands): |  |                                |       |      |   |        |  |   |      
|Interest                                 |  | $                              | 2,612 |      | $ | 10,321 |  | $ | 2,637
|Income taxes                             |  |                                | 1,277 |      |   | 110    |  |   | 32   



14. Comprehensive income (loss)



|                                        |  |                                 |      |   |                                |   |       |            |  |   |      |   |  |            |      |            |  |   |     |  |   |        |  
|--------------------------------------- |  | ------------------------------- | ---- | - | ------------------------------ | - | ----- | ---------- |  | - | ---- | - |  | ---------- | ---- | ---------- |  | - | --- |  | - | ------ | -
|                                        |  | Three Months Ended December 31, |      |   | Nine Months Ended December 31, |  
|                                        |  | 2005                            |      |   | 2004                           |   |       | 2003       |  |   | 2005 |   |  | 2004       |      | 2003       | 
|                                        |  |                                 |      |   | (Restated)                     |   |       | (Restated) |  |   |      |   |  | (Restated) |      | (Restated) | 
|Net income (loss)                       |  | $                               | (98  | ) |                                | $ | 1,136 |            |  | $ | 106  |   |  | $          | 995  |            |  | $ | 200 |  | $ | (2,103 | )
|Foreign currency translation adjustment |  |                                 | (20  | ) |                                |   | (535  | )          |  |   | (262 | ) |  |            | (257 | )          |  |   | 469 |  |   | 551    |  
|                                        |  |                                 |      |   |                                |   |       |            |  |   |      |   |  |            |      |            |  |   |     |  |   |        |  
|Comprehensive income (loss)             |  | $                               | (118 | ) |                                | $ | 601   |            |  | $ | (156 | ) |  | $          | 738  |            |  | $ | 669 |  | $ | (1,552 | )
|                                        |  |                                 |      |   |                                |   |       |            |  |   |      |   |  |            |      |            |  |   |     |  |   |        |  



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



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



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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 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.



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.



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##### 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 EndedDecember 31, |   |  | Nine Months Ended December 31, |  
|                                                          |  | 2005                           |   |  | 2004                           |   |  | 2003       |   |  | 2005   |   |  | 2004       |   |  | 2003       |  
|                                                          |  |                                |   |  | (Restated)                     |   |  | (Restated) |   |  |        |   |  | (Restated) |   |  | (Restated) |  
|Revenue                                                   |  | 100.00                         | % |  | 100.00                         | % |  | 100.00     | % |  | 100.00 | % |  | 100.00     | % |  | 100.00     | %
|Cost of revenue                                           |  | 67.20                          |   |  | 65.42                          |   |  | 61.13      |   |  | 66.50  |   |  | 65.79      |   |  | 66.97      |  
|                                                          |  |                                |   |  |                                |   |  |            |   |  |        |   |  |            |   |  |            |  
|Gross Margin                                              |  | 32.80                          |   |  | 34.58                          |   |  | 38.87      |   |  | 33.50  |   |  | 34.21      |   |  | 33.03      |  
|                                                          |  |                                |   |  |                                |   |  |            |   |  |        |   |  |            |   |  |            |  
|Operating expenses                                        |  |                                |   |  |                                |   |  |            |   |  |        |   |  |            |   |  |            |  
|Selling, general and administrative                       |  | 21.48                          |   |  | 15.97                          |   |  | 19.42      |   |  | 19.66  |   |  | 17.71      |   |  | 20.55      |  
|Research and development                                  |  | 6.81                           |   |  | 4.40                           |   |  | 4.56       |   |  | 6.32   |   |  | 4.46       |   |  | 4.40       |  
|                                                          |  |                                |   |  |                                |   |  |            |   |  |        |   |  |            |   |  |            |  
|Total operating expenses                                  |  | 28.29                          |   |  | 20.37                          |   |  | 23.98      |   |  | 25.98  |   |  | 22.17      |   |  | 24.95      |  
|                                                          |  |                                |   |  |                                |   |  |            |   |  |        |   |  |            |   |  |            |  
|Operating income                                          |  | 4.51                           |   |  | 14.21                          |   |  | 14.89      |   |  | 7.52   |   |  | 12.04      |   |  | 8.08       |  
|                                                          |  |                                |   |  |                                |   |  |            |   |  |        |   |  |            |   |  |            |  
|Other income (expense), net                               |  |                                |   |  |                                |   |  |            |   |  |        |   |  |            |   |  |            |  
|Interest expense on debt                                  |  | (5.87                          | ) |  | (4.34                          | ) |  | (8.15      | ) |  | (5.01  | ) |  | (6.54      | ) |  | (8.28      | )
|Dividends on mandatorily redeemable preferred stock       |  |                               |   |  |                               |   |  | (4.32      | ) |  |       |   |  | (2.56      | ) |  | (4.64      | )
|Other, net                                                |  | (0.29                          | ) |  | (1.29                          | ) |  | 0.96       |   |  | 0.01   |   |  | (1.12      | ) |  | 0.33       |  
|                                                          |  |                                |   |  |                                |   |  |            |   |  |        |   |  |            |   |  |            |  
|Total other income (expense)                              |  | (6.16                          | ) |  | (5.63                          | ) |  | (11.51     | ) |  | (5.00  | ) |  | (10.22     | ) |  | (12.59     | )
|                                                          |  |                                |   |  |                                |   |  |            |   |  |        |   |  |            |   |  |            |  
|Income (loss) before provision (benefit) for income taxes |  | (1.65                          | ) |  | 8.58                           |   |  | 3.38       |   |  | 2.52   |   |  | 1.82       |   |  | (4.51      | )
|Provision (benefit) for income taxes                      |  | (1.05                          | ) |  | 3.30                           |   |  | 2.75       |   |  | 0.75   |   |  | 1.50       |   |  | 0.09       |  
|                                                          |  |                                |   |  |                                |   |  |            |   |  |        |   |  |            |   |  |            |  
|Net income (loss)                                         |  | (0.60                          | ) |  | 5.28                           |   |  | 0.63       |   |  | 1.77   |   |  | 0.32       |   |  | (4.60      | )
|                                                          |  |                                |   |  |                                |   |  |            |   |  |        |   |  |            |   |  |            |  



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##### Table of Contents

Three Months Ended December 31, 2005 Compared to Three Months Ended December 31, 2004 (restated):



Net Revenues: Revenues decreased $4.9 million, or
22.8%, to $16.6 million for the three months ended December 31, 2005, as compared to $21.5 million for the three months ended December 31, 2004. Sales to international customers for the three months ended December 31, 2005 decreased
$4.9 million, or 45.4%, to $5.9 million. The international sales decrease is due primarily to the near completion of a large, long-term percentage-of-completion contract in fiscal 2005. Sales to U.S. military customers for the three months ended
December 31, 2005 remained constant at $9.3 million. Sales to U.S. law enforcement customers for the three months ended December 31, 2005 remained constant at $1.4 million.



Cost of Revenues: Cost of revenues decreased $2.9 million, or 20.6%, to $11.2 million for the three months ended
December 31, 2005, as compared to $14.1 million for the three months ended December 31, 2004. As a percentage of revenues, cost of revenues for the three months ended December 31, 2005 increased to 67.2%, as compared to 65.4% for the
three months ended December 31, 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
$1.9 million, or 25.7%, to $5.5 million, or 32.8% of revenues for the three months ended December 31, 2005, as compared to $7.4 million, or 34.6% of revenues, for the three months ended December 31, 2004.



Total Operating Expenses: Total operating expenses increased $0.3
million, or 6.8%, to $4.7 million for the three months ended December 31, 2005, as compared to $4.4 million for the three months ended December 31, 2004. As a percentage of revenues, total operating expenses increased to 28.3% for the
three months ended December 31, 2005, as compared to 20.4% for the three months ended December 31, 2004. Selling, general and administrative (SG&A) expenses, which include bid and proposal activities, increased from $3.4
million for the three months ended December 31, 2004 to $3.6 million for the three months ended December 31, 2005. In addition, as a percentage of revenues, SG&A increased from 16.0% at December 31, 2004 to 21.5% at
December 31, 2005. The increase in SG&A as a percentage of revenues is attributed primarily to lower revenues for the three months ended December 31, 2005. Research and development costs increased slightly from $1.0 million for the
three months ended December 31, 2004 to $1.1 million for the three months ended December 31, 2005.



Operating Income: As a result of the foregoing, operating income decreased $2.3 million to $0.8 million for the three months ended
December 31, 2005, as compared to $3.1 million for the three months ended December 31, 2004. As a percentage of revenues, operating income was 4.5% of revenues for the three months ended December 31, 2005, as compared to 14.2% of
revenues for the three months ended December 31, 2004.



Other Income (Expense), net: Other income (expense), net totaled $(1.0) million, or (6.2%) of revenues, for the three months ended December 31, 2005, as compared to $(1.2) million, or (5.6%) of revenues, for the three
months ended December 31, 2004.



Income (Loss) Before
Provision (Benefit) for Income Taxes: As a result of the foregoing, income before provision (benefit) for income taxes decreased $2.1 million from income of $1.8 million for the three months ended December 31, 2004 to a loss of $0.3 million
for the three months ended December 31, 2005.



Provision (Benefit) for Income Taxes: Net taxable loss for the three months ended December 31, 2005 resulted in a tax benefit of $0.2 million, while net taxable income for the three months ended December 31, 2004 resulted
in a tax provision of $0.7 million. The benefit for the three months ended December 31, 2005 is primarily due to the completion of research and development tax credit documentation during the current quarter which resulted in a larger credit
than was provided for in the March 31, 2005 year end provision.



Net Income (Loss): As a result of the foregoing, net income decreased by $1.2 million to a net loss of $0.1 million, or $0.00 diluted loss per share, for the three months ended December 31, 2005, from net income of $1.1 million,
or $0.01 diluted income per share, for the three months ended December 31, 2004.



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Three Months Ended December 31, 2004 (restated) Compared to Three Months Ended December 31, 2003 (restated):



Net Revenues: Revenues increased $4.7 million, or
28.0%, to $21.5 million for the three months ended December 31, 2004, as compared to $16.8 million for the three months ended December 31, 2003. Sales to international customers for the three months ended December 31, 2004 increased
$4.6 million, or 78.0%, to $10.8 million. The international sales increase is due primarily to the activation of an amendment to an existing contract with the United Kingdom. Sales to U.S. military customers for the three months ended
December 31, 2004 increased by $1.1 million, or 13.4%, to $9.3 million. The U.S. military increase is due primarily to system upgrades with existing customers. Sales to U.S. law enforcement customers for the three months ended December 31,
2004 decreased $1.0 million, or 41.7%, to $1.4 million reflecting state and municipality budgeting shortfalls associated with diversion of funds to offset operational costs.



Cost of Revenues: Cost of revenues increased $3.8 million, or 36.9%, to $14.1 million for the three months ended
December 31, 2004, as compared to $10.3 million for the three months ended December 31, 2003. As a percentage of revenues, cost of revenues for the three months ended December 31, 2004 increased to 65.4%, as compared to 61.1% for the
three months ended December 31, 2003. The increase in cost of revenues as a percentage of revenues is attributable primarily to the shift in weapon types delivered to domestic customers.



Gross Profit: As a result of the foregoing, gross profit increased
$0.9 million, or 13.8%, to $7.4 million, or 34.6% of revenues for the three months ended December 31, 2004, as compared to $6.5 million, or 39.0% of revenues, for the three months ended December 31, 2003.



Total Operating Expenses: Total operating expenses increased $0.4
million, or 10.0%, to $4.4 million for the three months ended December 31, 2004 as compared to $4.0 million for the three months ended December 31, 2003. As a percentage of revenues, total operating expenses decreased to 20.4% for the
three months ended December 31, 2004, as compared to 24.0% for the three months ended December 31, 2003. Selling, general and administrative (SG&A) expenses, which include bid and proposal activities, increased from $3.3
million for the three months ended December 31, 2003 to $3.4 million for the three months ended December 31, 2004. However, as a percentage of revenues, SG&A decreased from 19.4% at December 31, 2003 to 16.0% at December 31,
2004 due to a corporate focus of expense control initiatives. Research and development costs increased from $0.8 million for the three months ended December 31, 2003 to $1.0 million for the three months ended December 31, 2004.



Operating Income: As a result of the foregoing, operating income
increased $0.6 million to $3.1 million for the three months ended December 31, 2004 as compared to $2.5 million for the three months ended December 31, 2003. As a percentage of revenues, operating income was 14.2% of revenues for the three
months ended December 31, 2004, as compared to 15.0% of revenues for the three months ended December 31, 2003.



Other Income (Expense), net: Other income (expense), net totaled $(1.2) million, or (5.6%) of revenues for the three months ended
December 31, 2004, as compared to $(1.9) million, or (11.5%) of revenues for the three months ended December 31, 2003. 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 $0.7 million due to the conversion of the mandatorily redeemable preferred stock (Series B). In addition, due to the weaker dollar, the foreign currency exchange loss was $0.3
million for the three months ended December 31, 2004, as compared to $0.2 million gain for the three months ended December 31, 2003.



Income Before Provision for Income Taxes: As a result of the foregoing, the income before benefit for income taxes increased by $1.2 million from
income of $0.6 million for the three months ended December 31, 2003 to income of $1.8 million for the three months ended December 31, 2004.



Provision for Income Taxes: Net taxable income for the three months ended December 31, 2004 resulted in a tax provision of $0.7 million, while
net taxable income for the three months ended December 31, 2003 resulted in a tax provision of $0.5 million.



Net Income: As a result of the foregoing, net income increased by $1.0 million to $1.1 million, or $0.02 diluted income per share, for the three
months ended December 31, 2004, from net income of $0.1 million, or $0.0 diluted income per share, for the three months ended December 31, 2003.



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Nine Months Ended December 31, 2005 Compared to Nine Months Ended December 31, 2004 (restated):



Net Revenues: Revenues decreased $4.5 million, or
7.5%, to $55.9 million for the nine months ended December 31, 2005, as compared to $60.4 million for the nine months ended December 31, 2004. Sales to international customers for the nine months ended December 31, 2005 decreased $4.7
million, or 18.3%, to $21.0 million due primarily to the near completion of a large, long-term percentage-of-completion contract in fiscal 2005. Sales to U.S. military customers for the nine months ended December 31, 2005 increased $0.4
million, or 1.3%, to $31.5 million. Sales to U.S. law enforcement customers for the nine months ended December 31, 2005 decreased $0.2 million, or 5.5%, to $3.4.



Cost of Revenues: Cost of revenues decreased $2.5 million, or 6.3%, to $37.2 million for the nine months ended
December 31, 2005, as compared to $39.7 million for the nine months ended December 31, 2004. As a percentage of revenues, cost of revenues for the nine months ended December 31, 2005 increased slightly to 66.5%, as compared to 65.8%
for the nine months ended December 31, 2004.



Gross
Profit: As a result of the foregoing, gross profit decreased $2.0 million, to $18.7 million, or 33.5% of revenues for the nine months ended December 31, 2005, as compared to $20.7 million, or 34.2% of revenues, for the nine months ended
December 31, 2004.



Total Operating Expenses: Total
operating expenses increased $1.1 million, or 8.2%, to $14.5 million for the nine months ended December 31, 2005, as compared to $13.4 million for the nine months ended December 31, 2004. As a percentage of revenues, total operating
expenses increased to 26.0% for the nine months ended December 31, 2005, as compared to 22.2% for the nine months ended December 31, 2004. Selling, general and administrative (SG&A) expenses, which include bid and proposal
activities, increased from $10.7 million for the nine months ended December 31, 2004 to $11.0 million for the nine months ended December 31, 2005. In addition, as a percentage of revenues, SG&A increased from 17.7% at December 31,
2004 to 20.0% at December 31, 2005. The increase in SG&A as a percentage of revenues is attributed primarily to lower revenues for the nine months ended December 31, 2005. Research and development costs increased from $2.7 million for
the nine months ended December 31, 2004 to $3.5 million for the nine months ended December 31, 2005 due to increases in developmental efforts in improving our standard product and new product development.



Operating Income: As a result of the foregoing, operating income
decreased $3.1 million to $4.2 million for the nine months ended December 31, 2005, as compared to $7.3 million for the nine months ended December 31, 2004. As a percentage of revenues, operating income was 7.5% of revenues for the nine
months ended December 31, 2005, as compared to 12.0% of revenues for the nine months ended December 31, 2004.



Other Income (Expense), net: Other income (expense), net totaled $(2.8) million, or (5.0%) of revenues, for the nine months ended
December 31, 2005, as compared to $(6.2) million, or (10.2%) of revenues, for the nine months ended December 31, 2004. Interest on debt decreased $1.2 million, or 30.0%, due primarily to lower interest rates on the New Credit
Agreement. Dividends on mandatorily redeemable preferred stock decreased $1.5 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,
there was no foreign currency exchange loss for the nine months ended December 31, 2005, as compared to a $0.7 million loss for the nine months ended December 31, 2004.



Income (loss) Before Provision (Benefit) for Income Taxes: As a result of the foregoing, the income before provision
(benefit) for income taxes increased by $0.3 million from income of $1.1 million for the nine months ended December 31, 2004 to income of $1.4 million for the nine months ended December 31, 2005.



Provision (Benefit) for Income Taxes: Net taxable income for the nine
months ended December 31, 2005 resulted in a tax provision of $0.4 million, while net taxable income for the nine months ended December 31, 2004 resulted in a tax provision of $0.9 million. The tax provision for the nine months ended
December 31, 2004 contains a provision for nondeductible dividends on our Series B preferred stock.



Net Income (Loss): As a result of the foregoing, net income increased by $0.7 million to net income of $0.9 million, or $0.01 diluted income per
share, for the nine months ended December 31, 2005, from net income of $0.2 million, or $0.00 diluted income per share, for the nine months ended December 31, 2004.



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Nine Months Ended December 31, 2004 (restated) Compared to Nine Months Ended December 31, 2003 (restated):



Net Revenues: Revenues increased $14.6 million, or
31.9%, to $60.4 million for the nine months ended December 31, 2004, as compared to $45.8 million for the nine months ended December 31, 2003. Sales to international customers for the nine months ended December 31, 2004 increased $5.9
million, or 31.1%, to $25.7 million. The international sales increase is due primarily to the activation of amendments with existing contracts. Sales to U.S. military customers for the nine months ended December 31, 2004 increased by $11.5
million, or 58.7%, to $31.1 million. The increase in U.S. military sales is due primarily to the incremental sales of weapons and system upgrades with existing customers and sales of I-FACT (Close Air Support Trainer) and VCCT (Virtual Combat Convoy
Trainer). Sales to U.S. law enforcement customers for the nine months ended December 31, 2004 decreased $2.8 million, or 43.8%, to $3.6 million reflecting state and municipality budgeting shortfalls associated with diversion of funds to offset
operational costs.



Cost of Revenues: Cost of revenues
increased $9.1 million, or 29.7%, to $39.7 million for the nine months ended December 31, 2004, as compared to $30.6 million for the nine months ended December 31, 2003. As a percentage of revenues, cost of revenues for the nine months
ended December 31, 2004 remained fairly constant at 65.8%, as compared to 67.0% for the nine months ended December 31, 2003.



Gross Profit: As a result of the foregoing, gross profit increased $5.6 million, or 37.1%, to $20.7 million, or 34.2% of revenues, for the nine
months ended December 31, 2004, as compared to $15.1 million, or 33.0% of revenues, for the nine months ended December 31, 2003.



Total Operating Expenses: Total operating expenses increased $2.0 million, or 17.5%, to $13.4 million for the nine months ended December 31,
2004 as compared to $11.4 million for the nine months ended December 31, 2003. As a percentage of revenues, total operating expenses decreased to 22.2% for the nine months ended December 31, 2004 as compared to 25.0% for the nine months
ended December 31, 2003. Selling, general and administrative (SG&A) expenses, which include bid and proposal activities, increased from $9.4 million for the nine months ended December 31, 2003 to $10.7 million for the nine
months ended December 31, 2004. This increase in SG&A is due primarily to increased emphasis in sales and marketing, bid and proposal for new business, and expenses associated with the reengineering of our Enterprise Resource Planning
system. Research and development costs increased $0.7 million, or 35.0%, to $2.7 million for the nine months ended December 31, 2004, as compared to $2.0 million for the nine months ended December 31, 2003. This increase is due primarily
to increases in developmental efforts related to Bluefire weapons, enhancements to our I-FACT product, and single platform initiative.



Operating Income: As a result of the foregoing, operating income increased $3.6 million to $7.3 million for the nine months ended December 31,
2004, as compared to $3.7 million for the nine months ended December 31, 2003. As a percentage of revenues, operating income was 12.0% of revenues for the nine months ended December 31, 2004, as compared to 8.0% of revenues for the nine
months ended December 31, 2003.



Other Income
(Expense), net: Other income (expense), net totaled $(6.2) million, or (10.2%) of revenues for the nine months ended December 31, 2004 as compared to $(5.8) million, or (12.6%) of revenues for the nine months ended
December 31, 2003. Interest on debt decreased $0.2 million due primarily to lower interest rates on the New Credit Agreement. Dividends on mandatorily redeemable preferred stock decreased $0.6 million due to conversion of the mandatorily
redeemable preferred stock (Series B). In addition, due to the weaker dollar, the foreign currency exchange loss was $0.6 million for the nine months ended December 31, 2004, as compared to $0.2 million gain for the nine months ended
December 31, 2003.



Income (Loss) Before Provision
(Benefit) for Income Taxes: As a result of the foregoing, the income (loss) before provision (benefit) for income taxes decreased by $3.2 million from a loss of $2.1 million for the nine months ended December 31, 2003 to income of $1.1
million for the nine months ended December 31, 2004.



Provision (Benefit) for Income Taxes: Net taxable income for the nine months ended December 31, 2004 produced a tax provision of $0.9 million, while the net taxable loss for the nine months ended December 31, 2003 resulted
in a tax provision of $39,000.



Net Loss: As a result of
the foregoing, the net loss decreased by $2.3 million to net income of $0.2 million, or $0.00 diluted income per share for the nine months ended December 31, 2004, from a loss of $2.1 million, or $0.03 diluted loss per share for the nine months
ended December 31, 2003.



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ANALYSIS OF BACKLOG



As of December 31, 2005, the Company had a backlog of approximately $65.9 million compared with $52.1 million as of December 31, 2004. Our
backlog as of December 31, 2005 consisted of $49.8 million from international customers, $15.5 million from U.S. military customers and $0.6 million from U.S. law enforcement customers. Management expects that approximately $15.6 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 is as follows (in thousands):



|                              |  |                                 |         |   |                                |   |         |            |  |   |         |   |  |            |         |   |            |   |         |   |  |   |         |  
|----------------------------- |  | ------------------------------- | ------- | - | ------------------------------ | - | ------- | ---------- |  | - | ------- | - |  | ---------- | ------- | - | ---------- | - | ------- | - |  | - | ------- | -
|                              |  | Three Months Ended December 31, |         |   | Nine Months Ended December 31, |  
|                              |  | 2005                            |         |   | 2004                           |   |         | 2003       |  |   | 2005    |   |  | 2004       |         |   | 2003       |  
|                              |  |                                 |         |   | (Restated)                     |   |         | (Restated) |  |   |         |   |  | (Restated) |         |   | (Restated) |  
|Backlog  beginning of period |  | $                               | 53,597  |   |                                | $ | 46,607  |            |  | $ | 65,117  |   |  | $          | 58,411  |   |            | $ | 59,310  |   |  | $ | 64,346  |  
|New bookings                  |  |                                 | 28,991  |   |                                |   | 27,053  |            |  |   | 13,970  |   |  |            | 63,416  |   |            |   | 53,190  |   |  |   | 43,699  |  
|Revenue                       |  |                                 | (16,632 | ) |                                |   | (21,521 | )          |  |   | (16,800 | ) |  |            | (55,871 | ) |            |   | (60,361 | ) |  |   | (45,758 | )
|                              |  |                                 |         |   |                                |   |         |            |  |   |         |   |  |            |         |   |            |   |         |   |  |   |         |  
|Backlog  end of period       |  | $                               | 65,956  |   |                                | $ | 52,139  |            |  | $ | 62,287  |   |  | $          | 65,956  |   |            | $ | 52,139  |   |  | $ | 62,287  |  
|                              |  |                                 |         |   |                                |   |         |            |  |   |         |   |  |            |         |   |            |   |         |   |  |   |         |  



LIQUIDITY AND CAPITAL RESOURCES



As of December 31, 2005, we had working capital of
$27.2 million compared to a working capital of $27.6 million as of December 31, 2004. The net $0.4 million decrease in working capital is due primarily to a $2.7 million decrease in cash, a $4.1 million decrease in accounts receivable, and a
$4.4 million decrease in unbilled receivables, offset by a $3.6 million increase in costs and estimated earnings in excess of billings on incomplete contracts, a $4.0 million decrease in accounts payable and various accrued liability accounts, and a
$2.7 million decrease in billings in excess of cost and estimated earnings on incomplete contracts and deferred revenue.



We had a net decrease in cash and cash equivalents of $5.4 million for the nine months ended December 31, 2005, as compared to a net increase of cash
and cash equivalents of $1.3 million for the nine months ended December 31, 2004. For the period ended December 31, 2005, the Companys operating activities used cash of approximately $4.7 million compared to the providing of cash of
$7.0 million for the nine months ended December 31, 2004. During the nine months ended December 31, 2004, cash flows from operations had a positive impact from significant cash receipts on accounts receivable, as well as significant cash
receipts from advance billings.



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 next twelve months. 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 December 31, 2005, approximately $9.3 million in accounts receivable, or 74% of total net accounts receivable, was due from five of the
Companys customers.



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COMMITMENTS AND OTHER CONTRACTURAL OBLIGATIONS



Disclosure of Commitments and Other Obligations

December 31, 2005

(amounts in thousands)



|                             |  |       |        |                 |   |                 |  |                 |       |              |   |        |  |   |  
|---------------------------- |  | ----- | ------ | --------------- | - | --------------- |  | --------------- | ----- | ------------ | - | ------ |  | - | -
|                             |  | Total |        | Less than1 year |   | Within1-3 years |  | Within4-5 years |       | After5 years
|Long-term debt               |  |       |        |                 |   |                 |  |                 |       |              |   |        |  |   |  
|Working capital  borrowings |  | $     | 2,976  |                 | $ |                |  | $               |      |              | $ | 2,976  |  | $ | 
|Long-term debt  Term A      |  |       | 10,952 |                 |   | 2,552           |  |                 | 5,928 |              |   | 2,472  |  |   | 
|Long-term debt  Term B      |  |       | 15,000 |                 |   |                |  |                 |      |              |   | 15,000 |  |   | 
|Accrued PIK                  |  |       | 289    |                 |   |                |  |                 |      |              |   | 289    |  |   | 
|Other                        |  |       |        |                 |   |                 |  |                 |       |              |   |        |  |   |  
|Purchase orders              |  |       | 5,419  |                 |   | 5,139           |  |                 | 280   |              |   |       |  |   | 
|Operating lease obligations  |  |       | 2,225  |                 |   | 980             |  |                 | 1,154 |              |   | 91     |  |   | 
|                             |  |       |        |                 |   |                 |  |                 |       |              |   |        |  |   |  
|Total                        |  | $     | 36,861 |                 | $ | 8,671           |  | $               | 7,362 |              | $ | 20,828 |  | $ | 
|                             |  |       |        |                 |   |                 |  |                 |       |              |   |        |  |   |  



OFF-BALANCE SHEET ARRANGEMENTS



As of December 31, 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 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 December 31, 2005.



As of December 31, 2005, we had a total of approximately $29.2 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.



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There were no changes in the Companys internal control over financial reporting during the
Companys fiscal quarter ended December 31, 2005, that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.



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 1A. RISK FACTORS



Item 7 of Part II of our Form 10-K for the fiscal year ended March 31, 2005 summarizes various material risks that investors should carefully consider before deciding to buy or maintain an investment in our common stock. Any of
those risks, if they actually occur, would likely harm our business, financial condition and results of operations and could cause the trading price of our common stock to decline. The following sets forth material changes from the risk factors set
forth in our most recent Form 10-K.



The following risk factors
are updated:



Our business relies on maintaining key customer relationships
and certain key contracts.



In fiscal 2003, the
Companys five largest customers accounted for approximately 73.3% of the Companys revenues, with two customers accounting for more than 10% of revenues. In fiscal 2004, the Companys five largest customers accounted for
approximately 71.5% of the Companys revenues, with three customers accounting for more than 10% of revenues. In fiscal 2005, the Companys largest customers accounted for approximately 69.8% of the Companys revenues, with three
customers accounting for more than 10% of revenues. In fiscal 2006, for the nine months ended December 31, 2005, the Companys largest customers accounted for approximately 74.1% of the Companys revenues, with 3 customers accounting
for more than 10% of revenues. Amounts for 2003 and 2004 have been restated to reflect the combination of all customers controlled by the U.S. government. Given the nature of our contracts, revenues attributable to specific customers are likely to
vary from year to year, and a significant customer in one year may not be a significant customer in a subsequent year. In order to reach our growth objectives, we will be required to seek contracts from new domestic and international customers as
well as orders from existing customers for additional types of virtual simulated training solutions or increased quantities of previously ordered systems and simulated weapons. A significant decrease in demand by or the loss of one or more
significant customers could have a material adverse effect on our results of operations or financial condition.



Our business relies on obtaining key government contracts that are subject to regulatory requirements and availability of public funds.



Most of our customers to date have been in the public sector of the U.S.,
including the federal, state and local governments, and in the public sectors of a number of other countries. Approximately 49.4% of our revenues for fiscal 2005 were attributable to sales to military authorities in the U.S., 5.5% were attributable
to sales to law enforcement authorities in the U.S., and 45.1% were attributable to sales to military and law enforcement authorities internationally. For fiscal 2006, approximately 56.3% of our revenues for the nine months ended December 31,
2005 were attributable to sales to military authorities in the U.S, 6.0% were attributable to sales to law enforcement authorities in the U.S., and 37.7% were attributable to sales to military and law enforcement authorities internationally. Sales
to public sector customers are subject to a multiplicity of detailed regulatory requirements and public policies. For example, we are subject to export licensing requirements with respect to the transfer of arms and technical data used by our
foreign subsidiaries to modify simulated weapons for use in systems supplied to international customers. The key regulatory requirements for FATS are (1) the International Traffic in Arms Regulations (ITAR) whose oversight is performed by the
Directorate of Defense Controls (DDTC) of the U.S. State Department and (2) the U.S. Government Firearms Control Act whose oversight is performed by the Bureau of Alcohol, Tobacco and Firearms.



The ITAR regulates exports of U.S. military equipment and technical data to
our subsidiaries and foreign customers. The DDTC may revoke, suspend or amend our licenses without notice. The Bureau of Alcohol, Tobacco and Firearms (ATF)



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authorize FATS to be a dealer in regulated firearms and other destructive materials. The ATF, like the DDTC, may revoke
licenses or deny their renewal for failure to follow prescribed regulations or as a result of the commission of criminal offenses. All of our subsidiaries also have similar licenses in their jurisdictions of incorporation.



Any revocation of or refusal to renew our licenses would have a material
adverse effect on the conduct of our operations and financial condition since we must posses such licenses and comply with governmental regulations in order to manufacture and market our products. In addition, public sector customer contracts may be
conditioned upon the continuing availability of public funds, which in turn depends upon lengthy and complex budgetary procedures, and may be subject to certain pricing constraints. Moreover, U.S. government contracts and those of many international
government customers may generally be terminated for convenience for a variety of factors when it is in the best interest of the government. There can be no assurance that these factors or others unique to government contracts will not have a
material adverse effect on our future results of operations and financial condition.



Our business relies on maintaining and growing sales to international customers.



A significant portion of our sales is made to customers located outside the U.S., primarily in Europe and Asia. In fiscal 2005, 2004 and 2003, 45.1%,
51.6% and 48.8% of our revenues, respectively, were derived from sales to customers located outside the U.S. For the nine months ended December 31, 2005, 37.7% of our revenues were derived from sales to customers located outside the U.S. We
expect that our international customers will continue to account for a substantial portion of our revenues in the near future. Sales to international customers may be subject to political and economic risks, including political instability, wars,
civil unrest, acts of terrorism and other conflicts, currency controls, exchange rate fluctuations and changes in import/export regulations and tariff rates. In addition, various forms of protectionist trade legislation have been and in the future
may be proposed in the U.S. and certain other countries. Any resulting changes in current tariff structures or other trade and monetary policies could adversely affect our sales to international customers. Political and economic factors have been
identified by the Company with respect to certain of the markets in which we compete. There can be no assurance that these factors will not result in defaults by customers in making payments due to the Company, in reductions in the purchases of our
products by international customers or in foreign currency exchange losses. We do not currently hedge these foreign currency transactions. In certain cases, we have reduced certain of the risks associated with international contracts by obtaining
bank letters of credit to support the payment obligations of our customers and/or by providing in our contracts for payment in U.S. dollars.



Our financial condition, and the restrictive covenants contained in our credit facility may limit our ability to borrow additional funds or raise additional equity as
may be required to fund our future operations.



Our
accumulated deficit and stockholders deficit was approximately $157.6 million and $28.5 million, respectively, as of March 31, 2005 and $156.6 million and $27.7 million, respectively, as of December 31, 2005. Our New Credit Agreement
includes a number of financial covenants requiring us to maintain certain leverage ratios as well as minimum EBITDA and fixed charge coverage ratios for stated periods. If we fail to meet these required financial covenants and are unsuccessful
in obtaining a waiver from the lender, any default would permit the lender to increase the interest rates we pay under the loan facility. Moreover, the terms of our New Credit Agreement may limit our ability to, among other things:



| |  |  | incur additional debt;
| | - |  | ----------------------



| |  |  | retire or exchange outstanding debt;
| | - |  | ------------------------------------



| |  |  | pay cash dividends, redeem, retire or repurchase our stock or change our capital structure;
| | - |  | -------------------------------------------------------------------------------------------



| |  |  | acquire assets or businesses or make investments in other entities;
| | - |  | -------------------------------------------------------------------



| |  |  | enter into certain transactions with affiliates;
| | - |  | ------------------------------------------------



| |  |  | merge or consolidate with other entities;
| | - |  | -----------------------------------------



| |  |  | sell or otherwise dispose of assets or use the proceeds from any asset sale or other disposition; and
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | create additional liens on our assets.
| | - |  | --------------------------------------





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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS



The Company held its 2005 Annual Meeting of Stockholders on October 25, 2005. The stockholders were asked to reelect Mary Ann Gilleece and Cameron Breitner to serve an additional term as Class III directors to
serve on the Companys Board of Directors until the 2008 Annual Meeting of Stockholders.



The following votes were cast for and against the election of these individuals as Class III directors: (i) Ms. Gilleece 64,505,583 for / 339,165 withheld; (ii) Mr. Breitner 64,718,683 for /
126,065 withheld. There were no Broker non-votes or abstentions.



The following persons also continue to serve as directors: Scott Perekslis and Ronald C. Whitaker, as Class I directors whose terms expire in 2006; and Ronavan Mohling and Darrell Oyer, as Class II directors whose terms expire in 2007.



ITEM 6. EXHIBITS



|     |  |                                                                                                   
|---- |  | --------------------------------------------------------------------------------------------------
|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  



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SIGNATURES



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



DATED: February 14, 2006



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




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