**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

**FORM 10-K**

| **(Mark One)** | ** **                                                   |
|----------------|--------------------------------------------------------------|
| **x**          | **ANNUAL REPORT PURSUANT TO SECTION 13**                |
| ** **     | **OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934**    |
| ** **     | **For the fiscal year ended December 31, 2005**         |
| ** **     | **OR**                                                       |
| **o**          | **TRANSITION REPORT PURSUANT TO  SECTION**                   |
| ** **     | **13 OR 15(d) OF THE SECURITIES EXCHANGE ACT  OF 1934** |

 

**Forthe transition period from**                              to                              

**Commission File No.: 0-16182**

**AXSYS TECHNOLOGIES, INC.**

(Exact name of registrantas specified in its charter)

| **Delaware**                                               |   | **11-1962029**       |
|------------------------------------------------------------|--------|----------------------|
| (State or other  jurisdiction of                           |   | (I.R.S. Employer     |
| incorporation or  organization)                            |   | Identification  No.) |
| **175 Capital Boulevard, Suite 103**                  |   | ** **           |
| **Rocky  Hill, Connecticut**                               |   | **06067**            |
| (Address of  principal executive offices)                  |   | (Zip Code)           |
| **(860) 257-0200**                                         |
| (Registrant’s  telephone number, including area code) |

 

**Securitiesregistered pursuant to Section 12(b) of the Act: None**

**Securities registered pursuant to Section 12(g) ofthe Act:**

**Common Stock, par value $.01 per share**

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act. Yes  o      No x

Indicateby check mark if the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Exchange Act. Yes  o      No x* *

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

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 of RegulationS-K is not contained herein, and will not be contained, to the best ofregistrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. o

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the ExchangeAct. (Check One):

Large acceleratedfiler o                       Acceleratedfiler x                         Non-acceleratedfiler o

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). Yes  o    No x

The aggregate market valueof the voting and non-voting common stock held by non-affiliates of theregistrant as of the close of business on July 2, 2005, was $89,404,981.

Thenumber of shares outstanding of the registrant’s common stock as of February 21,2006 was 10,618,880.

Parts of the following document are incorporated byreference into Part III of this Annual Report on Form 10-K: theProxy Statement for the registrant’s 2006 Annual Meeting of Stockholders.

 

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**PART I**

**Item 1.**                        BUSINESS

Axsys Technologies, Inc. (together with oursubsidiaries, unless the context suggests otherwise, “Axsys”, “Company”, “we”, “us”or “our”) was originally incorporated in the State of New York in 1959 andreincorporated in the State of Delaware in 1968. We are a leading designer andmanufacturer of precision optical solutions for defense, aerospace, homelandsecurity and high-performance commercial applications. Thesesophisticated solutions are typically found in applications that demand thefinest optical surfaces, highest accuracy and tightest motion controltolerances. Application examples include weapon systems, long-rangesurveillance cameras and highly precise medical imagers.  We are also a technology leader in the supplyof infrared surveillance solutions to homeland security market customers suchas the U.S. Border Patrol, Army, Navy, Air Force, Coast Guard and various portauthorities.

Our solutions are often embedded in larger systemsthat depend on precise optical control for accurate operation of criticalfunctions. We are involved in many large-scale programs including the F-16,F-18, Apache, Stryker, M1A2 Abrams and Bradley Fighting Vehicle. Many ofthe applications with which we are involved include the continuing developmentof next-generation targeting, navigation and imaging systems for fighteraircraft, helicopters, aircraft carriers and armored vehicles. We also supplycritical guidance and seeker components for platforms such as the Minutemanintercontinental ballistic missile and the AIM-9X Sidewinder missile. Ourproducts are included on many platforms within the U.S. National MissileDefense program, or NMD. Our defense products are often used in sophisticatedstabilized optical platforms, or SOP, which are highly accurate opticalpositioning mechanisms. The SOPs are essential in applications such as militarytargeting and imaging systems.

In addition to optical solutions, we distributeprecision ball bearings used in a variety of industrial and commercialapplications. We sell our components, sub-systems and bearings to a variety oforiginal equipment manufacturers, or OEMs.

We are organized into twobusinesses: the Optical Systems Group and the Distributed Products Group.Financial information by business segment can be found in Note 16 to theconsolidated financial statements included elsewhere in this report.

*Optical Systems Group*

The Optical Systems Group designs, manufactures andsells highly precise systems, sub-systems and components that are typicallyused in surveillance, long-range observation, tracking and targeting andhigh-performance imaging applications. Customers include both government andcommercial applications.

Our thermal camera systems are typically used forborder surveillance, perimeter security and public safety, while sub-systemsand components are usually designed for integration into our customers’high-performance optical systems. Products can be grouped into four primaryareas: reflective optical products, infrared products, motion control productsand precision optical and mechanical structures. However, customer requirementssometimes demand an optical solution that combines products from several ofthese areas. Our defense products are often designed to be integrated intostabilized optical platforms, which are highly accurate optical positioningmechanisms. Stabilized optical platforms are essential in applications such asmilitary targeting and imaging systems.

We have completed two acquisitions in the past 2 years.On May 2, 2005, we acquired all of the capital stock of DiversifiedOptical Products, Inc., or DiOP, a privately owned company that designs,manufactures and assembles complex thermal imaging optical lens assemblies andcameras and infrared imaging solutions. On April 8, 2004, we acquired allof the capital stock of Telic Optics, Inc., or Telic, a privately ownedmanufacturer of infrared optical products. The financial results of DiOP andTelic are included in our Optical Systems Group’s results from the respectivedates of acquisition.

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DiOP’s and Telic’s broad infrared optics capabilitiesincrease our product offerings and complement our strong position in reflectiveoptical solutions. The complementary addition of DiOP’s and Telic’s technicalcapabilities to our core technical strengths are expected to increase ourcompetitive advantage by broadening our technical offerings to primecontractors who are seeking to outsource the fulfillment of their opticalrequirements.

The focus markets for our Optical Systems Group areaerospace and defense, homeland security, high-performance graphic arts,medical imaging and semiconductor capital equipment. Our products are typicallysold to OEMs, which in turn supply a variety of government and commercialend-customers. In addition, some of DiOP’s thermal imaging cameras and clip-onnight sights are sold directly to equipment integrators as well as government,military and commercial end users.

The core technologies and manufacturing techniquesthat we use to supply the aerospace and defense industry are transferable tocommercial markets. The commercial markets that we serve include thesemiconductor, high-performance graphic arts and medical imaging industries. Inall of these markets, highly precise optical and motion control systems are required.For example, doctors need precise optical performance from medical imagingmachines in order to make accurate diagnoses. Similarly, the semiconductorindustry demands precise inspection of silicon wafers to ensure accurate chipperformance.

The Optical Systems Group has design and manufacturingfacilities in San Diego, California, Cullman, Alabama, Rochester Hills,Michigan, North Billerica, Massachusetts and Salem, New Hampshire.

For the fiscal year ended December 31,2005, the Optical Systems Group generated $108.7 million, or approximately81.4% of our total revenues.

*DistributedProducts Group*

The Distributed ProductsGroup distributes precision ball bearings, spherical plain bearings andbushings, which are acquired from various domestic and international sources,to OEMs and maintenance repair organizations, or MROs. The bearings andbushings are used in a variety of industrial automation and commercial markets.Additionally, the Distributed Products Group designs, manufactures and sellsmechanical-bearing subassemblies for a variety of customers. The DistributedProducts Group is comprised of the AST Bearings Division located in Montville,New Jersey, with a satellite distribution center in Irvine, California. For thefiscal year ended December 31, 2005, the Distributed Products Groupgenerated $24.9 million, or approximately 18.6%, of our total revenues.

**Market Overview**

Our products are soldmainly to OEMs in a variety of markets that demand the precision andperformance that our products and capabilities provide.

*Optical SystemsGroup*

*DefenseElectronics.**  *Defenseelectronics represents one of the largest growth sectors in the Department ofDefense budget. This sector includes the growing market for optical sensors andthermal imaging equipment. We have a substantial heritage in this market andcontinue to focus on protecting and building upon this position. We areinvolved in many large-scale programs including the F-16, F-18,Apache, Stryker MIA2 Abrams and Bradley Fighter Vehicle. Many of theapplications with which we are involved include the continuing development ofthe next-generation targeting, navigation and imaging systems for fighteraircraft, helicopters, aircraft carriers and armored vehicles. We are alsoinvolved in contributing to the night vision capabilities of the U.S. military.Night vision devices enable warfighters to better operate at night, creating adistinct advantage over their enemies. To further enhance its advantage 

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in nighttime operations,the Department of Defense continues to upgrade its infrared equipment, asevidenced by our recent $12.8 million base-contract win on the Thermal WeaponSight program to supply infrared objective lens assemblies to BAE Systems.

Optical sensors and thermal imaging equipment arevitally necessary for the U.S. military to maintain its battlefield superiority.Planned upgrade and improvement of such optical and thermal imaging equipmentis not dependent upon spending on new platforms. Even as new platform spendingis projected to be challenging over the next few years, we expect that spendingto upgrade the sensors on existing platforms will continue to thrive. Inaddition, we expect to participate in providing heat sinks, structures, opticsand opto-mechanical subassemblies on the next generation of defensecommunications and surveillance satellites that will support the ground-and air-based network-centric warfare platforms.

We have the opportunity to provide value-addedsolutions by integrating our technologies into sophisticated optical systems. Ourintegration capabilities would create value for the prime contractors byreducing the number of suppliers and collapsing the supply chain. We believe weare strategically positioned to design, develop and manufacture these systemsfor stabilized optical platforms.

In addition, we have designed our entire line ofthermal cameras using a consistent architecture and are therefore able toeasily construct exactly the combination of product features that best meet acustomer’s needs. For example, we essentially use the same electronicsprocessing architecture and optics across our suite of different cameras. Thecommon design elements of our thermal imagers permit us to offer a wide varietyof thermal cameras to satisfy specific customer demand. This approach hasallowed us to adapt cutting edge focal plane array technologies for bothhigh-end and low-end market opportunities. 

Additionally, our software engineering team has madesignificant strides in proprietary designs that drive our complex thermalcamera integration and allow us to respond to a variety of customerrequirements.

*HomelandSecurity.*   Since September 11, 2001,government officials have increased their focus on designing plans to reducethe risk of terrorist attacks and prepare for the consequences of terroristattacks. Many of the preventative efforts of these initiatives involve surveillanceand imaging of people, baggage, cargo and vehicles. We are well positioned toparticipate in this emerging market with our imaging and infrared solutions,including the expected increase in spending on border security, as the U.S.Border Patrol upgrades and supplements existing systems on the nation’s bordersto bolster homeland security efforts.

*NationalMissile Defense.*   Restructuring the country’sdefense and deterrence capabilities to correspond to emerging threats remains ahigh priority for the United States. The deployment of missile defenses is anessential component of this effort. We are an integral member of the contractorteams involved in the rollout of key NMD programs from development toproduction, including EKV, THAAD, PAC-3, SBIRS-High and Airborne Laser.

*OtherAerospace and Defense Opportunities.*   Inconnection with the U.S. government’s efforts to continually enhance agingweaponry, we have the opportunity to be involved in retrofitting the nuclearmissile arsenal with advanced gas bearings. We were chosen as the U.S. AirForce’s Center of Excellence for gas bearing production. We also have a longhistory of involvement with space-based telescopes for use in U.S.-basedsurveillance applications, as well as weather and astronomical research. Weexpect to benefit from the future growth in satellite programs.

*HealthImaging.**  *Webelieve we have positioned ourselves as a key supplier to the medical imagingsector with an industry leading airbearing scanner solution. The airbearingscanner that we developed has enabled our customer to reach the highest levelof design and performance of any medical imaging systems available on themarket. We have the opportunity to continue expanding our position in thesector as the market moves to develop new systems that require the mostadvanced imaging technology.

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*SemiconductorCapital Equipment.*   Our products are used in theprecise inspection of semiconductor wafers. These products include completeauto-focus assemblies, motion control stages and precise distance measuringdevices. We have the opportunity to expand our position in this industry byintroducing new products and marketing to new customers.

*GraphicArt.**  *We werea pioneer in the development of airbearing laser scanners used for digitalimaging of film within the graphic arts market in the early 1990’s. Whiledeclining advertising revenues have negatively impacted the graphic artsmarket, we have expanded our product offering to include marker engines, whichcan increase our average selling price to a customer over six-fold. Although weanticipate a moderate decline in the overall graphic arts market, we expect tomitigate this decline with the introduction of marker engines to our customerbase.

*Thermal Imaging.**  *Advancements in cooled and uncooled focal plane arraytechnology have improved the quality of infrared images and drastically reducedthe costs of producing thermal imaging camera systems. The development ofuncooled focal plane array technology during the mid-1990s has resultedin a pronounced reduction in the cost of infrared cameras. The market hasresponded with a number of infrared related products designed for a variety ofapplications, including firefighting, surveillance, preventive maintenance andother commercial night vision needs. Furthermore, the availability of moremoderately priced alternatives enables manufacturers to employ the sameinfrared systems or components for both commercial and military applications. Theenhanced total market size accumulated thereby is sufficient to create theeconomies of scale that permit broad deployment. We have been at the forefrontof developing both cooled and uncooled camera product offerings and, like muchof the rest of the infrared market, we have experienced a broad increase inthermal imaging demand as the cost effectiveness of employing infraredcapabilities has escalated.

*DistributedProducts Group*

*Ball Bearings.**  *The markets we serve include industrial automation,semi-conductor capital equipment, aerospace and defense and consumer products. Themarket for the distribution of ball bearings and related products generallyfollows worldwide economic trends.  Inorder to position us for growth, we are introducing new products, lower costproducts and value-added services.

**Technologies,Products, and Capabilities**

We utilize several key manufacturing technologies andhave developed software and systems integration capabilities that enable us todesign, manufacture and assemble a wide variety of high-performance precisionoptical and motion control solutions.  Our core competencies include:

*ThermalImaging Cameras.**  *We haveleveraged our turnkey optical design, manufacturing and integrationcapabilities into an extensive and growing line of world-class thermal imagingcameras. We currently have a product line of seven integrated thermal imagingsystems, approximately 20 cooled and uncooled cameras and five clip-on weaponnight sights. Our success in thermal cameras is integrally tied to our coatingprocesses and ability to produce industry-leading optical lens assemblies. Ourcameras, including surveillance systems, clip-on weapon night sights andhandheld imagers, fill a variety of requirements of federal and militarycustomers, municipal first responders, firefighters and commercial entities. Wehave expanded into the design and manufacture of thermal cameras and systemsintended for a wide range of surveillance requirements in the military,homeland security and commercial sectors. We sell weapons sights, both imageintensified and uncooled thermal imagers, that are designed to clip onto asoldier’s existing day sight eliminating the need to change over from a dayscope to a dedicated night sight while allowing the weapon to retain itsboresight after repeated use. We also manufacture a line of handheld thermalcameras that we market and sell to both first responders in municipal fire, lawenforcement and security departments, as well as to the U.S. Border Patrol andthe U.S. military. We also 

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manufacture and sell aline of complementary products, which are thermal imaging cameras designedspecifically for firefighting.

*PrecisionOptics.**  *Webelieve we are a leading designer and manufacturer of custom precisionreflective and transmissive optical solutions and components. We providecomplete design, fabrication and testing of glass and metal optics ranging fromsingle and multi-faceted scan mirrors, plano and aspheric mirrors to complextelescope assemblies and thermal camera lenses. We have designed and/ormanufactured numerous optical products for a variety of military andastronomical applications over the past 40 years.

We specialize in the manufacture of diamond-machinedaspheric metal optics that are significantly enhanced for optical figure andoptical finish by post polishing, typically while using custom engineeredinterferometric null tests. “Bolt together” assemblies with post polished metalaspheres are routine. We produce a variety of aspheric surfaces including conicaspheres, general case aspheres, cylindrical aspheres and toric aspheres withup to 0.80-meter aperture. Our precision metal optic products are used inapplications where performance requirements cannot be met with glass optics. Theadvantages of our optics include lighter weight, thermal stability and ease ofmechanical interface with housing and actuation devices. We sell our precisionmetal optical components for use in high speed electro-mechanical scanners,weapon fire control systems, forward-looking infrared, or FLIR, night visionweapon systems and high-performance space-borne instruments used on weather,mapping and scientific satellites.

We also specialize in the production of precisionglass lenses using infrared materials through the use of conventional grindingand polishing techniques. We produce aspheric lenses in glass by hand polishingand produce aspheric and diffractive lenses in infrared materials by diamondturning. Surfaces are tested using null test and profilometry. These glasslenses are integrated into sophisticated lens assemblies for use with thermalcameras or imaging systems, or sold as components for use by OEM suppliers invarious infrared applications. Our infrared lens assemblies are tested usinginfrared interferometry.

*PrecisionMotion Control.**  *Wedesign a complete line of brushless and brush type torque motors andservomotors that can be customized to meet customers’ unique specifications. Thedirect drive motor replaces conventional servomotor-gearhead configurationsimproving the response characteristics of the unit. Motors incorporate rareearth magnets with outer diameters ranging from 0.5” to 48” and provide peaktorques up to 1,650 ft-lbs.

The gearless DC motor drive is ideally suited for highacceleration applications requiring improved response for rapid start/stopactions such as missile seekers, optical stabilization and turret control. Theabsence of gearing also eliminates errors caused by friction and backlashcreating high threshold sensitivity. These motors achieve accuracies of onearc-second in a high performance positioning system. Our DC torque motors aredesigned using premium materials that offer unique space and weight savingproperties while generating maximum power output. Limited angle torque motorsdo not require commutation electronics and have near zero cogging.

We also manufacture highly reliable multi-speed andsegmented positioning sensors, such as resolvers and induction potentiometers,which provide a high degree of angular accuracy and resolution. These devicestypically accompany our motors to provide position feedback within a highperformance system.

Resolvers are available with transmitter, differentialor receiver functions. These resolvers are specifically designed to withstandhigh-impact shock and environments containing dirt, grease, oil or othercontaminants, and are available housed or un-housed in a variety ofconfigurations. Resolvers are either single or multi-speed (up to 64-speed),with outer diameters ranging from 0.7” to 15”, and provide accuracies to 5 arcseconds.

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Induction potentiometers, also defined as lineartransmitters, provide high linearity output over a wide angular range.Induction potentiometers are available in frameless and housed configurationsand brush and brushless designs.

*Electronics.**  *We design and manufacture several key electroniccomponents for the semiconductor capital equipment and high-end digital imagingmarkets, including laser interferometers and electronic controllers and drives.Our electronic components control the speed and position of electro-mechanicalsystems, such as precision motors, actuators, X-Y positioning stages and laserscanners. Laser interferometers, which are designed to permit precise linearposition sensing, are sold to customers principally in the semiconductorcapital equipment market. Electronic controllers coordinate the positioning andspeed of electro-mechanical systems by interfacing with other motion controlcomponents. Drives provide power to a motor based on input from the controllerin order to achieve a designated position or to achieve a specific speed.

*PrecisionMachining.*   We are a leading fabricator ofprecision machined and processed exotic materials. These include beryllium,AlBeMet, titanium, halfnium, quartz and glass used in the defense, space andhigh-performance commercial markets. Operating within a 120,000 square footenvironmentally-controlled manufacturing facility, we provide completefabrication services including manual and CNC milling, turning, EDM, lappingand grinding, chemical and special processing and mechanical assembly. Usingthese technologies, we are able to meet our customers’ extremely high tolerancerequirements. Applications include precision optics, airbearings, heat sinks,structural housings and gimbals. Our airbearings provide high-speed precisionpositioning and are used in high-speed scanners for digital imaging and weaponguidance systems. Our heat sinks are used to dissipate heat in high-performanceavionics and satellite electronics, and our gimbals are used in variousapplications, including positioning optical sensors in FLIR night visionsystems. We also manufacture optical substrates used internally and by ourcustomers in a variety of precision metal optical applications such as weaponfire control systems and space-borne instruments.

Thefollowing table summarizes our core engineering and manufacturing capabilities:

| **Core Manufacturing Technologies** |
|-------------------------------------|
| Precision Optics                    | ** ** | **Precision Motion Control** | ** ** | **Electronics** | ** ** | **Precision Machining** |
| Infrared Lenses                     |   | Multi-Axis Gimbals |   | AC & DC Motor |   | Optical Substrates |
| Infrared Cameras                    |   | AC Motors |   | Speed Controls |   | Gimbals and Yokes |
| Optical Lens  Assemblies            |   | Brush & Brushless |   | Custom DSP Motion |   | Airbearings |
| Telescopes                          |   | DC Motors: |   |    Controllers |   | Components |
| Thin Film Coating                   |   | Torque |   | Motor Drives |   | Structural Housings |
| Polygon Mirrors                     |   | Servo |   |   |   | Heat Sinks |
| Monogon Mirrors                     |   | Limited Angle |   |   |   |   |
| Aspheric Optics  Flat               |   | Resolvers |   |   |   |   |
| Optics Head  Mirrors                |   | Synchros |   |   |   |   |
| Fold Mirrors                        |   |   |   |   |   |   |
| Collimators                         |   |   |   |   |   |   |

 

Utilizing these core technologies, we have developedan array of solutions to create value-added, vertically integrated solutionsfor the aerospace, defense and high-performance commercial equipment industries.Examples of these solutions include:

*InfraredZoom Lenses:**  *Wedesign and manufacture sophisticated zoom and multi-field-of-view thermallenses for use in a variety of military applications. These lenses are sold toOEMs who subsequently integrate them with infrared cameras and imagers formilitary and intelligence purposes.

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*InfraredCameras and Systems.**  *Wehave developed a broad range of cooled and uncooled camera systems, culminatingin the recently released Electro Optical Sensor Suite, a state-of-the-artintegrated system comprised of a cooled or uncooled thermal imager, pan/tiltmounting, joystick controller, optional visible camera and numerous otherfeatures.

*Motion-ControlSolutions.**  *Weprovide precision micro-positioning systems. These high-performance systems areused in a diverse array of high-end commercial applications such as stabilizedoptical platforms, semiconductor and flat panel process and inspectionssystems, as well as laser imaging systems.

*FastSteering Mirrors.**  *We haveapplied extensive experience designing and building opto-mechanical systems todevelop fast steering mirror, or FSM, technology. The single-axis and two-axis,flexure mounted FSM represents a compact, low cost, high-performance designsolution for a variety of emerging optical scanning and beam stabilizationapplications. Such devices may be used to correct for polygon cross scanerrors, acquire and lock beams within free space laser systems, modulate tiltand cavity control in interferometers, maintain beam stabilization in thepresence of thermal drift and vibration, and provide general two-axis beamscanning.

*MarkerEngines.**  *We haveleveraged our experience providing high-speed airbearing scanners with ourprecision optics and electronics capabilities to produce ultra-high performanceflat bed marker engines. Each engine is self-contained, pre-aligned and readyto integrate into a customer’s system.

*Rotary AirbearingScanners.*   We design and manufacturer rotaryairbearing scanners for use in high precision graphic arts and medical imagingapplications, semiconductor mask production and inspection applications, aswell as defense applications. Airbearing scanners provide numerous advantagesover mechanical bearings due to their low noise characteristics, repeatabilityand ability to rotate at high speeds (up to 100,000 RPMs). When combined withour electronic controllers, our airbearing scanners provide extremely highcross-scan accuracy and extremely low jitter.

***Backlog and Orders***

Axsys recognized, in 2005,bookings of $148.2 million, ending the year with record backlog of $112.7 million,of which 10.2% will be shipped beyond 12 months. Our backlog increased by $24.5million, or 27.8%, compared to our ending backlog of $88.2 million as of December 31,2004.

**Competition**

The markets for our products are competitive. Wecompete primarily on the basis of our ability to design and engineer productsto meet performance specifications set by our customers. Most of our customersare OEMs that purchase component parts or subassemblies, which they incorporateinto their end products. Although most of our customers are OEM’s, our thermalimaging cameras and clip-on night sights are typically sold directly toequipment integrators, as well as government, military and commercial end users.Product pricing, quality, customer support, experience, reputation andfinancial stability are also important competitive factors.

There are a limited number of competitors in each ofthe markets for the various types of precision optical, infrared and motioncontrol systems and components that we design, manufacture and sell. Ourcompetitors are often well entrenched particularly in the aerospace and defensemarkets. Some of these competitors have substantially greater resources than wedo. We believe that the breadth of our technologies and product offerings providesus with a competitive advantage over certain manufacturers that supply onlydiscrete components or who are not vertically integrated with enablingtechnologies.

There are numerous competitors in markets to which wedistribute our precision ball bearings. These competitors vary in size andinclude bearing manufacturers and other distributors. We believe that our 

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product breadth andavailability, combined with the value-added services we supply, providecompetitive advantages.

We expect our competitors tocontinue to improve the design and performance of their products. We cannotassure you that our competitors will not develop enhancements to, or futuregenerations of, competitive products that will offer superior price orperformance features, or that new technology or processes will not emerge thatrender our products less competitive or obsolete. Increased competitivepressure could lead to lower prices for our products, thereby adverselyaffecting our business, financial condition and results of operations. Wecannot assure you that we will be able to compete successfully in the future.

**Customers**

Our customers include OEMs, equipment integrators andend-users that design or utilize high-precision, performance and throughputequipment. We sell our products primarily to OEM customers in the aerospace anddefense, homeland security, high-end graphic art, medical imaging,semiconductor capital equipment and industrial automation markets.

Sales to Raytheon Company, an aerospace and defensesystems supplier, represented 12.3% of our net sales in 2005, 18.9% in 2004,and 15.5% in 2003.  Our accountsreceivable for Raytheon were $1.0 million at December 31, 2005, $4.5million at December 31, 2004 and $696 thousand at December 31, 2003. WhileRaytheon, a prime contractor with the U.S. government, does constitute asignificant portion of our business, our sales are diversified since we sell to14 separate locations within five of Raytheon’s seven segments. Consequently,we do not currently believe that this is at-risk business.

We had aggregate sales, both military andnon-military, directly to the U.S. government, including its agencies anddepartments, of approximately $4.6 million in 2005, $2.4 million in 2004 and$3.4 million in 2003. These sales accounted for approximately 3.4% of total netsales in 2005, 2.3% in 2004 and 4.0% in 2003. Approximately 56.3% of net salesin 2005, 46.0% in 2004 and 43.0% in 2003 were derived from subcontracts withU.S. government contractors. The majority of these contracts are subject totermination at the convenience of the U.S. government, and certain contractsare also subject to renegotiation. Currently, we are not aware of any proposedtermination or renegotiation of such contracts that would have a materialadverse effect on our business.

Because a substantial partof our business is derived directly from contracts with the U.S. government,U.S. government agencies or departments, or indirectly through subcontractswith U.S. government contractors, our operational results could be materiallyaffected by changes in U.S. government expenditures for projects or programsusing our products. However, we believe that the broad number and diversity ofthe programs with which we are involved and the breadth of our productapplications may lessen our exposure to such risk.

**Sales,Marketing and Customer Support**

As of December 31, 2005, we employed 69 sales,marketing and customer support personnel throughout our organization, comparedto 56 employees in similar functions at the end of 2004. We utilize two OEMsales organizations, one focused on aerospace and defense customers and theother focused on high-performance commercial customers. We have a separatedistributed products sales force that is focused on selling ball bearings, bushingsand assemblies, principally to commercial and industrial oriented OEMs as wellas MRO distributors.

Our sales organization included 26 direct sales fieldpersonnel, most of whom have engineering backgrounds, with the remainderinvolved in inside sales, customer service, program management, contractadministration and applications engineering. We believe that our sales effortis enhanced by having 

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engineering-trained salespersonnel available to meet with our customers’ engineering personnel. Ourapplication and design engineers are also involved in the sales process.

We also sell our productsthrough a significant number of manufacturers’ sales representatives and agents.Although we believe that we have satisfactory relationships with these salesrepresentatives and agents, we cannot assure you that these relationships willcontinue to be satisfactory or will continue at all.

**Domestic and Foreign Sales**

Thetable below presents sales from continuing operations to specific geographicregions. Substantially all of our assets are located within the United States.

| ** **    | ** ** | **Years Ended December 31,** | ** ** |
|---------------|------------|---------------------------------------------|------------|
| ** **    | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **    | ** ** | **(In thousands)**                          | ** ** |
| United States |       | $                                           | 118,218    |   | $ | 91,069 |   | $ | 73,051 |   |
| Europe        |       | 10,026                                      |       | 8,672 |   | 8,991 |   |
| Other foreign |       | 5,299                                       |       | 3,789 |   | 3,067 |   |
| Total sales   |       | $                                           | 133,543    |   | $ | 103,530 |   | $ | 85,109 |   |

 

**Research,Development and Engineering**

We seek to develop new products and improve existingproducts in order to keep pace with the increasing performance requirements ofour customers. We devote significant resources, a portion of which isreimbursed by customers, to development programs directed at creating newproducts and product enhancements, as well as developing new applications forexisting products. Because we believe that our ability to compete effectivelydepends in part on maintaining and enhancing our expertise in applying newtechnologies and developing new products, we dedicate substantial resources toengineering, research and development. On December 31, 2005, we employed88 individuals in engineering, research and development functions.We cannotassure you that our product development efforts will be successful in producingproducts that respond to technological changes or new products introduced byothers.

Our costs associated withresearch, development and engineering expenses were $3.8 million in 2005, $2.7million in 2004 and $2.1 million in 2003. We intend to direct our research anddevelopment activities toward integrating our various technologies andcontinuing to develop sub-systems.

**Raw Materials Suppliers**

The raw materials and components that we purchase aregenerally available from multiple suppliers. However, beryllium, a materialused extensively by our Company, is only available from BrushWellman, Inc., the sole U.S. supplier. Historically, we have had anexcellent relationship with Brush Wellman and have not encountered problems inobtaining our supply requirements. However, the partial or complete loss ofBrush Wellman as a supplier of beryllium, or production shortfalls orinterruptions that otherwise impair the supply of beryllium, would have amaterial adverse effect on our business, financial condition and results ofoperations. If such conditions were to occur, it is uncertain whetheralternative sources could be developed.

In addition, we purchase a substantial amount of ballbearings that we distribute from two foreign suppliers. While we believe thatwe could obtain alternate sources of supply, any interruption in the flow ofproducts from these suppliers, or significant increases in the cost of theseproducts, could have an adverse effect on our business, financial condition andresults of operations. We paid these two suppliers $5.8 million in 2005, $6.4million in 2004 and $5.4 million in 2003.

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**Patents and Trademarks**

We are not dependent upon any single patent ortrademark. We have a combination of patents, trademarks and trade secrets,non-disclosure agreements and other forms of intellectual property protectioncovering our proprietary technology. Although we believe that our patents andtrademarks may have value, we believe that our future success will dependprimarily on the innovation, technical expertise, manufacturing and marketingabilities of our personnel. We cannot assure you as to the degree of protectionoffered by our patents. We cannot assure you that we will be able to maintainthe confidentiality of our trade secrets or that our non-disclosure agreementswill provide meaningful protection of our trade secrets, know-how or other proprietaryinformation in the event of any unauthorized use, misappropriation or otherdisclosure.

Competitors in the UnitedStates and foreign countries, many of which have substantially greaterresources, may have applied for or obtained, or may in the future apply for andobtain, patents that will prevent, limit or interfere with our ability to makeand sell some of our products. Although we believe that our products do notinfringe on the patents or other proprietary rights of third parties, we cannotassure you that third parties will not assert infringement claims against us orthat such claims will not be successful.

**Environmental Regulation**

We believe that we are currently in compliance, in allmaterial respects, with federal, state and local laws and regulations governingthe use and discharge of hazardous substances and other pollutants into theenvironment or otherwise relating to the protection of the environment and thatany non-compliance with such laws will not have a material adverse effect uponour business, financial condition, results of operations, capital expenditures,earnings or competitive position. We cannot assure you, however, (1) thatchanges in federal, state or local laws, regulations or regulatory policy orthe discovery of unknown problems or conditions will not in the future requiresubstantial expenditures or (2) as to the extent of our liabilities, ifany, for past failures, if any, to comply with applicable environmental laws,regulations and permits, any of which also could have a materially adverseeffect on our business, financial condition or results of operations.

We have incurred, and may in the future incur, costsand liabilities under the Comprehensive Environmental Response, Compensationand Liability Act, or CERCLA, or similar state laws for the investigation andcleanup of hazardous waste or contamination at third party waste disposal sitesor at current or former facilities, related in part to historical practices orwaste disposed of prior to the purchase of facilities by us. We are in theprocess of remediating two formerly owned sites in Bedford, Ohio and St.Petersburg, Florida and we are participating as a potentially responsibleparty, or PRP, at a third-party waste disposal site in Norwalk, Connecticut.  Although liability under CERCLA is joint andseveral, meaning that liability can exceed a PRP’s pro rata share of cleanupcosts, we believe, based on currently available information, that costsassociated with these sites will not have a material adverse effect on ourbusiness and financial condition. It is possible, however, that our results ofoperations for a particular fiscal period could be materially affected.

At December 31, 2005, we have an accrual of $463thousand for future costs related primarily to our former sites in Bedford,Ohio and St. Petersburg, Florida. These estimates have been developed inconsultation with outside environmental and legal consultants handling thesematters and are based upon an analysis of the anticipated remediation plans. Wedo not anticipate these matters will have a material adverse effect on ourconsolidated financial position. It is possible, however, that our futureoperations could be materially adversely affected if our assumptions regardingthe anticipated remediation plans are changed, for example, by the discovery ofadditional contamination, increased difficulty in remediation, 

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changes in regulatoryrequirements or the failure of other PRPs to pay their pro-rata share of theremediation costs.

In addition, in 2001, we were notified by the UnitedStates Environmental Protection Agency, or the EPA, that it considers us a PRPfor the US Cap and Jacket site in Prospect, Connecticut. Our former subsidiary,which was merged into us in 1979, operated a screw machine shop at thislocation from 1961 to 1978. The EPA demanded reimbursement for its costsincurred in connection with a time-critical removal action at the site in 2001.In April 2004, the EPA notified us that the total amount of these costswas approximately $650 thousand, including indirect costs and interest accruedthrough that date. We advised the EPA of our position that the contaminationmust have occurred after our ownership of the site and that, accordingly, weare not responsible for the EPA’s costs or the remediation of the site. The EPAcontinued its investigation of the site, including serving us with a formalrequest for information under Section 104(e) of CERCLA in July 2004(to which we responded). The EPA designated no other PRPs. The EPA informed usthat it was prepared to commence a CERCLA cost-recovery action against us if wewere unable to amicably resolve the matter. On July 18, 2005, we signed aSettlement Agreement with the EPA, settling this matter for $175 thousand, plusaccrued interest from this date through the date of payment. We have no furtherresponsibility to the EPA as it relates to the EPA’s 2001 removal action atthis site. During 2005, we recognized an after-tax charge of $150 thousand indiscontinued operations for the settlement costs and legal expenses associatedwith the settlement of this matter.

We use or generate certainhazardous substances in our manufacturing and engineering facilities. Webelieve that our handling of these substances is in compliance with, andexceeds what is required by, applicable local, state and federal environmental,safety and health regulations at each operating location. For example, we haveinstituted engineering controls to meet the As Low As Reasonably Achievablestandard with respect to airborne beryllium particulates at our Cullman,Alabama plant. Thus, the air quality standard for our facility is..2 micrograms per meter cubed, which exceeds the standard set by theOccupational Safety and Health Administration’s standard of 2 microgramsper meter cubed. We invest in protective equipment, process controls andspecialized training to minimize risks to employees, surrounding communitiesand the environment due to the presence and handling of these hazardoussubstances. We regularly conduct employee physical examinations and workplaceair monitoring related to these substances. When potential or actual exposureproblems have been indicated, we implement corrective actions. In general,re-occurrence has been minimal or non-existent. We do not carry environmentalimpairment insurance. Accordingly, any failure by us to properly manageexposure to hazardous substances could have a materially adverse effect on ourbusiness, financial condition and our operations.

**Employees**

As of December 31,2005, we employed 749 persons, including 524 in manufacturing, 69 in sales, 88in engineering and 68 in administration. We currently do not have any unionsand we consider our relationship with our employees to be satisfactory. Therehas been no significant interruption of operations due to labor disputes.

**Available Information**

Our Internet website ishttp://www.axsys.com. We make available free of charge on our website ourannual reports on Form 10-K, quarterly reports on Form 10-Q,current reports on Form 8-K and amendments to those reports as soonas reasonably practicable after we electronically file or furnish suchmaterials to the Securities and Exchange Commission. In addition, we haveposted the charters for our Audit Committee, Compensation Committee, andNominating and Governance Committee on our website under the headings “Investors.”These charters are not incorporated herein by reference. We will also provide acopy of these documents to shareholders upon request.

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**Item 1A.**                RISKFACTORS

You should carefully consider each of the risk anduncertainties we describe below and all of the other information in this annualreport. The risk and uncertainties we describe below are not the only ones weface. Additional risks and uncertainties of which we are currently unaware orthat we currently believe to be immaterial may also adversely affect ourbusiness.

**We depend on contracts with the U.S. federalgovernment for a significant portion of our sales. Most of these contracts aresubject to termination and renegotiation by the U.S. federal government at anytime.**

The aerospace and defense industry, which representsthe majority of our sales, is largely dependent upon government contracts. Asignificant portion of our business and business development efforts isconcentrated in the aerospace and defense industry. Our business depends, insignificant part, upon the U.S. government’s continued demand in the area ofdefense for high-end, high-performance products of the type that wemanufacture. Approximately 60% of our sales in 2005, 48% in 2004 and 47% in2003 were derived directly from contracts with the U.S. government, or itsagencies or departments, or indirectly from subcontracts with U.S. governmentcontractors.

The majority of these government contracts are subjectto termination and renegotiation. Generally, government contracts andsubcontracts are subject to oversight audits by government representatives andcontain provisions permitting termination, in whole or in part, without priornotice at the government’s convenience upon the payment of compensation onlyfor work done and commitments made at the time of termination. We can give noassurance that one or more of our government contracts or subcontracts will notbe terminated under these circumstances. Also, we can give no assurance that wewould be able to procure new government contracts or subcontracts to offset therevenues lost as a result of any termination of our contracts. Because ourrevenues are dependent on our procurement, performance and payment under our contracts,the loss of one or more critical contracts could have a materially adverseeffect on our business, financial condition and results of operations.

**The lossof Raytheon as a customer or a significant reduction in sales to Raytheon couldhave a materially adverse effect on our business, financial condition andresults of operations.**

We rely on key customers.We currently have one customer that represents a significant portion of oursales. During 2005, approximately 12.3% of our sales were to Raytheon. The lossof Raytheon as a customer or a significant reduction in sales to Raytheon couldhave a materially adverse effect on our business, financial condition andresults of operations.

If Raytheon or any of ourother key customers becomes insolvent or files for bankruptcy, our ability torecover accounts receivable from that customer would be adversely affected andany payments we received in the preference period prior to a bankruptcy filingmay be potentially recoverable, which could have a materially adverse effect onour business, financial condition and results of operations.

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**U.S. federalgovernment spending priorities may change in a manner adverse to our business.**

We actas a subcontractor for many different government programs. The funding of governmentprograms is subject to congressional appropriations. Although multi-yearcontracts may be authorized in connection with major procurements, Congressgenerally appropriates funds on a fiscal year basis even though a program maycontinue for several years. Consequently, programs are often only partiallyfunded initially, and additional funds are committed only as Congress makesfurther appropriations. The termination of funding for a government programwould result in a loss of anticipated future revenues attributable to thatprogram, which could have a materially adverse effect on our business,financial condition and results of operations. In addition, the termination ofa program or failure to commit additional funds to a program already started couldincrease our overall costs of doing business. Among the factors that couldmaterially adversely affect our federal government contracting business are:

·       budgetaryconstraints affecting federal government spending generally, or defense andintelligence spending in particular, and annual changes in fiscal policies oravailable funding;

·       changesin federal government programs, priorities, procurement policies or  requirements;

·       newlegislation, regulations or government union pressures, on the nature andamount of services the government may obtain from private contractors;

·       federalgovernmental shutdowns (such as during the government’s 1996 fiscal year) andother potential delays in the government appropriations process;  and

·       delaysin the payment of our invoices by government payment offices due to problemswith, or upgrades to, government information systems, or for other reasons.

These or other factorscould cause federal governmental agencies, or prime contractors where we areacting as a subcontractor, to reduce their purchases under contracts, toexercise their right to terminate contracts or to not exercise options to renewcontracts, any of which could have a materially adverse effect on our business,financial condition and results of operations.

**We couldbe suspended or debarred from contracting with the federal government.**

We could be debarred orsuspended from contracting with the federal government generally, or anysignificant agency in the intelligence community or Department of Defense, for,among other things, actions or omissions that are deemed by the government tobe so serious or compelling that they affect our contractual responsibilities.For example, we could be debarred for committing a fraud or criminal offense inconnection with obtaining, attempting to obtain or performing a contract, orfor embezzlement, fraud, forgery, falsification or other causes identified inSubpart 9.4 of the Federal Acquisition Regulation. In addition, our reputationor relationship with the government agencies could be impaired. If we weresuspended or debarred, or if our relationship or reputation were impaired, ourbusiness, financial condition and results of operations could be materiallyadversely affected.

**Thefailure to obtain, or any delays in obtaining, export authorizations from thefederal government in connection with the export of our products, or theimposition of sanctions for failing to comply with the export control laws andregulations, could have a materially adverse effect on our business, financialcondition and results of operations.**

We must often obtain theprior review and approval of the federal government in connection with theexport of our products and technology. Such approvals are provided via licensesor other authorizations issued by government agencies under the Arms ExportControl Act, the International Traffic in Arms Regulations, the ExportAdministration Regulations and other laws and regulations that control exportsof hardware and technology to foreign countries and the transfer of technologyto foreign persons wherever 

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located.We can give no assurance that we will be successful in obtaining andmaintaining the necessary licenses or other authorizations required to conductbusiness in foreign countries or with foreign persons. Recently, heightenedgovernment enforcement of the export control laws and regulations, and anincreasingly restrictive federal government policy with respect to the exportlicensing of certain technologies including infrared and night vision systems,has resulted in lengthened review periods for our license applications andincreased risks that such requests for licenses or other authorizations couldbe denied. The failure to comply with such export control laws and regulationscan result in the imposition of sanctions, which may include monetary penaltiesand the loss of export privileges. The imposition of such sanctions, or thefailure to obtain or delays in obtaining export licenses or other necessaryauthorizations that would prevent or delay us from selling our products outsidethe United States, could have a materially adverse effect on our business,financial condition and results of operations.

**We mustcomply with complex procurement laws and regulations.**

Wemust comply with and are affected by laws and regulations relating to theformation, administration and performance of federal government contracts,which affect how we do business with our customers and may impose added costson our business. Among the most significant regulations are:

·       theFederal Acquisition Regulation, and agency regulations supplemental to theFederal Acquisition Regulation, which comprehensively regulate the formation,administration and performance of government contracts;

·       theTruth in Negotiations Act, which requires certification and disclosure  of all cost and pricing data in connectionwith contract negotiations;

·       theCost Accounting Standards and Cost Principles, which impose accountingrequirements under certain government contracts; and

·       laws,regulations and executive orders restricting the use and dissemination ofinformation classified for national security purposes and the exportation  of certain products and technical data.

Moreover, we are subjectto industrial security regulations of the Department of Defense and otherfederal agencies that are designed to safeguard against foreigners’ access toclassified information. If we were to come under foreign ownership, control orinfluence, our federal government customers could terminate or decide not to renewour contracts, and it could impair our ability to obtain new contracts.

**Wemay not be able to implement our business plan effectively because theindustries in which we operate are subject to fluctuations and other factorsthat are difficult to forecast.**

Our operatingresults may vary substantially due to factors that are difficult to forecast.Factors such as announcements of technological innovations or new products byus or our competitors, domestic and foreign general economic conditions and thecyclical nature of the industries that we serve could cause substantialvariations in our operating results. The aerospace and defense, semiconductorcapital equipment, high-performance graphic art, medical imaging capitalequipment and industrial automation OEM and MRO industries, each of whichrepresents a significant market for our products, have historically beensubject to substantial economic fluctuations due to changing demands for theirproducts and services, introduction of new products and product obsolescence.Any future fluctuations arising from these or other conditions could have amaterially adverse impact on our business, financial condition and results ofoperations. We have experienced, and expect to continue to experience,significant fluctuations in our quarterly and annual operating results due to avariety of factors, including:

·       marketacceptance of new and enhanced versions of our products;

·       timingand shipment of significant orders;

·       mixof products sold;

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·       lengthof sales cycles;

·       plantopenings and closings;

·       thetiming of acquisitions or dispositions;

·       delaysin raw materials shipments, as well as other manufacturing delays anddisruptions;

·       completionof large projects;

·       thelevel of backlog of orders;

·       domesticand foreign general economic conditions; and

·       demandin the markets that we serve.

To some extent, primarilyin our bearing distribution division, our net sales and operating results for aspecific quarter will depend upon generating orders to be shipped in the samequarter in which the order is received. The failure to receive anticipatedorders or delays in shipments near the end of a particular quarter, due, forexample, to unanticipated rescheduling or cancellations of shipments by our customersor unexpected manufacturing difficulties, may cause our net sales in aparticular quarter to fall significantly below expectations, which could have amaterially adverse effect on our business, financial condition and results ofoperations for such quarter.

**If weare unable to adapt to technological change, demand for our products may bereduced.**

The rapid pace oftechnological change will require continuous new product development. Oursuccess will continue to depend in substantial part upon our ability tointroduce new products that keep pace with technological developments andevolving industry standards and to apply appropriate levels of engineering,research and development resources necessary to keep pace with thesedevelopments. In addition, our success will depend on how well we respond tochanges in customer requirements and achieve market acceptance for our productsand capabilities. Any failure by us to anticipate or respond adequately totechnological developments and customer requirements could have a materiallyadverse effect on our business, financial condition and results of operations.In order to develop new products successfully, we are dependent upon closerelationships with our customers and their willingness to share proprietaryinformation about their requirements and participate in collaborative effortswith us. We cannot assure you that our customers will continue to provide uswith timely access to information or that we will be successful in developingand marketing new products and services or their enhancements. In addition, wecannot assure you that the new products and services or their enhancements, ifany, that we develop will achieve market acceptance.

**Weoperate in highly competitive markets with competitors who may have greaterresources than we possess, which could reduce the volume of products we cansell and our operating margins.**

Our markets are extremely competitive. We competeprimarily on the basis of our ability to design and engineer our products tomeet performance specifications set by our customers, most of whom are OEMs whopurchase component parts or sub-systems for inclusion in their end products.Product pricing and quality, customer support, experience, reputation andfinancial stability are also important competitive factors.

There are a limited number of competitors in each ofthe markets for the various types of precision optical and positioning productsthat we sell. Our competitors, especially those in the precision optical andpositioning product lines, are typically focused on a smaller number of productofferings than we are, and they are often well entrenched. Some of ourcompetitors have substantially greater resources than we do. Our competitorscould develop enhancements to or future generations of competitive productsthat will 

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offer superior price orperformance features to ours. In addition, new processes or technologies couldemerge that render our products less competitive or obsolete.

In addition, a substantial investment is required by anexisting or potential customer to integrate components and sub-systems intotheir product design. We believe that once a customer has selected particularcomponents or sub-systems from one vendor, the customer generally relies uponthat vendor to provide equipment for the specific product application and mayseek to rely upon that vendor to meet other component or sub-systemrequirements. Accordingly, we may be at a competitive disadvantage with respectto a prospective customer that chooses to utilize a competitor’s components orsub-systems.

Further, there are numerous competitors in markets towhich we distribute precision ball bearings. Our competitors, who vary in size,include other ball bearings distributors as well as ball bearingsmanufacturers.

The basis of competitionin the industries in which we compete could shift and we may not be able tocompete successfully.

**Ourbacklog is subject to reduction and cancellation.**

Backlog representsproducts or services that our customers have committed by contract to purchasefrom us. Our backlog as of December 31, 2005 was $112.7 million. Ourbacklog is subject to fluctuations and is not necessarily indicative of futuresales. Moreover, cancellations of purchase orders or reductions of productquantities in existing contracts could materially reduce our backlog and,consequently, future revenues. Our failure to replace canceled or reducedbacklog could result in lower revenues.

**Weoperate internationally, which exposes us to the risks of doing business abroad.**

Our levels ofinternational sales and purchases could pose risks to our operating results.Our international sales from continuing operations accounted for approximately11.5% of our sales in 2005, 12.0% in 2004 and 14.2% in 2003. In addition, ourproducts are sold to domestic customers who use them in products that they sellinto international markets. Also, we purchase a substantial portion of our ballbearing products from two foreign suppliers and certain other products fromother foreign suppliers. Our international sales and purchases are subject to anumber of risks generally associated with international operations, includingthe following:

·       generaleconomic conditions;

·       importand export duties and restrictions;

·       currencyfluctuations;

·       changesin regulatory requirements;

·       theimposition of tariffs and other barriers;

·       politicaland economic instability;

·       potentiallyadverse income tax consequences;

·       transportationdelays and interruptions;

·       laborunrest and current and changing regulatory environments;

·       ourability to comply with regulations governing foreign government  contracts;

·       difficultiesin staffing and managing multi-national operations; and

·       limitationson our ability to enforce legal rights and remedies.

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Any of these factors couldhave a materially adverse effect on our business, financial condition andresults of operations. We cannot assure you that we will continue to operate incompliance with applicable customs, currency exchange control regulations,transfer pricing regulations or any other laws or regulations to which we maybe subject. We also cannot assure you that these laws will not be modified.

**Oursales growth and earnings may be reduced if we cannot implement our acquisitionstrategy.**

We may not be able to successfully manageacquisitions. As part of our business development strategy, we plan to pursueacquisitions in order to expand our product offerings, add to or enhance ourbase of technical and sales personnel or provide desirable customerrelationships. This growth could result in a significant strain on ourmanagerial, financial, engineering and other resources. The rate of our futureexpansion, if any, in combination with the complexity of the technologiesinvolved in our businesses, may demand an unusually high level of managerialeffectiveness in anticipating, planning, coordinating and meeting ouroperational needs as well as the needs of our customers.

We may not successfullyacquire the most complementary businesses. We cannot assure you that we will beable to acquire complementary businesses on a cost-effective basis, integrateacquired operations into our organization effectively, retain and motivate keypersonnel, or retain customers of acquired firms. We compete for attractiveacquisition candidates with other companies or investors, and that competitioncould increase the cost of pursuing our acquisition strategy or reduce thenumber of attractive candidates to be acquired.

**Wemay be unable to integrate our acquired companies successfully.**

If we fail to integrate acquired businessessuccessfully, especially the recently acquired DiOP, or to manage our growth,that failure could have a materially adverse effect on our business, financialcondition and results of operations. Further, there can be no assurance that wewill be able to maintain or enhance the profitability of DiOP or any otheracquired business or consolidate operations to achieve cost savings.

In addition, there may beliabilities that we fail, or are unable, to discover in the course of performingdue diligence investigations on each company or business we have alreadyacquired or may acquire in the future. Such liabilities could include thosearising from employee benefits contribution obligations of a prior owner ornon-compliance with applicable federal, state or local environmentalrequirements by prior owners for which we, as a successor owner, may beresponsible. In addition, there may be additional costs relating toacquisitions including, but not limited to, possible purchase price adjustments.We cannot assure you that rights to indemnification by sellers of assets to us,even if obtained, will be enforceable, collectible or sufficient in amount,scope or duration to fully offset the possible liabilities associated with thebusiness or property acquired. Any such liabilities, individually or in theaggregate, could have a materially adverse effect on our business, financialcondition and results of operations.

**Wemay experience production delays if suppliers fail to deliver materials to us.**

Many key product components come from single sourcesuppliers. A significant portion of our precision machining business depends onthe adequate supply of specialty metals, such as beryllium, at competitiveprices and on reasonable terms. We currently procure all of our beryllium fromBrush Wellman, Inc., or Brush Wellman, the sole U.S. supplier, and expectto continue to rely on Brush Wellman for beryllium for the foreseeable future.Although we have not experienced significant problems with our supplier in thepast, we cannot assure you that such relationship will continue or that we willcontinue to obtain such supplies at cost levels that would not adversely affectour gross profit. The partial or complete loss of Brush Wellman as a supplierof beryllium, or production shortfalls or interruptions that otherwise impairour supply of beryllium, could have a materially adverse effect on ourbusiness, financial condition 

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and results of operations.It is uncertain whether alternative sources of supply could be developedwithout a material disruption in our ability to provide beryllium products toour customers.

In addition, we purchase asubstantial amount of the ball bearings that we distribute from two foreignsuppliers. Although we have not experienced significant problems with our othersuppliers in the past, we cannot assure you that such relationships willcontinue or that, in the event of the termination of one or more of ourrelationships with those other suppliers, we would be able to obtain alternativesources of supply without a material disruption in our ability to provideproducts to our customers. Any material disruption in our supply of productscould have a materially adverse effect on our business, financial condition andresults of operations.

**Ourfuture growth and continued success are dependent on our key personnel.**

Our success depends to asignificant extent on the continued services of our key executive officers andsenior management personnel. The loss of the services of one or more of theseindividuals could have a materially adverse effect on our business, financialcondition and results of operations. We do not maintain key man life insuranceon our executive officers. In addition, since our continued success is largelydependent upon our ability to design, manufacture and sell high-performancesolutions for the high-performance technology market, we are particularlydependent upon our ability to identify, attract, motivate and retain qualifiedtechnical personnel, including engineers and skilled machinists, with therequisite educational background and industry experience. Our employees mayvoluntarily terminate their employment with us at any time, and competition forpersonnel is intense. Accordingly, we cannot assure that we will be successfulin retaining our existing personnel. The loss of the services of a significantnumber of our technical or skilled personnel, or the future inability toattract technical or skilled personnel, could have a materially adverse effecton our business, financial condition and results of operations.

**Ourintellectual property rights are valuable, and any inability to protect themcould reduce the value of our products, services and brand.**

We must protect our intellectual property rights. Ourability to compete effectively with other companies will depend, in part, onour ability to maintain the proprietary nature of our technology. We rely upona combination of patents, trademarks and trade secrets, non-disclosureagreements and other forms of intellectual property protection to safeguard ourproprietary technology. We cannot assure you as to the degree of protectionoffered by these patents. We also cannot assure you that we will be able tomaintain the confidentiality of our trade secrets or that our non-disclosureagreements will provide meaningful protection of our trade secrets, know-how orother proprietary information in the event of any unauthorized use,misappropriation or disclosure of such trade secrets, know-how or otherproprietary information.

The patents of competitors could impact our business.Competitors in the United States and foreign countries, many of which havesubstantially greater resources than we do and have made substantialinvestments in competing technologies, may have applied for or obtained, or mayin the future apply for and obtain, patents that will prevent, limit orinterfere with our ability to make and sell some of our products. Although webelieve that our existing products do not infringe on the patents or other proprietaryrights of third parties, third parties could assert infringement claims againstus and such claims could be successful.

In addition, we do nothave the right to prohibit the U.S. government from using certain technologiesdeveloped by us or to prohibit third-party companies, including ourcompetitors, from using those technologies in providing products and servicesto the U.S. government. The U.S. government has the right to royalty-free useof technologies that we have developed under U.S. government contracts. We arefree 

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tocommercially exploit those government-funded technologies and may assert ourintellectual property rights to seek to block other non-government usersthereof, but we cannot assure you that we could successfully do so.

**Weare subject to significant environmental, health and safety laws andregulations and related compliance expenditures and liabilities.**

We are subject to a variety of federal, state andlocal laws, rules and regulations relating to the use, storage, dischargeand disposal of hazardous substances and wastes used or generated during ourengineering, research and development and manufacturing activities. Failure tocomply with applicable environmental requirements could result in substantialliability to us, including civil or criminal penalties, suspension or cessationof our operations, restrictions on our ability to expand our operations orrequirements for the acquisition of additional equipment or other significantexpense, any of which could have a materially adverse effect on our business,financial condition and results of operations. In addition, environmental lawsalso impose obligations and liability for the cleanup of properties affected byhazardous substance spills or releases. These liabilities can be imposed on theparties generating or disposing of such substances or on the owner or operatorof the affected property, often without regard to whether the owner or operatorknew of, or was responsible for, the presence of hazardous substances.Accordingly, we may become liable, either contractually or by operation of law,for remediation costs even if the contaminated property is not presently ownedor operated by us, or if the contamination was caused by third parties. Wecannot assure you (1) that changes in federal, state or local laws,regulations or regulatory policy, or the discovery of unknown problems orconditions, will not in the future require substantial expenditures or (2) asto the extent of our liabilities, if any, for past failures, if any, to complywith applicable environmental laws, regulations and permits, any of which alsocould have a materially adverse effect on our business, financial condition andresults of operations.

We have made and continueto make investments in protective equipment, process controls, manufacturingprocedures and training in order to minimize the risks to our employees,surrounding communities and the environment due to the presence and handling ofhazardous materials. The failure to properly handle these materials could leadto harmful exposure for employees or to the discharge of certain hazardouswaste materials. Since we do not carry environmental impairment insurance, sucha failure could have a materially adverse effect on our business, financialcondition and results of operations.

**As aresult of processing beryllium, we are subject to liability and compliancecosts.**

The processing of beryllium, one of the materials usedin some of our products, may result in the release of beryllium into theworkplace and the environment and in the creation of beryllium oxide as aby-product. Beryllium is classified as a hazardous air pollutant, a toxicsubstance and a hazardous substance under environmental, safety and health lawsand regulations. Various acute and chronic health effects may result fromexposure to beryllium, including the development of a chronic lung diseaseknown as chronic beryllium disease, or CBD. Because of the health risksassociated with beryllium, we may be subject to product liability claims and third-partylawsuits and increased levels of scrutiny from federal, state, foreign andinternational regulatory authorities. Concerns over CBD and other potentialadverse health effects relating to beryllium, as well as concerns regardingpotential liability from the use of beryllium, may discourage our customers’use of our beryllium-containing products and significantly reduce demand forour products.

In addition, we arerequired to comply with certain regulatory requirements to process beryllium.In response to these regulatory requirements, we have incurred, and continue toincur, costs for employee training as well as monitoring and protectiveequipment. Any future changes in these regulatory requirements may increase ourcost of compliance, which could have a materially adverse effect on ourbusiness, financial condition and results of operations.

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**If weare unable to maintain and upgrade our manufacturing capabilities, our abilityto compete could be materially and adversely impacted.**

We must continue to investsignificant resources to maintain and upgrade our manufacturing capabilities.We have invested, and intend to continue to invest, in state-of-the-artequipment in order to increase, expand, update or relocate our manufacturingcapabilities and facilities. Changes in technology or sales growth beyondcurrently established manufacturing capabilities would require that we makefurther investment. We cannot assure you that we will generate sufficient fundsfrom operations to finance any required investment or that other sources offunding will be available on terms acceptable to us, if at all. In addition,any further expansion could have a materially adverse effect on our business,financial condition and results of operations.

**Failureto anticipate technical problems, estimate costs accurately or control costsduring performance of a fixed-price contract may reduce our profit or cause aloss.**

We provide our servicesprimarily through firm fixed-price contracts. Substantially all of our netsales for 2005 were derived from firm fixed-price contracts, which require usto perform services under a contract at a stipulated price. We assume greaterfinancial risk on firm fixed-price contracts. Failure to anticipate technicalproblems, estimate costs accurately or control costs during performance of afixed-price contract will reduce our profit or cause a loss. Although webelieve that adequate provision for our costs of performance is reflected inour financial statements, we can give no assurance that this provision isadequate or that losses on firm fixed-price contracts will not occur in thefuture.

**Weare dependent in part upon our relationships and strategic alliances withindustry participants in order to generate revenue.**

We rely on the strength of our relationships withmilitary industry organizations to form strategic alliances. If any of ourexisting relationships with our strategic partners were impaired or terminated,we could experience significant delays in the development of our new productsourselves and we would incur additional development costs. We would need tofund the development of our new products internally or identify new strategicpartners.

Some of our likelypartners are also potential competitors, which may impair the viability of newstrategic relationships. While we must compete effectively in the marketplace,our future alliances may depend on our strategic partners’ perception of us. Asa result, our ability to win new and/or follow-on contracts may be dependentupon our relationships within the military industry.

**Restrictivecovenants under our credit facility may reduce our operating and financialflexibility.**

Our credit facility requires us to maintain compliancewith certain covenants, including covenants regarding minimum EBITDA, a minimumfixed charge coverage ratio and a maximum leverage ratio. Our ability to complywith these covenants may be affected by events beyond our control. Ourinability to comply with the required financial covenants could result in adefault under our credit facility. In the event of any such default, thelenders under our credit facility could elect to declare all outstanding debt,accrued interest and fees under the facility to be due and immediately payable.

If we are unable to repayany of this debt when due, the lenders under our credit facility couldforeclose on our assets pledged to them as security. If the indebtedness underour credit facility were to be accelerated, our assets may not be sufficient torepay such indebtedness in full.

**Aportion of our business is dependent upon obtaining and maintaining requiredsecurity clearances.**

Some of our federalgovernment contracts require our employees to maintain various levels ofsecurity clearances, and at three of our manufacturing facilities, we arerequired to maintain certain facility security 

21

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clearancescomplying with federal government requirements. Obtaining and maintainingsecurity clearances for employees involves a lengthy process, and it isdifficult to identify, recruit and retain employees who already hold securityclearances. If our employees are unable to obtain or retain security clearancesor if our employees who hold security clearances terminate employment with us,any customer whose work requires cleared employees could terminate its contractor decide not to renew its contract upon its expiration. In addition, we expectthat some of the contracts on which we will bid will require us to demonstrateour ability to obtain facility security clearances and perform work withemployees who hold specified types of security clearances. To the extent we arenot able to obtain facility security clearances or engage employees with therequired security clearances for a particular contract, we may not be able tobid on or win new contracts, or effectively re-compete on expiring contracts.

**Ouremployees may engage in misconduct or other improper activities.**

We are exposed to the riskthat employee fraud or other misconduct could occur. Misconduct by employeescould include intentional failures to comply with federal governmentprocurement regulations and failing to disclose unauthorized activities to us.Employee misconduct could also involve the improper use of our customers’sensitive or classified information, which could result in regulatory sanctionsand serious harm to our reputation. It is not always possible to identify anddeter employee misconduct, and the precautions we take to detect and preventthis activity may not be effective in controlling unknown or unmanaged risks orlosses.

**Theconcentration of our common stock ownership with our Chairman of the Board andChief Executive Officer may limit our ability to influence corporate matters.**

Our Chairman of the Boardand Chief Executive Officer beneficially owned approximately 18.3% of the commonstock outstanding as of December 31, 2005. As a result, he will have theability to exert influence with respect to corporate actions, including theelection of directors and certain sales or mergers and acquisitions. Inaddition, the interests of our Chairman of the Board and Chief ExecutiveOfficer may conflict with the interests of the other holders of our commonstock.

**Provisionsin our charter documents and under Delaware law could discourage a takeoverthat stockholders may consider favorable.**

Certain anti-takeover provisions could cause harm toour stockholders. Our Restated Certificate of Incorporation, as amended, ourBy-Laws and the General Corporation Law of the State of Delaware, which werefer to as DGCL, contain various provisions which could delay or impede theremoval of incumbent directors and could make a merger, tender offer or proxycontest involving us more difficult, even if such a transaction would bebeneficial to the interests of the stockholders, or could discourage a third partyfrom attempting to acquire control of us.

We have authorized 4,000,000 shares of our preferredstock, none of which is currently outstanding, and which we could issue withoutfurther stockholder approval and upon terms and conditions, and having rights,privileges and preferences, as the Board of Directors may determine. We have nocurrent plans to issue any preferred stock.

Our By-Laws include provisions establishing advancenotice procedures with respect to stockholder proposals and director nominations,and permitting the calling of special stockholder meetings only by the writtenconsent of three-quarters of the Board of Directors or the Chairman of theBoard. Our Restated Certificate of Incorporation provides that in lieu of ameeting, action may be taken by written consent of our stockholders only byunanimous consent. These provisions could have the effect of delaying,deterring or preventing a change in control of Axsys, and may adversely affectthe voting and other rights of holders of common stock.

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In addition, we aresubject to section 203 of the DGCL, which, among other things and subject tovarious exceptions, restricts certain business transactions between acorporation and a stockholder owning 15% or more of the corporation’soutstanding voting stock, which we refer to as an interested stockholder inthis prospectus, for a period of three years from the date the stockholderbecomes an interested stockholder. These provisions may have the effect ofdelaying or preventing a change of control of Axsys without action by thestockholders and, therefore, could adversely affect the price of our commonstock. In the event of a change of control of Axsys, the vesting of outstandingoptions issued under our stock incentive plan may be accelerated at the discretionof the committee administering the plan or may be required to be acceleratedunder certain circumstances provided for in incentive agreements.

**Item 1B.**               UNRESOLVEDSTAFF COMMENTS

None.

**Item 2.**         PROPERTIES

Axsysleases approximately 4,740 square feet of office space, located at 175 CapitalBoulevard in Rocky Hill, Connecticut, for our corporate headquarters. Thislease expires in 2010.  The principalplants and other significant properties at December 31, 2005 are:

| **Location**        | ** ** | ** **                                  | ** ** | **Type of Facility** | ** ** | **Square Footage** | ** ** | **Leased/Owned; Expiration** |
|---------------------|------------|---------------------------------------------|------------|----------------------|------------|--------------------|------------|------------------------------|
| Cullman, AL         |       | Manufacturing,  Engineering                 |       |                 | 120,000    |               |       | Owned                        |
| San Diego, CA       |       | Manufacturing,  Engineering                 |       |                 | 64,800     |               |       | Leased; 2010                 |
| Montville, NJ       |       | Distribution                                |       |                 | 34,400     |               |       | Leased; 2009                 |
| Salem, NH           |       | Administrative,  Manufacturing, Engineering |       |                 | 30,000     |               |       | Leased; 2006                 |
| Rochester Hills, MI |       | Manufacturing,  Engineering                 |       |                 | 29,000     |               |       | Leased; 2006                 |
| North Billerica, MA |       | Manufacturing, Engineering                  |       |                 | 19,900     |               |       | Leased; 2007                 |

 

We believe that ourfacilities are sufficient to meet our current and reasonably anticipatedmanufacturing, distribution and related requirements. We, however, periodicallyreview space requirements to ascertain whether our facilities are sufficient tomeet our needs. All properties are used by the Optical Systems group exceptMontville, New Jersey, which is used by our Distributed Products group.

**Item 3.**                        LEGALPROCEEDINGS

Axsys is a defendant invarious lawsuits, none of which are expected to have a material adverse effecton Axsys’ business or financial position. It is possible, however, that ourresults of operations for a particular fiscal period could be materiallyaffected.

**Item 4.**                        SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

None during the quarterended December 31, 2005.

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**PART II**

**Item 5.**                        MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES

Axsys’common stock trades on the Nasdaq National Market under the symbol “AXYS.” Thefollowing table sets forth the range of high and low sales prices as reportedby Nasdaq during the fiscal years 2005 and 2004:

| ** **                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|
| ** **                            | ** ** | **High** | ** ** | **Low**  | ** ** | **High** | ** ** | **Low** | ** ** |
| Fiscal Years  Ended December 31: |       |     |       |     |       |   |   |   |   |
| First Quarter                         |       | $        | 22.750     |     | $          | 16.520 |   | $ | 16.220 |   | $ | 12.500 |   |
| Second Quarter                        |       | 22.640   |       | 16.450   |       | 24.240 |   | 14.510 |   |
| Third Quarter                         |       | 20.600   |       | 17.510   |       | 15.750 |   | 11.250 |   |
| Fourth Quarter                        |       | 19.800   |       | 16.800   |       | 19.050 |   | 12.420 |   |
|                                       |            |          |            |          |            |  |  |  |  |  |  |  |  |

 

On February 21, 2006, the high sales price was$16.91 and the low sales price was $16.58.

On February 21, 2006,the approximate number of holders of record of Axsys’ common stock was 454. Inaddition, we believe that as of that date, there were approximately 1,900beneficial owners.

**Dividend Policy**

Axsys has applied andcurrently intends to continue to apply its retained and current earnings towardthe development of its business and to finance growth. Axsys did not pay cashdividends on its common stock during the three years ended December 31,2005 and does not anticipate paying cash dividends in the foreseeable future.Our ability to declare and make dividends payments is restricted under ourcredit facility.

**IssuerPurchases of Equity Securities**

| ** **                                    | ** ** | **Total  Number of  Shares  Purchased** | ** ** | **Average  Price Paid  per Share** | ** ** | **Total Number of  Shares Purchased as  Part of Publicly  Announced Plans or  Programs** | ** ** | **Maximum Number of  Shares that May Yet  Be Purchased Under  the Plans or  Programs(1)** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------|------------|
| October 2—October 29,  2005    |       |                                         | —     |                                         |       |                                                                                                                             | $          | —                                                                                                                                 |       |   |   | — |   |   |   | — |   |   |
| October 30—November 26,  2005  |       |                                         | —     |                                         |       |                                                                                                                             | —     |                                                                                                                                   |       |   | — |   |   |   | — |   |   |
| November 27—December 31,  2005 |       |                                         | 7          |                                         |       |                                                                                                                             | 19.12      |                                                                                                                                   |       |   | 7 |   |   |   | 199,955 |   |   |
| Total                                         |       |                                         | 7          |                                         |       |                                                                                                                             | $          | 19.12                                                                                                                                  |       |   |   | 7 |   |   |   | 199,955 |   |   |

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(1)          On****May 11, 2004, Axsys’ Board ofDirectors authorized the repurchase, from time to time, on the open market orotherwise, of up to 200,000 shares of its common stock at prevailing marketprices or at negotiated prices.  We planto use the repurchased shares for general corporate purposes, including thesatisfaction of commitments under our employee benefit plans and the exerciseof stock option grants.

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**Item 6.**                        SELECTEDFINANCIAL DATA

Thefollowing selected financial data for the five fiscal years presented below isderived from Axsys’ audited Consolidated Financial Statements as adjusted toreflect the discontinuance of the Automation Group in 2002. The data should beread in conjunction with the Consolidated Financial Statements and the relatedNotes thereto included elsewhere herein.

| ** **                                                                                                                  | ** ** | **Years Ended December 31,**                        | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                                                                  | ** ** | **2005  (1)(2)**                                                   | ** ** | **2004  (3)(4)(7)** | ** ** | **2003  (4)(7)** | ** ** | **2002  (4)(5)(6)(7)** | ** ** | **2001  (4)(5)(6)** | ** ** |
| ** **                                                                                                                  | ** ** | **(In thousands, except per share data)** | ** ** |
| **Statement of Operations Data:**                                                                                           |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |
| Sales                                                                                                                       |       | $                                                                  | 133,543    |   | $ | 103,530 |   | $ | 85,109 |   |   | $ | 79,586 |   |   | $ | 86,131 |   |
| Gross profit                                                                                                                |       | 41,646                                                             |       | 30,656 |   | 23,073 |   |   | 20,132 |   |   | 13,747 |   |
| Income (loss)  from continuing operations before cumulative effect of change in accounting  principle                       |       | 7,473                                                              |       | 9,159 |   | 4,998 |   |   | (3,014 | ) |   | (5,266 | ) |
| Net income (loss)                                                                                                           |       | 7,323                                                              |       | 8,664 |   | 4,998 |   |   | (7,061 | ) |   | (7,152 | ) |
| Basic net  earnings (loss) per share from continuing operations before cumulative effect  of change in accounting principle |       | $                                                                  | 0.93       |   | $ | 1.30 |   | $ | 0.72 |   |   | $ | (0.43 | ) |   | $ | (0.75 | ) |
| Basic earnings  (loss) per share                                                                                            |       | $                                                                  | 0.91       |   | $ | 1.23 |   | $ | 0.72 |   |   | $ | (1.00 | ) |   | $ | (1.02 | ) |
| Weighted-average  basic common shares outstanding                                                                           |       | 8,006                                                              |       | 7,020 |   | 6,986 |   |   | 7,038 |   |   | 7,032 |   |
| Diluted earnings  (loss) per share from continuing operations before cumulative effect of change  in accounting principle   |       | $                                                                  | 0.90       |   | $ | 1.26 |   | $ | 0.71 |   |   | $ | (0.43 | ) |   | $ | (0.75 | ) |
| Diluted earnings  (loss) per share                                                                                          |       | $                                                                  | 0.88       |   | $ | 1.19 |   | $ | 0.71 |   |   | $ | (1.00 | ) |   | $ | (1.02 | ) |
| Weighted-average diluted  common shares outstanding                                                                         |       | 8,355                                                              |       | 7,289 |   | 7,074 |   |   | 7,038 |   |   | 7,032 |   |

 

| ** **                                                  | ** ** | **At December 31,** | ** ** |
|-------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                  | ** ** | **2005**                      | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                  | ** ** | **(in thousands)**       | ** ** |
| **Balance Sheet Data:**                                     |       |                          |       |   |   |   |   |   |   |   |   |
| Total assets                                                |       | $                             | 156,208    |   | $ | 85,815 |   | $ | 66,845 |   | $ | 62,372 |   | $ | 68,636 |   |
| Long-term capital  lease obligations (less current portion) |       | —                        |       | 150 |   | 568 |   | 1,191 |   | 1,392 |   |
| Long-term debt  (less current portion)                      |       | —                        |       | 3,333 |   | — |   | — |   | — |   |
| Shareholders’ equity                                   |       | 119,541                       |       | 53,093 |   | 43,898 |   | 39,093 |   | 46,440 |   |
|                                                             |            |                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          On September 27,2005, Axsys issued and sold 3,450,000 shares of common stock at a publicoffering price of $18.00 per share. The proceeds of this offering were used toprepay our existing credit facilities in 2005. This prepayment triggered acharge of  $480 thousand for the loss onextinguishment of debt.

(2)          On May 2, 2005, weacquired DiOP. We accounted for this acquisition under the purchase method ofaccounting and, accordingly, results of DiOP’s operations have been included inour Consolidated Statements of Operations since the date of acquisition.

(3)          On April 8, 2004,we acquired Telic. We accounted for this acquisition under the purchase methodof accounting and, accordingly, the results of Telic’s operations have beenincluded in our Consolidated Statements of Operations since the date ofacquisition.

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(4)          In the second quarter of2004, the Board of Directors announced the declaration of a 3:2 stock spliteffected as a stock dividend payable on June 30, 2004 to stockholders ofrecord on June 15, 2004. Stockholders received a dividend of oneadditional share our common stock for every two shares owned on the record date.Fractional shares were cashed out, and payments were made to stockholders inlieu of fractional shares on June 30, 2004. Share and per shareinformation for all prior periods have been restated to reflect the stocksplit.

(5)          For 2002 and 2001,certain engineering costs have been reclassified from cost of goods sold tooperating expenses to conform to the current presentation.

(6)          In the third quarter of2002, the Automation Group was divested, which included the Fiber Automationdivision and Automation Engineering, Inc., a wholly owned subsidiary. Accordingly,the Automation Group has been accounted for as discontinued operations and theoperating results have been reported separately from continuing operations forall applicable periods. Sales applicable to these discontinued operations were$1.2 million in 2002 and $3.1 million in 2001.

(7)          Inaccordance with SFAS No. 109, we established a $4.6 million valuationallowance against our deferred income tax asset in 2002. As we reported income,we reduced the valuation allowance and utilized $3.2 million in 2004 and $1.4million in 2003 as deferred income tax assets were realized.

**Item 7.**                     MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Thefollowing table sets forth selected financial data on a consolidated basis (inthousands): * *

| ** **                                                    | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                    | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Sales                                                         |       | $                                           | 133,543    |   | $ | 103,530 |   | $ | 85,109 |   |
| Cost of sales                                                 |       | 91,897                                      |       | 72,874 |   | 62,036 |   |
| Gross profit                                                  |       | 41,646                                      |       | 30,656 |   | 23,073 |   |
| Selling, general and administrative expenses                  |       | 23,957                                      |       | 18,634 |   | 15,986 |   |
| Research,  development and engineering expenses               |       | 3,766                                       |       | 2,677 |   | 2,059 |   |
| Operating income                                              |       | 13,923                                      |       | 9,345 |   | 5,028 |   |
| Interest expense                                              |       | (1,684                                      | )          | (254 | ) | (172 | ) |
| Interest income                                               |       | 167                                         |       | 98 |   | 115 |   |
| Loss on  extinguishment of debt                               |       | (480                                        | )          | — |   | — |   |
| Other income  (expense)                                       |       | 33                                          |       | (38 | ) | 263 |   |
| Income from  continuing operations before income taxes        |       | 11,959                                      |       | 9,151 |   | 5,234 |   |
| Provision for  (benefit from) income taxes                    |       | 4,486                                       |       | (8 | ) | 236 |   |
| Income from  continuing operations                            |       | 7,473                                       |       | 9,159 |   | 4,998 |   |
| Discontinued operations:                                      |       |                                        |       |   |   |   |   |
| Loss from discontinued operations, net of income tax  benefit |       | (150                                        | )          | (495 | ) | — |   |
| Net income                                                    |       | $                                           | 7,323      |   | $ | 8,664 |   | $ | 4,998 |   |

 

Thefollowing table sets forth the percent of sales by segment:

| ** **                  | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------|------------|---------------------------------------------|------------|
| ** **                  | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Optical Systems  Group      |       | 81.4                                        | %          | 75.5 | % | 74.3 | % |
| Distributed Products  Group |       | 18.6                                        |       | 24.5 |   | 25.7 |   |

 

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***Overview***

Axsys is a leading designer and manufacturer ofprecision optical solutions for defense, aerospace, homeland security and high-performancecommercial applications. These sophisticated solutions are typically found inapplications that demand the finest optical surfaces, highest accuracy andtightest motion control tolerances. Application examples include weaponsystems, long-range surveillance cameras and highly precise medical imagers. Weare also a technology leader in the supply of infrared surveillance solutionsto homeland security market customers, such as the U.S. Border Patrol, Army,Navy, Air Force, Coast Guard and various port authorities.

Our solutions are often embedded in larger systemsthat depend on precise optical control for accurate operation of criticalfunctions. For example, our products are embedded in several next generationthermal imaging and targeting systems for platforms such as the F-16, F-18,Bradley Fighting Vehicle, M1A2 Abrams and Stryker. We also supply criticalguidance and seeker components for platforms such as the Minuteman intercontinentalballistic missile and the AIM-9X Sidewinder missile. Our products areincluded on several platforms within the U.S. National Missile Defense program.We are well positioned within this market, with strong positions on a diversearray of high-profile military programs.

In addition to optical solutions, we also distributeprecision ball bearings used in a variety of industrial and commercialapplications. We sell our components, sub-systems and bearings to a variety ofOEMs.

We are organized into twobusinesses: the Optical Systems Group and the Distributed Products Group.

*Optical SystemsGroup*

The Optical Systems Groupdesigns, manufactures and sells highly precise systems, sub-systems andcomponents that are typically used in surveillance, long-range observation,tracking and targeting and high-performance imaging applications. Customersinclude both governmental and commercial organizations. The Optical SystemsGroup has design and manufacturing facilities in San Diego, California,Cullman, Alabama, Rochester Hills, Michigan, North Billerica, Massachusetts andSalem, New Hampshire.

*DistributedProducts Group*

The Distributed ProductsGroup distributes precision ball bearings, spherical plain bearings, andbushings, acquired from various domestic and international sources, to OEMs andMROs. Additionally, the Distributed Products Group designs, manufactures andsells mechanical-bearing subassemblies for a variety of customers. TheDistributed Products Group is comprised of the AST Bearings Division located inMontville, New Jersey, with a satellite distribution center in Irvine,California.

*Public StockOffering*

On September 27,2005, we issued and sold 3,450,000 shares of common stock at the publicoffering price of $18.00 per share. We received all of the net proceeds fromthe offering after payment of underwriting discounts and commissions. Gross proceeds from the stock offering were$62.1 million. After underwriting discounts and commissions, we received $57.6million. We utilized $54.6 million to repay all of the amounts outstandingunder our credit facility, including accrued interest and fees, and $791thousand to pay expenses related to the stock offering, and we used theremaining $2.2 million for working capital and general corporate purposes. As of December 31, 2005, we had10,636,734 shares of common stock outstanding.

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*SignificantCustomers*

Raytheon Company, anaerospace and defense systems supplier, represented 12.3% of our net sales in2005, 18.9% in 2004 and 15.5% in 2003. While Raytheon, a prime contractor withthe U.S. government, does constitute a significant portion of our business, wedo not currently believe that this is at-risk business. 

*Backlog and Orders*

Axsys recognized, in 2005,bookings of $148.2 million, ending the year with record backlog of $112.7million, of which 10.2% will be shipped beyond 12 months. Our backlog increasedby $24.5 million, or 27.8%, compared to our ending backlog of $88.2 million asof December 31, 2004. As we look forward, we expect continued growth inthe Optical Systems Group, which is supported by the segment’s backlog of $98.8million at the end of 2005.  This groupwill continue to target orders that require highly precise optical and motioncontrol solutions. Examples include surveillance, military navigation andtargeting, ‘smart’ weapons, and medical imaging.

*Acquisition ofDiversified Optical Products, Inc.*

On May 2, 2005, we acquired all of the stock ofDiOP, a manufacturer of high-end thermal camera systems and lenses, for $55.2million in cash plus $1.9 million of legal, audit and other acquisition relatedcosts incurred in connection with the acquisition. The acquisition of DiOPbrought us new, high value technologies, leveraged our existing infrared andmotion control technologies, and provided us with a new base of customers. Further,the combination of DiOP and Axsys positioned us as a leading independentinfrared lens manufacturer. At the time of the acquisition, DiOP employedapproximately 120 people at its Salem, New Hampshire headquarters. DiOP isdoing business as Axsys Technologies IR Systems and the financial results areincluded in our Optical Systems Group’s results.

In connection with the acquisition of DiOP, on May 2,2005, we also entered into a new $70.0 million credit facility with Fleet Bank.The credit facility consisted of a five-year term loan A in the amount of $20.0million, a two-year term loan B in the amount of $35.0 million and a three-yearrevolving line of credit in the maximum amount of $15.0 million. Borrowingsunder this credit facility provided a portion of the consideration used toacquire DiOP.

Pursuant to the terms of the credit facility, we usedthe net proceeds from the 2005 stock offering to repay all of the amountsoutstanding under the term loan B.  Inaddition to repaying term loan B, we also repaid in full the amountsoutstanding under the term loan A with the net proceeds of the stock offering.

At December 31, 2005,there were no borrowings outstanding under the revolving credit facility;however, $1.0 million of the revolving credit facility was utilized foroutstanding letters of credit.

*Acquisition ofTelic Optics, Inc.*

On April 8, 2004, we acquired all of the stock ofTelic, a manufacturer of infrared optical products. The financial results ofTelic are included in our Optical Systems Group’s results.

Telic’s broad infrared optics capabilities increaseour product offerings and complement our strong position in reflective opticalsolutions. In addition, Telic’s products are typically used in ground- andsea-based programs. This complements our historical focus on air- andspace-based programs and expands our overall market and program penetration.Finally, the complementary addition of Telic’s technical capabilities to ourcore technical strengths is expected to increase our competitive advantage bybroadening our technical offering to prime contractors who are seeking tooutsource the fulfillment of their optical requirements.

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The initial purchase priceof this acquisition, after a working capital adjustment of $15 thousand, was$14.4 million with an additional earn out payment of up to $4.0 million over 36months following the closing date based on the achievement of certain revenuegoals. During 2005, $2.8 million of the earn out was earned, which increasedthe purchase price to $17.2 million. This additional earn-out payment will bepaid during 2006. If remaining revenue goals are achieved, over the next 15months the earn out could increase the total purchase price to $18.4million. Included in the purchase price was $438 thousand of legal, auditand other acquisition related expenses that were incurred in connection withthe acquisition. We funded the purchase price and associated transaction coststhrough a combination of existing cash balances and outside bank financing.

*James Webb SpaceTelescope*

During 2004, we received an $18.6 million definitivecontract from Ball Aerospace and Technology Corporation to produce the opticalmirror substrates for the James Webb Space Telescope, or JWST.  The contract contains $9.9 million ofproduction sales and $8.7 million for facilitization. We recognized revenue of$4.0 million during 2005 and $1.0 million during 2004 under the percentage ofcompletion method of accounting related to the JWST project.

The JWST, which is currently expected to launch in2013, will replace the Hubble as NASA’s premier space telescope. NorthropGrumman is the prime contractor. The primary mirror is comprised of 18individual lightweight beryllium segments, all of which will be fabricated byAxsys.  Because of the large size of theprimary mirror, JWST will be significantly more sensitive than ground-basedinfrared telescopes, enabling it to search for the first stars and galaxiesformed in the universe billions of years ago.

Our contract includes theproduction of optical substrates for an engineering development unit, 18primary mirror segments and support structures. We expect to deliver all 18segments by the end of 2006.

**Results of Segment Operations**

The following tables anddiscussion set forth selected financial information from continuing operationson a segment basis for the years ended December 31, 2005, 2004 and 2003. Thesegment tables, shown below, exclude one-time charges, which are shownseparately.

**OpticalSystems Group Segment**

*(table in thousands and as a percentage of sales)*

| ** **    | ** ** | **Years Ended December 31,** | ** ** |
|---------------|------------|---------------------------------------------|------------|
| ** **    | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Sales         |       | $                                           | 108,666    |   | 100.0 | % | $ | 78,189 |   | 100.0 | % | $ | 63,246 |   | 100.0 | % |
| Cost of sales |       | 74,393                                      |       | 68.5 | % | 55,429 |   | 70.9 | % | 46,728 |   | 73.9 | % |
| Gross profit  |       | $                                           | 34,273     |   | 31.5 | % | $ | 22,760 |   | 29.1 | % | $ | 16,518 |   | 26.1 | % |

 

Sales in the Optical Systems Group segment increased39.0% for the year ended December 31, 2005 compared to 2004, while salesin this segment increased 23.6% for the year ended December 31, 2004compared to 2003. The increase in sales was largely due to the acquisition ofDiOP, which brought us new, high value technologies, leveraged our existinginfrared and motion control technologies, and provided us with a new base ofcustomers. We also benefited from strong military spending on surveillance andtargeting programs, particularly those using our infrared imaging and motioncontrol technology. During 2005, we recognized increased revenues year overyear from the JWST contract under the percentage of completion method ofaccounting compared 2004, the first year of production. Lastly, sales of ourscanners, which are used in medical imaging and graphic art applications, werecomparable to 2004 revenues and slightly higher than 2003.

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Gross profit as a percent of sales for the year ended December 31,2005 increased compared to 2004 and 2003 mainly due to increased volume, salesmix and improved efficiencies in comparison to the past two years.  Our recent acquisitions over the past twoyears have had a favorable impact on the sales mix resulting in higher than historicalmargins.

The Optical Systems Group,as of December 31, 2005, had a backlog of definitive orders of $98.8million, of which 9.1% is expected to ship beyond the 2006 fiscal year.

**DistributedProducts Group Segment**

*(table inthousands and as a percentage of sales)*

| ** **    | ** ** | **Years Ended December 31,** | ** ** |
|---------------|------------|---------------------------------------------|------------|
| ** **    | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Sales         |       | $                                           | 24,877     |   | 100.0 | % | $ | 25,341 |   | 100.0 | % | $ | 21,863 |   | 100.0 | % |
| Cost of sales |       | 17,504                                      |       | 70.4 | % | 17,445 |   | 68.8 | % | 15,308 |   | 70.0 | % |
| Gross profit  |       | $                                           | 7,373      |   | 29.6 | % | $ | 7,896 |   | 31.2 | % | $ | 6,555 |   | 30.0 | % |

 

Sales in the Distributed Products Group for the yearended December 31, 2005 were comparable to 2004 sales and higher than 2003sales. Revenues remained consistent despite increased pricing pressures andcompetition. In 2005, the Distributed Products Group experienced a number ofdelays from various large customers, contributing to a record backlog of $13.9million. Revenues were higher in 2005 and 2004 compared to 2003 as a result ofincreased sales in the industrial automation and consumer goods markets as wellas a general increase in new customer activities.

Gross profit as a percentof sales decreased in 2005 compared to the prior two years primarily as aresult of competitive pricing pressures and increased anti-duty dumping costs.

**Operating Expenses**

*(table inthousands and as a percentage of sales)*

| ** **                                      | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                      | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Selling, general  and administrative expenses   |       | $                                           | 23,957     |   | 17.9 | % | $ | 18,634 |   | 18.0 | % | $ | 15,986 |   | 18.8 | % |
| Research, development  and engineering expenses |       | 3,766                                       |       | 2.8 |   | 2,677 |   | 2.6 |   | 2,059 |   | 2.4 |   |

 

*Selling,general and administrative expenses.*   Selling,general and administrative expenses, or SG&A, were $24.0 million in 2005compared to $18.7 million in 2004 and $16.0 million in 2003. The spendingincrease, year over year, on a dollar basis, was primarily due to theacquisition of DiOP and the incremental expenses associated with a full year ofexpense for Telic compared to nine months of expense in 2004. DiOP incurred$3.3 million of SG&A in 2005, while Telic incurred an additional $400thousand of SG&A as a result of a full year of operation. In addition, weexperienced increased spending for audit and consulting fees related toSarbanes-Oxley compliance. Amortization expense totaled $816 thousand in 2005as compared to $73 thousand in 2004 and $0 in 2003. Despite the overallincrease in SG&A as a percentage of sales, SG&A was lower than in theprior years primarily due to higher sales volume and continued efforts tocontrol costs.

*Research, development andengineering expenses.*   Research, development andengineering expenses in 2005 increased by $1.1 million compared to 2004primarily as a result of the newly acquired infrared product line.  This product line is research intensive as wecontinuously make improvements on products, which are sold to end-users. Ourlegacy product lines are primarily manufactured and sold to OEMs based on theirunique design specifications.

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***Other Income and Expenses***

*Interestexpense.*   Interest expense was $1.7 million inthe year ended December 31, 2005, compared to $254 thousand in 2004 and$172 thousand in 2003. The increase in expense in 2005 compared to 2004 and2003 is primarily due to interest on our $55 million term loan, which weincurred in conjunction with the acquisition of DiOP, which was partiallyoffset by lower interest paid on capital leases compared to 2004 and 2003.

*Interestincome.**  *Interestincome was $167 thousand in the year ended December 31, 2005 compared to$98 thousand in 2004 and $115 thousand in 2003.  Interest income was primarily composed ofincome from cash and cash equivalents and short-term investments.

*Losson extinguishment of debt.**  *In conjunction with our prepayment of the principaland accrued interest on the $20.0 million term loan A and the $35.0 millionterm loan B during 2005, we incurred a charge of $421 thousand for the writeoff of loan origination fees and a charge of $59 thousand for the earlytermination of the related interest rate swap agreement.

*Otherincome and expense, net.**  *Netother income in 2005 was $33 thousand compared to net other expense of $38thousand in 2004 and net other income of $263 thousand in 2003. In 2005, otherincome and expense was composed primarily of the effects of foreign exchangegains and losses**.**

*IncomeTaxes.*   The consolidated effective income taxrate was 37.5% for the year ended December 31, 2005 compared to (0.1)% in2004 and 4.5% in 2003. The effective rates for 2004 and 2003 were impacted bythe reversal of a valuation allowance. In accordance with the SFAS No. 109,we established a $4.6 million valuation allowance against our deferred incometax asset in 2002. As we reported income, we reduced the valuation allowanceand utilized $3.2 million in 2004 and $1.4 million in 2003 as deferred incometax assets were realized. A valuation allowance is not currently required as itis more likely than not that the net deferred income tax asset will be realizedin the future.

*Discontinued operations.**  *In 2005, we incurred an after-tax charge of $150thousand from the settlement of the Prospect, Connecticut environmental claimrelated to a previously divested operation. As of December 31, 2005, wehave no further responsibility to the EPA as it relates to this site.

During 2004, we incurredan after tax charge of $421 thousand related to the 2002 divestiture of ourAutomation Group. In 2002, we believed that we would be able to sublease twofacilities formerly occupied by our divested businesses. However, we had notbeen able to locate tenants for these facilities. The lease on one facility wasnegotiated and final settlement was paid in February 2005. The other leasewill expire in 2006 and the additional charge is sufficient to cover the remaininglease obligations.

In addition, during 2004we recognized an after tax charge $74 thousand for an environmental-relatedexpense for previously divested operations.

*Net income.*   Wehad net income of $7.3 million or $0.88 per diluted share in 2005, net incomeof $8.7 million or $1.19 per diluted share in 2004 and net income of $5.0million or $0.71 per diluted share in 2003. In addition, we issued 3,450,000shares of common stock through a public stock offering in September 2005,which impacted earnings per share.

**Liquidityand Capital Resources**

We fund our operationsprimarily from cash on hand and cash flow from operations. As of December 31,2005, cash and cash equivalents totaled $7.1 million. We have maintained a highlevel of liquidity as evidenced by our current ratio (current assets divided bycurrent liabilities), which was 2.1 as of December 31, 2005 and 2.3 as of December 31,2004.

Gross proceeds from the2005 stock offering were $62.1 million. After underwriting discounts andcommissions, we received $57.6 million. We utilized $54.6 million to repay theamounts outstanding under 

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the termloans of the credit facility entered into in May 2005 in connection withthe acquisition of DiOP, as described below, including accrued interest andfees, $791 thousand to pay expenses related to the stock offering, and we usedthe remaining $2.2 million for working capital and general corporate purposes.

We completed theacquisition of DiOP on May 2, 2005. The purchase price was $55.2 millionin cash, plus $1.9 million of acquisition related costs. In connection with theacquisition of DiOP, we entered into a new credit facility on May 2, 2005with Fleet Bank. The new credit facility providedfor a three-year $15.0 million revolving line of credit, a five-year term loanA in the principal amount of $20.0 million and a two-year term loan B in theprincipal amount of $35.0 million. The amounts outstanding under the term loanA and term loan B were paid in full on September 27, 2005 with the netproceeds from the stock offering.

The $15.0 millionrevolving credit facility remains available through May 2008, subject tooptional prepayment in accordance with its terms. Up to $2.0 million of therevolving credit facility may be utilized to issue letters of credit. We mayelect to have any borrowing under the revolving credit facility bear interesteither at the bank’s prime rate or the LIBOR rate plus a margin of 100 to 275basis points, depending on our consolidated funded debt-to-consolidated EBITDAratio, as defined in the credit facility. We have the option of selecting the 1-month,2-month, 3-month or 6-month LIBOR rate. On December 31,2005, there were no borrowings outstanding under the revolving credit facility.However, as of December 31, 2005, $1.0 million of the revolving creditfacility was utilized for outstanding letters of credit.

Repaymentsof amounts borrowed under the revolver are secured by a lien on all of ourassets and the assets of our subsidiaries, including a pledge of the stock ofall of our subsidiaries and is guaranteed by all of our subsidiaries.

Net cash provided byoperations was $7.6 million in 2005, $7.6 million in 2004 and $6.8 million in2003. In 2005, our primary sources of operating cash were $7.3 million of netincome plus non-cash expenses, which primarily consisted of $4.0 million ofdepreciation and amortization, $1.3 million decrease in our net deferred incometax asset and $66 thousand of stock to partially fund the Company 401(k) plan.In addition, we spent $907 thousand on discontinued operations primarily forleases and environmental clean-up activities.

In 2005, we utilized $4.2million of cash to fund changes in our operating assets and liabilities. Weused $2.6 million of cash to fund an increase in our inventories, which resultedfrom long lead-time orders and increased sales from our Optical Systems Group.  We also utilized $809 thousand of cash to fundan increase in accounts receivable primarily as a result of unbilledreceivables generated by service contracts and excess of cost over billings onpercentage of completion accounting.  Additional cash outflows of $800 thousand wereprimarily for the utilization of loss contract reserves, legal and consultingcosts associated with environmental activities and the reduction of deferredincome as we completed some long lead-time orders.

In 2004, our primarysources of operating cash were $8.7 million of net income plus non-cashexpenses, which primarily consists of $2.7 million of depreciation andamortization and a $242 thousand non-cash charge related to the modification ofstock option grants for a terminated employee. These non-cash charges werepartially offset by non-cash benefits, including a $1.7 million increase in ournet deferred income tax assets, due to the utilization and reversal of avaluation allowance for these assets. We also paid out $902 thousand forliabilities related to discontinued operations, which was offset by anadditional accrual for discontinued operations of $762 thousand.

In 2004, we utilized $2.2 million of cash to fundchanges in our operating assets and liabilities. We used $4.5 million of cashto fund an increase in our accounts receivable, which resulted from salesgrowth and higher deferred income billings in our Optical Solutions Group. Wealso utilized $4.1 million to fund inventory growth in 2004. The inventorygrowth was related to certain large long-term programs in our Optical SystemsGroup. The increases in accounts receivable and inventory were partially offsetby a $2.1 

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million increase inaccounts payable and a $2.6 million increase in deferred income. The increasein deferred income was the result of our strategy to actively negotiateprogress payments into certain large dollar contracts for long lead-timeproducts and long-term programs. This strategy helps to mitigate the near-termnegative cash impact of these contracts. The net change in accrued expenses andother liabilities and other long-term liabilities was a $784 thousand increase.The increase was related to increased accruals for compensation-relatedexpenses and an accrual for capital equipment that was received but notinvoiced, which were partially offset by the liquidation of an inactive pensionplan and the utilization of the reserve for loss contracts. During 2004, wealso received a $563 thousand federal income tax refund and a $224 thousanddecrease in current assets primarily due to the timing of insurance payments.

In 2003, our primarysources of operating cash were $5.0 million of net income, $2.9 million ofdepreciation and a $1.5 million federal income tax refund. The income taxrefund was partially offset by a $563 thousand income tax receivable that wasrecognized in 2003. One of our primary uses of cash was inventory, which grew$2.7 million in 2003. The inventory growth was related to certain largeprograms in our Optical Systems Group. The cash outflows for inventory werealmost entirely offset by a $1.1 million increase in accounts payable and a$1.4 million increase in deferred income. In 2003, we reduced accrued expensesand other liabilities and long-term liabilities by $612 thousand. This wasprimarily due to the utilization of reserves for loss contracts andrestructuring. In addition, we utilized $1.3 million to fund obligationsrelated to our discontinued operations.

In 2006, we signed a definitive agreement to purchasea 78,000 square foot building in New Hampshire for $3.8 million. This facilitywill become the new consolidated manufacturing facility for our AxsysTechnologies IR Systems division. Additionally in 2006, we expect to spendbetween $6.0 and $6.5 million on capital equipment. The majority of thiscapital investment will be used to purchase production and testing equipment,which will expand our capacity and improve our efficiency.

Net cash used in investing activities was $60.7million in 2005, $11.0 million in 2004 and $10.0 million in 2003. We utilized$57.1 million to acquire DiOP in 2005 and $13.7 million to acquire Telic in2004. The purchase of Telic was partially funded by the sale of $7.0 million ofshort-term investment securities. In addition, capital expenditures were $3.5million in 2005, $4.2 million in 2004 and $3.0 million in 2003. In 2005,capital was primarily used to purchase machinery and equipment used in manufacturing.The additional capital used in 2004 was for the construction of a 20,000 squarefoot, climate-controlled manufacturing facility in Cullman, Alabama. Theadditional space is being used to produce the beryllium mirror substrates andsupport structures for an engineering development unit, 18 optical mirrorsegments and two spare units and support structures that comprise the 6.5 meterprimary mirror as well as the secondary mirror for JWST.

During 2003, we invested $7.0 million in short-terminvestment securities. The funds were invested in short-term investmentsecurities in order to minimize interest rate risk and to allow for rapidredeployment when profitable long-term investment or expansion opportunitieswere identified. In 2003, we also invested $3.0 million in capital equipment.

Financing activities provided $54.1 million of cash in2005 and $4.1 million in 2004 and used $1.5 million of cash in 2003. During2005, we borrowed $55.0 million to purchase DiOP and paid off $4.4 million offinancing related to the acquisition of Telic in April 2004. In addition,we completed a public stock offering of 3,450,000 shares of common stock, whichgenerated net proceeds of $57.6 million during the third quarter of 2005. In2005, we made a $1.0 million principal payment and utilized a portion of thenet proceeds from the public stock offering to prepay the remaining $54.0million outstanding on our credit facility. During 2005, we also received $1.3million in proceeds from the exercise of options and paid off the remaining$518 thousand of capital lease obligations.

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During 2004, we obtained a $5.0 million term loan forthe acquisition of Telic and received $360 thousand in proceeds from theexercise of stock options. These sources of funds were partially offset byrepayments of $667 thousand on the term loan and $473 thousand on our capitalleases. In 2003, funds were used to retire five of our capital leases with thehighest interest rates before their maturity date. The prepayment penalties onthese leases had expired, which enabled us to achieve a modest interest ratesavings. During 2003, we also paid $201 thousand to settle litigation regardingour preferred stock, which was liquidated in 1997.

With our existing cash balance, anticipated cash flowsfrom operations and the $15.0 million revolving credit facility, managementbelieves that the Company has sufficient liquidity to finance its operations,capital expenditures, and working capital requirements for the foreseeablefuture.

Shareholder’s equity was$119.5 million, or $11.26 per common share outstanding, at December 31,2005 compared to $53.1 million, or $7.52 per common share outstanding, at December 31,2004. The increase in shareholders’ equity was due primarily to the publicstock offering and net income of $7.3 million. Most of the remaining increasein shareholders’ equity was related to the exercise of stock options and stockoption compensation.

***Off-Balance Sheet Arrangements***

As part of our ongoingbusiness, we do not participate in transactions that generate relationshipswith unconsolidated entities or financial partnerships established for thepurpose of facilitating off-balance sheet arrangements or other contractuallynarrow or limited purposes. As of December 31, 2005, we are not involvedin any unconsolidated single-purpose entities.

***Contracts and Commitments***

We have entered into certain contractual obligations,which will result in material cash outlays over the next several years. Asummary of our contractual obligations and commitments for capital leases,minimum lease payment obligations under non-cancelable operating leases andother obligations as of December 31, 2005 are as follows (in thousands):

| ** **                   | ** ** | **PAYMENTS DUE BY PERIOD** | ** ** |
|------------------------------|------------|-------------------------------------------|------------|
| **CONTRACTUAL  OBLIGATIONS** | ** ** | ** **                                | ** ** | **TOTAL** | ** ** | **LESS THAN  1 YEAR** | ** ** | **1 to 3  YEARS** | ** ** | **3 to 5  YEARS** | ** ** | **AFTER 5  YEARS** | ** ** |
| Operating leases             |       | $                                         | 5,466      |   |   | $ | 1,673 |   |   | $ | 2,397 |   | $ | 1,396 |   |   | $ | — |   |   |
| Purchase  obligations        |       | 1,721                                     |       |   | 1,657 |   |   | 55 |   | 9 |   |   | — |   |   |
| Other long-term  obligations |       | 963                                       |       |   | 524 |   |   | 375 |   | 12 |   |   | 52 |   |   |
| Total                        |       | $                                         | 8,150      |   |   | $ | 3,854 |   |   | $ | 2,827 |   | $ | 1,417 |   |   | $ | 52 |   |   |
|                              |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

As of December 31, 2005, Axsys had operatinglease commitments for all of our facilities, with the exception of our Cullman,Alabama facility, which is owned. In addition, our operating lease commitmentsincluded leases on some office equipment.

As of December 31, 2005, we had various purchaseobligations, which include long-distance phone service, ATM lines and othercommitments.

Incorporated in other long-term obligations arecommitments related to environmental remediation plans and building leasesassociated with discontinued operations.

We are involved in various stages of investigation andcleanup related to environmental remediation matters at three  sites, which include one site that is in thefinal stage of monitoring. The ultimate cost of site cleanup is difficult topredict given the uncertainties regarding the extent of cleanup, theinterpretation of applicable laws and regulations and alternative cleanupmethods. As of December 31, 2005, we 

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determined that it wasprobable that we would incur approximately $574 thousand of remediation andmonitoring costs, of which $210 thousand is included in current liabilities and$364 thousand is in other long-term liabilities.

During 2002, we disposed of the Automation Group,which included facilities in Wilmington, Massachusetts and Pittsburgh,Pennsylvania. As part of the terms of the sale, we remain obligated under theoperating leases for these facilities. The Pittsburgh lease was renegotiatedand final settlement was made in February 2005. The Wilmington leaseexpires in 2006 and we anticipate our remaining commitment to be $284 thousand.Since 2002, we have been sub-leasing a small portion of our Wilmingtonfacility, however, given the uncertainties regarding the real estate market inthis region, we do not believe that we will be able to sublease the entireWilmington facility at our contractual rates.  Therefore, we have fully reserved for ourremaining lease commitments for the facility and any remaining costs associatedwith this site will not have a material adverse effect on our business andfinancial condition.

As of December 31, 2005, we were contingentlyliable for $1.0 million under outstanding letters of credit. We have issuedletters of credit for certain business transactions including insuranceprograms and building lease security deposits.

As of December 31, 2005, we had one pension planfor which benefits and participation have been frozen. Pension benefits underthis plan are generally based upon years of service and compensation. The planis an unfunded plan with an annual payout of approximately $105 thousand.

In 2006, we signed aagreement to purchase a 78,000 square foot building in New Hampshire for $3.8million. This facility will become the new consolidated manufacturing facilityfor our Axsys Technologies IR Systems division.

***Critical Accounting Estimates***

The discussion andanalysis of our financial condition and results of operations are based uponour financial statements, which have been prepared in accordance with generallyaccepted accounting principles in the United States. The preparation of thesefinancial statements requires management to make estimates and judgments thataffect the reported amounts of assets, liabilities and related disclosure ofcontingent assets and liabilities at the date of the financial statements and thereported amounts for revenues and expenses during the reporting period. On anongoing basis, management evaluates estimates, including those related toinventory allowances, contingencies, bad debts, warranties, environmentalremediation efforts and income taxes. We base our estimates on historical data,when available, experience, and on various other assumptions that are believedto be reasonable under the circumstances, the combined results of which formthe basis for making judgments about the carrying values of assets andliabilities that are not readily apparent from other sources. Actual resultsmay differ from these estimates.

***Critical Accounting Policies***

The preparation of financial statements in conformitywith generally accepted accounting principles requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and the disclosure of contingent assets and liabilities at the dateof the financial statements and the reported amounts of revenues and expensesduring the reporting periods. The most significant estimates and assumptionsrelate to inventory valuation and the adequacy of allowances for doubtfulaccounts, long-term loss contract reserves and environmental contingencies. Actualamounts could differ significantly from these estimates.

*Revenuerecognition.*   We manufacture ordistribute products, which are either components or subassemblies that are soldto other manufacturers or OEMs. We do not sell any finished productsdirectly to consumers. Therefore, we are generally not responsible for anyinstallation or customer training.  

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However, some of ourcontracts are subject to customer acceptance and generally the customer willinspect and accept the product at our facility prior to shipment. Generally,legal title passes to the customer upon shipment. However, occasionally productis shipped FOB destination. When the product is shipped FOB destination,revenues are not recognized until the customer receives the product.

Our policy is to recognize revenues when a product iseither shipped to or received by the customer based on the terms of thespecific sale. However, certain long-term contracts are accounted for under thepercentage-of-completion model. Revenues and estimated gross profit are recognizedas work is performed based on the percentage that incurred costs bear toestimated total costs. Cost estimates include direct and indirect costs such aslabor, materials and overhead. These contracts require judgment relative toassessing risks, estimating, and making assumptions for schedule and technicalissues. Contract changes are included when the costs can be reasonablyestimated.  We may receive progresspayments that exceed costs incurred on these long-term contracts. Such advancesare recognized as billings in excess of costs and are included in accruedexpenses and other current liabilities on our consolidated balance sheets.

Deferred income primarily results form the advancebillings to our customers for the cost of beryllium, known as material onlybillings. These material only billings are deferred and subsequently recognizedas revenue only when the associated finished product is shipped.

Certain contracts are accounted for under the servicecontract model.  Under these contracts,revenues are deferred and recognized on a straight-line basis over the contractperiod.

Due to the build-to-order nature of our products,except for the distribution of ball bearings and the manufacture of infraredcameras, we do not offer price protection and generally do not offer discounts.To the extent discounts are offered, they are reflected at the time of the saleas a reduction in revenues. The price is fixed upon acceptance of the purchaseorder. When customer change orders occur, any pricing changes are reflected ina revised purchase order.

*Allowancefor doubtful accounts.*   We periodically reviewthe aging of our accounts receivable over ninety days to identify potentiallyuncollectible accounts and establish an allowance based on experience anddiscussion with customers. Historically, our estimated allowance hasapproximated actual write-offs. However, actual write-offs could differ fromour allowance for doubtful accounts. If circumstances change (i.e., higher thanexpected defaults or an unexpected material adverse change in a customer’sability to meet its financial obligations), our estimates of recoverability ofamounts due to us could be reduced by a material amount. Accounts receivableare written off only when all reasonable collection efforts are exhausted.

*Inventoryvaluation.*   We value our inventory at the lowerof the actual cost to purchase and/or manufacture the inventory or the currentestimated market value of the inventory. We regularly review inventoryquantities on hand and record a provision for excess or obsolete inventorybased on current requirements and historical usage. A significant increase inthe demand for our products could result in a short-term increase in the costof inventory purchases while a significant decrease in demand could result inan increase in the amount of excess or obsolete inventory quantities on hand. Inaddition, some of our markets are characterized by rapid technological changeor frequent new product development that could result in an increase in theamount of obsolete inventory on hand. Additionally, our estimates of futureproduct demand may prove to be inaccurate, in which case we may haveunderstated or overstated the provision required for excess or obsoleteinventory.

In the future, if we determine our inventory to beovervalued, we would be required to recognize those costs in our cost of goodssold at the time of such determination. Likewise, if our inventory isundervalued, we may have over-reported our costs of goods sold in previousperiods and would be required to recognize additional operating income at thetime of sale.  Therefore, although wemake every effort to ensure the accuracy of our forecasts of future productdemand, any significant unanticipated changes in 

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demand or technologicaldevelopments could have a significant impact on the value of our inventory andour reported operating results. Historically, our estimate of inventoryreserves has approximated actual results.

*Losscontract reserves.**  *Generally,our customer contracts are completed within one year of receiving the order. However,occasionally, longer lead-time orders are received and we monitor thesecontracts periodically to determine if our actual costs are comparable to ourcost estimates used at the time of order acceptance. If we determine that ouractual costs are significantly exceeding our original estimates, we will recorda loss contract reserve. Currently, one contract is covered by a loss contractreserve. We accrued for this contract based on the contract price and thecurrent cost structure, including estimated cost increases.

*Environmentalcontingencies.**  *We arecurrently involved in two environmental remediation projects and one site thatis in the final stage of monitoring. We accrue for environmental contingencieswhen (1) responsibility for cleanup is determined and (2) costs areprobable and can be reasonably estimated. When costs are not probable andcannot be reasonably estimated, no accrual is made. We have accrued ourestimate of the probable costs for the resolution of these claims. Theseestimates have been developed in consultation with outside environmentalconsultants handling these matters and are based upon an analysis of theanticipated remediation plans. We do not anticipate these projects will have amaterial adverse effect on our consolidated financial position. Although our estimatesto date have proven to be accurate, it is possible that future results ofoperations could be materially affected by changes in our assumptions.

*SelfInsurance.**  *Weare self-insured for certain losses related to general liability, workers’compensation and medical claims. Our liability represents an estimate of theultimate cost of claims incurred as of the balance sheet date. The estimatedliability is established based on an analysis of historical data and isreviewed by management on a quarterly basis to ensure that the liability isappropriate. While we believe that our estimates are reasonable based on theinformation currently available, if actual trends, including the severity andfrequency of claims, medical cost inflation or fluctuations in premiums, differfrom our estimates, our results from operations could be impacted.

*Accounting for IncomeTaxes.**  *Aspart of the process of preparing the consolidated financial statements, we arerequired to estimate the income taxes in each jurisdiction in which we operate.This process involves estimating the actual current tax liabilities togetherwith assessing temporary differences resulting from the differing treatment ofitems for tax and accounting purposes. These differences result in deferred taxassets and liabilities, which are included in the Consolidated Balance Sheet.We must then assess the likelihood that the deferred tax assets will berecovered, and to the extent that we believe that recovery is not more thanlikely, we are required to establish a valuation allowance. If a valuationallowance is established or increased during any period, we are required toinclude this amount as an expense within the tax provision in the ConsolidatedStatements of Operations. Significant judgment is required in determining ourprovision for income taxes, deferred tax assets and liabilities and anyvaluation allowance recognized against net deferred assets. The valuationallowance is based on our estimates of the taxable income in the jurisdictionsin which we operate and the period over which the deferred tax assets will berecoverable. In the event that actual results differ from these estimates ormanagement adjusts these estimates in future periods, we may need to establishan additional valuation allowance, which could materially impact our results ofoperations.

***Recently Issued Accounting Standards***

In December 2004, the FASB issued SFAS No. 123(revised 2004), or SFAS No. 123 (R), “Share-Based Payment,” which revisedSFAS No. 123, “Accounting for Stock-Based Compensation.”  The revised statement addresses theaccounting for share-based payment transactions with employees and other thirdparties, eliminates the ability to account for share-based compensationtransactions using APB 25 and 

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requires that the compensationcosts relating to such transactions be recognized in the consolidated statementof operations. SFAS No. 123 (R) must be adopted no later than January 1,2006. Early adoption is permitted. We expect to adopt the statement effective January 1,2006, as required. The impact of adoption of SFAS No. 123 (R) cannotbe predicted at this time because it will depend on levels of share-basedpayments granted in the future. However, had we adopted SFAS No. 123 (R) inprior periods, the annual impact of that standard would have approximated theimpact of SFAS No. 123 as described in the disclosure of pro forma netincome (loss) and net income (loss) per share in the stock-based compensationaccounting policy note included in Note 1 to the consolidated financialstatements.

In November 2004, theFASB issued SFAS No. 151, “Inventory Costs, an amendment of ARBNo. 43, Chapter 4,” to clarify that abnormal amounts of idle facilityexpense, freight, handling costs and wasted material (spoilage) should berecognized as current period charges, and that fixed production overheadsshould be allocated to inventory based on normal capacity of productionfacilities.  This statement is effectivefor Axsys’ fiscal year 2006.  The Companydoes not believe that adoption of this statement will have a significant impacton its overall results of operations or financial position.

***Cautionary Factors That May Affect Future Results***

This annual reportcontains forward-looking statements within the meaning of Section 21E ofthe Securities Exchange Act, including, without limitation, statementsregarding our ability to reduce design and manufacturing lead times andmanufacturing costs, our ability to integrate existing technologies, ourability to implement our strategy to develop and sell, among other things,higher level sub-systems, the changes to be achieved from our cost reductionefforts, our objective to grow through strategic acquisitions and anticipatedexpenditures for environmental remediation. One can identify these forward-lookingstatements by the use of the words such as “expect,” “anticipate,” “plan,” “may,”“will,” “estimate” or other similar expressions. Discussion containing suchforward-looking statements is found in the material set forth under “Business”and “Management’s Discussion and Analysis of Financial Condition and Results ofOperations,” as well as within the filing generally. One should understand thatmany factors could cause actual results to differ from those expressed orimplied in the forward-looking statements. These factors include thosediscussed below as well as inaccurate assumptions. We caution the reader thatthis list of factors may not be exhaustive. Because these forward-lookingstatements involve risks and uncertainties, you should be aware that there areimportant factors that could cause our actual results, level of activity,performance or achievements to differ materially from the results, level ofactivity, performance or achievements expressed or implied by theseforward-looking statements including, but not limited to:

·       ourdependence on sales to the U.S. federal government and Raytheon;

·       changesto U.S. federal government spending priorities;

·       ourability to continue to contract with the federal government or Department ofDefense;

·       ourability to comply with complex procurement laws and regulations;

·       ourability to implement effective business plans in the industries in which weoperate;

·       ourability to adapt to technological change;

·       ourability to compete in the industries in which we operate;

·       thepotential for our backlog to be reduced or cancelled;

·       therisks of doing business internationally;

·       ourability to implement our acquisition strategy and integrate our acquiredcompanies successfully;

38

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·       thetimely delivery of materials to us by our suppliers;

·       ourability to manage costs under our fixed-price contracts effectively;

·       ourability to attract and retain qualified personnel;

·       theability to protect our intellectual property rights;

·       fluctuationsin workers’ compensation and health care costs for our employees;

·       ourability to comply with environmental, health and safety laws and regulations;

·       ourability to maintain and upgrade our manufacturing capabilities to staycompetitive;

·       ourability to comply with restrictive covenants under our new credit  facility;

·       ourability to maintain security clearances for classified government systems; and

·       the other factors that wedescribe in Item 1A of this annual report.

**Item 7A.**                QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Axsys’ market risksensitive instruments do not subject Axsys to material market risk exposures.

**Item 8.**                        FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

Axsys’ Consolidated Financial Statements, togetherwith the Report of Independent Registered Public Accounting Firm thereon dated February 17,2006, is included in this annual report and listed in the index to financialinformation on page F-1.

The selected quarterlyinformation required by this item is included under the caption “SelectedQuarterly Financial Data (Unaudited)” in Note 18 to the Consolidated FinancialStatements included in this annual report.

**Item 9.**                        CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

**Item 9A.**                CONTROLSAND PROCEDURES

*Management’s Responsibilityfor Financial Statements*

Management is responsible for the integrity andobjectivity of the consolidated financial statements and other financialinformation presented in this annual report. These statements have beenprepared in accordance with generally accepted accounting principles andnecessarily include amounts based on judgments and estimates by management.

The Audit Committee of theBoard of Directors, which is composed solely of independent directors, meetsregularly with the independent auditors and representatives of management toreview accounting, financial reporting, internal control and audit matters, aswell as the nature and extent of the audit effort. The Audit Committee isresponsible for the engagement of the independent auditors. The independentauditors and internal auditor have unrestricted access to the Audit Committee.

39

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*Disclosure Controlsand Procedures*

As of the end of theperiod covered by this annual report management, including our principalexecutive officer and principal financial officer, evaluated the effectivenessof the design and operation of the Company’s disclosure controls andprocedures.

The principal executiveofficer and principal financial officer have concluded, based on their review,that the Company’s disclosure controls and procedures, as defined in ExchangeAct Rules 13a-15(e), were, as of the end of the period covered bythis annual report, effective to ensure that information required to bedisclosed by the Company in reports it files under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission rules and forms.

*Management’s Reporton Internal Control over Financial Reporting*

Management is responsible for establishing andmaintaining adequate internal control over financial reporting, as such term isdefined in the rules promulgated under the Exchange Act of 1934. Under thesupervision and with the participation of our management, including ourprincipal executive, financial and accounting officers, the Company hasconducted an evaluation of the effectiveness of its internal control overfinancial reporting based on the framework in “Internal Control-IntegratedFramework” issued by the Committee of Sponsoring Organizations of the TreadwayCommission. The evaluation included a review of the documentation of controls,evaluation of the design effectiveness of controls, and testing of theoperating effectiveness of controls. However, this review did not include theinternal controls of our Salem, New Hampshire operations, which were assumed inconjunction with the May 2, 2005 acquisition of Diversified OpticalProducts, Inc. This operation, which is included in our 2005 consolidatedfinancial statements, constituted 44.4% of total assets and 54.2% of net assetsas of December 31, 2005, and 14.5% of our revenues for the year thenended.

Based on this evaluation,management has concluded that as of December 31, 2005, the Company did nothave any material weakness in its internal control over financial reporting andits internal control over financial reporting was effective. Management’sassessment of the effectiveness of its internal control over financialreporting on December 31, 2005, has been audited by Ernst & YoungLLP, an independent registered public accounting firm, as stated in theirreport, which is included in this Annual Report on Form 10-K andlisted in the index to financial information on page F-1.

*Changes in InternalControl over Financial Reporting*

No change to the Company’s internal control overfinancial reporting occurred during the fourth quarter of 2005 that hasmaterially affected, or is reasonably likely to materially affect, the Company’sinternal control over financial reporting.

40

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

To the Shareholders of Axsys Technologies, Inc.

We have audited management’s assessment, included inthe accompanying *Management’s Report onInternal Control over Financial Reporting*, included at Item 9A, thatAxsys Technologies, Inc. maintained effective internal control overfinancial reporting as of December 31, 2005, based on criteria establishedin Internal Control-Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (the COSO criteria). AxsysTechnologies, Inc.’s management is responsible for maintaining effectiveinternal control over financial reporting and for its assessment of theeffectiveness of internal control over financial reporting. Our responsibilityis to express an opinion on management’s assessment and an opinion on theeffectiveness of the company’s internal control over financial reporting basedon our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion.

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

As indicated in the accompanying *Management’s Report on Internal Control overFinancial Reporting*, management’s assessment of and conclusion onthe effectiveness of internal control over financial reporting did not includethe internal controls of Diversified Optical Products, Inc., which isincluded in the 2005 consolidated financial statements of Axsys Technologies, Inc.and constituted 44.4% and 54.2% of total and net assets, respectively, as of December 31,2005, and  14.5% of revenues  for the year then ended. Diversified OpticalProducts, Inc. was acquired by Axsys Technologies, Inc. on May 2,2005. Our audit of internal controls over financial reporting of AxsysTechnologies, Inc. also did not include an evaluation of the internalcontrol over financial reporting of Diversified Optical Products, Inc.

In our opinion, management’s assessment that AxsysTechnologies, Inc. maintained effective internal control over financialreporting as of December 31, 2005, is fairly stated, in all materialrespects, based on the COSO criteria. Also, in our opinion, Axsys Technologies, Inc.maintained, in all material respects, effective internal control over financialreporting as of December 31, 2005, based on the COSO criteria.

41

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We also have audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), theconsolidated balance sheets as of December 31, 2005 and 2004, and therelated consolidated statements of operations, shareholders’ equity andcomprehensive income (loss), and cash flows for each of the three years in theperiod ended December 31, 2005, of Axsys Technologies, Inc. andsubsidiaries and our report dated February 17, 2006 expressed anunqualified opinion thereon.
|                         | **ERNST &  YOUNG LLP** |
|-------------------------|---------------------------------|
| Hartford,  Connecticut  |                            |
| February 17,  2006 |                            |

 

42

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**Item 9B. OTHERINFORMATION**

None.

**PART III**

The information requiredby items 10, 11, 12, 13 and 14 of Part III, other than the disclosureregarding the adoption of our Code of Ethics as required by Item 406(a) ofRegulation S-K and the table required by Item 201(d) of Regulation S-K, isincorporated by reference to Axsys’ definitive proxy statement for our 2006Annual Meeting of Stockholders (“2006 Proxy Statement”) to be filed with theSecurities and Exchange Commission within 120 days following the end of Axsys’fiscal year ended December 31, 2005. If such proxy statement is not sofiled, that information will be filed as an amendment to this Form 10-Kwithin 120 days following the end of Axsys’ fiscal year ended December 31,2005.

**Item10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT**

**Exceptfor the information concerning our Code of Ethics, the information required bythis item is incorporated by reference from our 2006 Proxy Statement.**

**Code of Ethics**

Axsys adopted a code ofethics applicable to our Chief Executive Officer and Chief Financial Officer,which is a “code of ethics” as defined by applicable rules of theSecurities and Exchange Commission. This code of ethics is publicly availableon our web site, www.axsys.com. The information in our web site is not part ofthis report. If we make any amendments to this code of ethics other thantechnical, administrative, or other non-substantive amendments, or grant anywaivers, including implicit waivers, from a provision of this code of ethics toour Chief Executive Officer or Chief Financial Officer, we will disclose thenature of the amendment or waiver, the effective date and to whom it applies ina report on Form 8-K filed with the Securities and ExchangeCommission.

**Item11. EXECUTIVE COMPENSATION**

The information requiredby this item is incorporated by reference from our 2006 Proxy Statement.

**Item12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATEDSTOCKHOLDER MATTERS**

Except for the informationconcerning equity compensation plans, the information required by this item isincorporated by reference from our 2006 Proxy Statement under the caption, “SecuritiesOwnership of Directors and Officers.”  The following table gives information about our equity securities thatmay be issued under equity compensation plans as of December 31, 2005.Those securities are shares of common stock that can be issued under ourexisting Long-Term Stock Incentive Plan.

43

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| **Plan category**                                      | ** ** | **Number of shares of  common stock to be  issued upon exercise of  outstanding options,  warrants and rights** | ** ** | **Weighted-average exercise  price of outstanding options,  warrants and rights** | ** ** | **Number of shares of common  stock remaining available for  further issuance under equity  compensation plans (excluding  securities reflected in column (a))** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **(a)**                                                                                                                                                                     | ** ** | **(b)**                                                                                                         | ** ** | **(c)**                                                                                                                                                                                                                                          | ** ** |
| Equity  compensation plans approved by security holders     |       |                                                                                                                                                                        | 898,966    |                                                                                                            |       |                                                                                                                                                                                                                                             | $          | 11.45 |   |   |   | 356,422 |   |   |
| Equity  compensation plans not approved by security holders |       |                                                                                                                                                                        | —     |                                                                                                            |       |                                                                                                                                                                                                                                             | —     |   |   |   | — |   |   |
| Total                                                       |       |                                                                                                                                                                        | 898,966    |                                                                                                            |       |                                                                                                                                                                                                                                             | $          | 11.45 |   |   |   | 356,422 |   |   |

 

**Item 13.**              CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS

The information requiredby this item is incorporated by reference from our 2006 Proxy Statement.

**Item 14.**              PRINCIPALACCOUNTANT FEES AND SERVICES

The information requiredby this item is incorporated by reference from our 2006 Proxy Statement.

**PART IV**

**Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES**

**(a)(1) Financial Statements**

See accompanying index to consolidated financialstatements and schedule on page F-1 of this annual report.

**(a)(2) Financial Statement Schedules**

See accompanying index to consolidated financialstatements and schedule on page F-1 of this annual report.

**(a)(3) Exhibits**

| ExhibitNumber | ** ** | **Description**                                                                                                                                                                                                                                                                                                         |
|---------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1           |       | Restated Certificate of  Incorporation of Axsys (filed as Exhibit 3(4) to Axsys’ Amendment  No. 2 to Registration Statement on Form S-1, dated  October 17, 1997 (File No. 333-36027) (the “Form S-1”)  and incorporated herein by reference).                        |
| 3.2           |       | By-Laws of Axsys (filed  as Exhibit 2 to the Form 8-A dated August 8, 1991 (file  No. 000-16182) and incorporated herein by reference).                                                                                                                                                             |
| 10.1          |       | Form of Incentive  Stock Option Agreement, dated as of September 30, 1991 (filed as  Exhibit 10(17) to Axsys’ Annual Report on Form 10-K for the  fiscal year ended December 30, 1991(File No. 000-16182)and  incorporated herein by reference).*                                    |
| 10.2          |       | Severance Protection  Agreement between Axsys and Stephen W. Bershad dated as of February 11,  1999 (filed as Exhibit 10(1) to Axsys’ Form 10-Q, dated  May 11, 1999, for the fiscal quarter ended March 31, 1999 (File  No. 000-16182) and incorporated herein by reference).* |

44

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| 10.3  |   | Amendment to Axsys  Technologies, Inc. Long-Term Stock Incentive Plan (filed as  Exhibit A to Axsys’ Proxy Statement dated April 24, 2000 (File  No. 000-16182) and incorporated herein by reference).*                                                             |
|-------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.4  |   | Employment Agreement,  dated as of October 12, 2000, between Axsys and Stephen W. Bershad  (filed as Exhibit 10(27) to the December 31, 2000 Form 10-K  (File No. 000-16182) and incorporated herein by reference). *                                               |
| 10.5  |   | Form of Indemnification  Agreement for all Directors and Officers of Axsys (filed as  Exhibit 10(17) to the December 31, 2001 Form 10-K (File  No. 000-16182) and incorporated herein by reference).*                                                               |
| 10.6  |   | Letter Agreement between  David A. Almeida and Axsys dated as of November 14, 2001 (filed as  Exhibit 10(18) to the December 31, 2001 Form 10-K (File  No. 000-16182) and incorporated herein by reference). *                                                      |
| 10.7  |   | Severance Protection  Agreement between Axsys and David A. Almeida dated as of May 13, 2003  (filed as Exhibit 10.2 to the June 28, 2003 Form 10-Q  (File No. 000-16182) and incorporated herein by reference).*                                                    |
| 10.8  |   | Letter Agreement between  Stephen W. Bershad and Axsys dated August 4, 2005, extending term of  initial period of the Employment Agreement. (filed as Exhibit 10.1 to  the October 26, 2005 Form 10-Q (File No. 000-16182)  and incorporated herein by reference).* |
| 10.9  |   | Severance Protection  Agreement between Axsys and Scott B. Conner dated as of December 3, 2004  (filed as Exhibit 10.9 to the December 31, 2004 Form 10-K  (File No. 000-16182) and incorporated herein by reference).*                                             |
| 10.10 |   | Summary of Management  Incentive Plan. (filed as Exhibit 10.10 to the December 31, 2004  Form 10-K (File No. 000-16182) and incorporated herein  by reference).*                                                                                                         |
| 10.11 |   | Purchase and Sale Agreement  filed as Exhibit 99.1 to Form 8-K on February 16, 2006                                                                                                                                                                                           |
| 21    |   | Subsidiaries of the  Registrant                                                                                                                                                                                                                                                              |
| 23    |   | Consent of Ernst and  Young LLP                                                                                                                                                                                                                                                              |
| 31.1  |   | Certification pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002—Chief Executive Officer                                                                                                                                                                                   |
| 31.2  |   | Certification pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002—Chief Financial Officer                                                                                                                                                                                   |
| 32.1  |   | Certification pursuant  to 18 U.S.C. Section 1350—Chief Executive Officer                                                                                                                                                                                                          |
| 32.2  |   | Certification pursuant  to 18 U.S.C. Section 1350—Chief Financial Officer                                                                                                                                                                                                          |

 

*                    Indicatesmanagement contracts or compensatory plans or arrangements.

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**SIGNATURES**

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized.

| Dated: February 27, 2006 | AXSYS TECHNOLOGIES, INC. |
|-------------------------------|--------------------------|
|                          | (Registrant)             |
|                          | By                       | /s/ STEPHEN W. BERSHAD |
|                          |                     | Stephen W. Bershad |
|                          |                     | Chairman of the Board of Directors |
|                          |                     | and Chief Executive Officer |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities indicated this the 27th day of February 2006.

| /s/ STEPHEN W. BERSHAD             |   | Chairman of the  Board of Directors and Chief Executive |
|------------------------------------|--------|---------------------------------------------------------|
| Stephen W.  Bershad                |   | Officer(Principal  Executive Officer)                   |
| /s/  DAVID A. ALMEIDA              |   | Vice President, Chief  Financial Officer, Treasurer     |
| David A. Almeida                   |   | (Principal  Financial and Accounting Officer)           |
| /s/  ANTHONY J. FIORELLI, Jr. |   | Director                                                |
| Anthony J.  Fiorelli, Jr.     |   |                                                    |
| /s/  ELIOT M. FRIED                |   | Director                                                |
| Eliot M. Fried                     |   |                                                    |
| /s/  RICHARD F. HAMM, Jr.     |   | Director                                                |
| Richard F.  Hamm, Jr.         |   |                                                    |
| /s/  ROBERT G. STEVENS             |   | Director                                                |
| Robert G. Stevens                  |   |                                                    |

 

46

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**ANNUAL REPORT ON FORM 10-K**

**ITEM 8, ITEM 15(a)(1) and(2)**

**INDEX TO CONSOLIDATEDFINANCIAL STATEMENTSAND FINANCIAL STATEMENT SCHEDULE**

**FINANCIALSTATEMENTS**

**YEAR ENDED DECEMBER31, 2005**

**AXSYS TECHNOLOGIES,INC.**

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**AXSYS TECHNOLOGIES, INC.INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**

**AND FINANCIAL STATEMENT SCHEDULE**

Thefollowing consolidated financial statements of Axsys Technologies, Inc.are included in Item 8:

| Report of Independent  Registered Public Accounting Firm                                                                                              |   | F-2    |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|
| Consolidated  Balance Sheets—December 31, 2005 and 2004                                                                                     |   | F-3    |   |
| Consolidated Statements of Operations—For the years  ended December 31, 2005, 2004 and 2003                                                 |   | F-4    |   |
| Consolidated Statements of Cash Flows—For the years  ended December 31, 2005, 2004 and 2003                                                 |   | F-5    |   |
| Consolidated Statements of Shareholders’ Equity and  Comprehensive Income (Loss)—For the years ended December 31, 2005, 2004  and 2003 |   | F-6    |   |
| Notes to  the consolidated financial statements                                                                                                       |   | F-7    |   |
| The following  consolidated financial statement schedule of Axsys Technologies, Inc.,  is included in Item 15(a)(2):                             |   |   |   |
| Schedule  II—Valuation and qualifying accounts.                                                                                                  |   | F-32   |   |

 

All other schedules for which provision is made in theapplicable accounting regulations of the Securities and Exchange Commission arenot required under the related instructions or are inapplicable and, therefore,have been omitted.

F-1

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Shareholders ofAxsys Technologies, Inc.

We have audited the accompanying consolidated balancesheets of Axsys Technologies, Inc. and subsidiaries as of December 31,2005 and 2004, and the related consolidated statements of operations,shareholders’ equity and comprehensive income (loss), and cash flows for eachof the three years in the period ended December 31, 2005. Our audits alsoincluded the financial statement schedule listed in the Index at Item 15(a)(2).These financial statements and schedule are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements and schedule based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board  (United States). Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred toabove present fairly, in all material respects, the consolidated financialposition of Axsys Technologies, Inc. and subsidiaries at December 31,2005 and 2004, and the consolidated results of their operations and their cashflows for each of the three years in the period ended December 31, 2005,in conformity with U.S. generally accepted accounting principles. Also, in ouropinion, the related financial statement schedule, when considered in relationto the basic financial statements taken as a whole, presents fairly in allmaterial respects the information set forth therein.

We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of Axsys Technologies, Inc.’s internalcontrol over financial reporting as of December 31, 2005, based oncriteria established in Internal Control-Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission and our reportdated February 17, 2006, expressed an unqualified opinion thereon.

**ERNST &YOUNG LLP**

Hartford, ConnecticutFebruary 17, 2006

F-2

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**AXSYS TECHNOLOGIES, INC.Consolidated Balance Sheets(Dollars in thousands, except share and per share data)**
|                                                                                                                                                                  | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                       | ** ** | **2005**              | ** ** | **2004** | ** ** |
| ASSETS                                                                                                                                                           |       |                  |       |   |   |
| CURRENT ASSETS:                                                                                                                                                  |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                                                        |       | $                     | 7,079      |   | $ | 6,000 |   |
| Accounts receivable, net                                                                                                                                         |       | 18,821                |       | 15,715 |   |
| Inventories, net                                                                                                                                                 |       | 37,866                |       | 29,698 |   |
| Income taxes—deferred                                                                                                                                       |       | 3,256                 |       | 3,553 |   |
| Other current assets                                                                                                                                             |       | 1,182                 |       | 1,020 |   |
| TOTAL CURRENT ASSETS                                                                                                                                             |       | 68,204                |       | 55,986 |   |
| PROPERTY, PLANT  AND EQUIPMENT, net                                                                                                                              |       | 15,351                |       | 13,337 |   |
| INTANGIBLE ASSETS,  net                                                                                                                                          |       | 10,461                |       | 2,127 |   |
| GOODWILL                                                                                                                                                         |       | 61,048                |       | 13,013 |   |
| OTHER ASSETS                                                                                                                                                     |       | 1,144                 |       | 1,352 |   |
| TOTAL ASSETS                                                                                                                                                     |       | $                     | 156,208    |   | $ | 85,815 |   |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                                                                                                       | ** ** | ** **            | ** ** | ** ** | ** ** |
| CURRENT LIABILITIES:                                                                                                                                             |       |                  |       |   |   |
| Accounts payable                                                                                                                                                 |       | $                     | 8,019      |   | $ | 6,459 |   |
| Accrued expenses and other current liabilities                                                                                                                   |       | 16,835                |       | 9,513 |   |
| Deferred income                                                                                                                                                  |       | 7,044                 |       | 7,195 |   |
| Current portion of long-term capital lease  obligations                                                                                                          |       | —                |       | 368 |   |
| Current portion of long-term debt                                                                                                                                |       | —                |       | 1,000 |   |
| TOTAL CURRENT LIABILITIES                                                                                                                                        |       | 31,898                |       | 24,535 |   |
| CAPITAL LEASES,  less current portion                                                                                                                            |       | —                |       | 150 |   |
| LONG-TERM DEBT,  less current portion                                                                                                                            |       | —                |       | 3,333 |   |
| OTHER LONG-TERM  LIABILITIES                                                                                                                                     |       | 4,769                 |       | 4,704 |   |
| COMMITMENTS  AND CONTINGENCIES (Note 14)                                                                                                                         |       |                  |       |   |   |
| SHAREHOLDERS’ EQUITY:                                                                                                                                       |       |                  |       |   |   |
| Common stock, $.01 par value: authorized 30,000,000  shares, issued 10,636,734  shares at December 31, 2005 and 7,186,734 shares at December 31,  2004 |       | 106                   |       | 72 |   |
| Capital in excess of par                                                                                                                                         |       | 97,875                |       | 39,612 |   |
| Accumulated other comprehensive income (loss)                                                                                                                    |       | 3                     |       | (97 | ) |
| Retained earnings                                                                                                                                                |       | 21,712                |       | 14,389 |   |
| Treasury stock, at cost: 18,907 shares at  December 31, 2005 and 130,216 shares  at December 31, 2004                                                  |       | (155                  | )          | (883 | ) |
| TOTAL SHAREHOLDERS’ EQUITY                                                                                                                                  |       | 119,541               |       | 53,093 |   |
| TOTAL LIABILITIES  AND SHAREHOLDERS’ EQUITY                                                                                                                 |       | $                     | 156,208    |   | $ | 85,815 |   |

 

See accompanying notes to consolidated financial statements.

F-3

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**AXSYS TECHNOLOGIES, INC.Consolidated Statementsof Operations(Dollars in thousands, except share and per share data)**

| ** **                                                                              | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
|                                                                                         | ** ** | **2005**                          | ** ** | **2004** | ** ** | **2003** | ** ** |
| Sales                                                                                   |       | $                                 | 133,543    |   | $ | 103,530 |   | $ | 85,109 |   |
| Cost of sales                                                                           |       | 91,897                            |       | 72,874 |   | 62,036 |   |
| Gross profit                                                                            |       | 41,646                            |       | 30,656 |   | 23,073 |   |
| Selling, general and administrative expenses                                            |       | 23,957                            |       | 18,634 |   | 15,986 |   |
| Research,  development and engineering expenses                                         |       | 3,766                             |       | 2,677 |   | 2,059 |   |
| OPERATING INCOME                                                                        |       | 13,923                            |       | 9,345 |   | 5,028 |   |
| Interest expense                                                                        |       | (1,684                            | )          | (254 | ) | (172 | ) |
| Interest income                                                                         |       | 167                               |       | 98 |   | 115 |   |
| Loss on  extinguishment of debt                                                         |       | (480                              | )          | — |   | — |   |
| Other income  (expense), net                                                            |       | 33                                |       | (38 | ) | 263 |   |
| Income from  continuing operations before income taxes                                  |       | 11,959                            |       | 9,151 |   | 5,234 |   |
| Provision for  (benefit from) income taxes                                              |       | 4,486                             |       | (8 | ) | 236 |   |
| INCOME FROM  CONTINUING OPERATIONS                                                      |       | 7,473                             |       | 9,159 |   | 4,998 |   |
| Discontinued  operations:                                                               |       |                              |       |   |   |   |   |
| Loss from  discontinued operations, net of tax benefit of $90 in  2005 and $266 in 2004 |       | (150                              | )          | (495 | ) | — |   |
| NET INCOME                                                                              |       | $                                 | 7,323      |   | $ | 8,664 |   | $ | 4,998 |   |
| BASIC EARNINGS (LOSS)  PER SHARE:                                                       |       |                              |       |   |   |   |   |
| Continuing operations                                                                   |       | $                                 | 0.93       |   | $ | 1.30 |   | $ | 0.72 |   |
| Discontinued operations                                                                 |       | (0.02                             | )          | (0.07 | ) | — |   |
| Total                                                                                   |       | $                                 | 0.91       |   | $ | 1.23 |   | $ | 0.72 |   |
| Weighted-average  basic common shares outstanding                                       |       | 8,006,029                         |       | 7,020,184 |   | 6,986,094 |   |
| DILUTED EARNINGS  (LOSS) PER SHARE:                                                     |       |                              |       |   |   |   |   |
| Continuing operations                                                                   |       | $                                 | 0.90       |   | $ | 1.26 |   | $ | 0.71 |   |
| Discontinued operations                                                                 |       | (0.02                             | )          | (0.07 | ) | — |   |
| Total                                                                                   |       | $                                 | 0.88       |   | $ | 1.19 |   | $ | 0.71 |   |
| Weighted-average diluted  common shares outstanding                                     |       | 8,355,400                         |       | 7,289,437 |   | 7,074,342 |   |

 

See accompanying notes to consolidated financial statements.

F-4

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**AXSYS TECHNOLOGIES, INC.Consolidated Statementsof Cash Flows(Dollars in thousands)**

| ** **                                                                          | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
|                                                                                     | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| CASH FLOWS FROM OPERATING  ACTIVITIES:                                              |       |                                        |       |   |   |   |   |
| Net income                                                                          |       | $                                           | 7,323      |   | $ | 8,664 |   | $ | 4,998 |   |
| Adjustments to reconcile  net income to net cash provided by  operating activities: |       |                                        |       |   |   |   |   |
| Depreciation                                                                        |       | 3,148                                       |       | 2,674 |   | 2,920 |   |
| Amortization                                                                        |       | 816                                         |       | 73 |   | — |   |
| Deferred income taxes (benefit)                                                     |       | 1,333                                       |       | (1,747 | ) | — |   |
| Stock option compensation expense                                                   |       | —                                      |       | 242 |   | — |   |
| Contribution to 401(k) plan                                                    |       | 66                                          |       | 58 |   | 55 |   |
| Loss on disposal of capital equipment                                               |       | 3                                           |       | 19 |   | 55 |   |
| Changes in operating  assets and liabilities:                                       |       |                                        |       |   |   |   |   |
| Accounts receivable                                                                 |       | (809                                        | )          | (4,464 | ) | (129 | ) |
| Inventories                                                                         |       | (2,587                                      | )          | (4,073 | ) | (2,706 | ) |
| Other current assets and other assets                                               |       | (93                                         | )          | 787 |   | 868 |   |
| Accounts payable                                                                    |       | (64                                         | )          | 2,112 |   | 1,132 |   |
| Accrued expenses and other liabilities                                              |       | 591                                         |       | 1,232 |   | (108 | ) |
| Deferred income                                                                     |       | (481                                        | )          | 2,649 |   | 1,431 |   |
| Long-term liabilities                                                               |       | (734                                        | )          | (448 | ) | (504 | ) |
| Net cash provided  by continuing operations                                         |       | 8,512                                       |       | 7,778 |   | 8,012 |   |
| Net cash used in  discontinued operations                                           |       | (907                                        | )          | (140 | ) | (1,261 | ) |
| NET CASH PROVIDED BY OPERATING ACTIVITIES                                           |       | 7,605                                       |       | 7,638 |   | 6,751 |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                              |       |                                        |       |   |   |   |   |
| Capital expenditures                                                                |       | (3,533                                      | )          | (4,239 | ) | (3,027 | ) |
| Purchase of DiOP, net of cash acquired                                              |       | (57,138                                     | )          | — |   | — |   |
| Purchase of Telic, net of cash acquired                                             |       | —                                      |       | (13,728 | ) | — |   |
| Net sale (purchase) of marketable securities                                        |       | —                                      |       | 6,983 |   | (6,983 | ) |
| NET CASH USED IN  INVESTING ACTIVITIES                                         |       | (60,671                                     | )          | (10,984 | ) | (10,010 | ) |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                              |       |                                        |       |   |   |   |   |
| Proceeds from stock offering                                                        |       | 57,620                                      |       | — |   | — |   |
| Proceeds from long-term debt                                                        |       | 55,000                                      |       | 5,000 |   | — |   |
| Repayment of borrowings                                                             |       | (59,851                                     | )          | (1,140 | ) | (1,255 | ) |
| Proceeds from the exercise of options                                               |       | 1,301                                       |       | 360 |   | 4 |   |
| Escheatment and settlement of preferred stock                                       |       | 76                                          |       | (71 | ) | (213 | ) |
| Payments under stock buy-back program                                               |       | (1                                          | )          | — |   | — |   |
| NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES                                 |       | 54,145                                      |       | 4,149 |   | (1,464 | ) |
| NET CHANGE IN CASH AND CASH EQUIVALENTS                                             |       | 1,079                                       |       | 803 |   | (4,723 | ) |
| CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR                                      |       | 6,000                                       |       | 5,197 |   | 9,920 |   |
| CASH AND CASH  EQUIVALENTS AT END OF YEAR                                           |       | $                                           | 7,079      |   | $ | 6,000 |   | $ | 5,197 |   |

 

See accompanying notes to consolidated financial statements.

F-5

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**AXSYS TECHNOLOGIES, INC.Consolidated Statementsof Shareholders’ Equity and Comprehensive Income (Loss)(Dollars in thousands)**
|                                                   | ** ** | ** ** | ** ** | ** **          | ** ** | **Accumulated**        | ** ** | ** **   | ** ** | ** **   | ** ** | ** ** | ** ** | ** **             | ** ** |
|---------------------------------------------------|------------|------------|------------|---------------------|------------|------------------------|------------|--------------|------------|--------------|------------|------------|------------|------------------------|------------|
| ** **                                        | ** ** | **Common** | ** ** | **Capital in** | ** ** | **Other**              | ** ** | ** **   | ** ** | **Treasury** | ** ** | ** ** | ** ** | ** **             | ** ** |
| ** **                                        | ** ** | **Stock**  | ** ** | **Excess of**  | ** ** | **Comprehensive**      | ** ** | **Retained** | ** ** | **Stock**    | ** ** | ** ** | ** ** | **Comprehensive**      | ** ** |
| ** **                                        | ** ** | **Amount** | ** ** | **Par**             | ** ** | **Income (Loss)** | ** ** | **Earnings** | ** ** | **Amount**   | ** ** | **Total**  | ** ** | **Income (Loss)** | ** ** |
| Balance at December 31, 2002                 |       |       | $          | 72                  |       |                   |       | $            | 39,587     |         |       |       | $          | —                 |       |   |   | $ | 727 |   |   |   | $ | (1,293 | ) |   | $ | 39,093 |   |   |   |   |   |
| Net income                                        |       |       | —     |                |       |                   | —     |         |       |         | —     |       |       |                   | 4,998      |   |   |   | — |   |   | 4,998 |   |   | $ | 4,998 |   |   |
| Foreign exchange contract                         |       |       | —     |                |       |                   | —     |         |       |         | (39        | )          |       |                   | —     |   |   |   | — |   |   | (39 | ) |   | (39 | ) |   |
| Total comprehensive income                        |       |       |       |                |       |                   |       |         |       |         |       |       |       |                   |       |   |   |   |   |   |   |   |   |   | $ | 4,959 |   |   |
| Exercise of stock options                         |       |       | —     |                |       |                   | (1         | )            |       |         | —     |       |       |                   | —     |   |   |   | 5 |   |   | 4 |   |   |   |   |   |
| Contribution to 401(k) plan                  |       |       | —     |                |       |                   | 2          |         |       |         | —     |       |       |                   | —     |   |   |   | 53 |   |   | 55 |   |   |   |   |   |
| Escheatment of preferred stock                    |       |       | —     |                |       |                   | (12        | )            |       |         | —     |       |       |                   | —     |   |   |   | — |   |   | (12 | ) |   |   |   |   |
| Preferred stock settlement                        |       |       | —     |                |       |                   | (201       | )            |       |         | —     |       |       |                   | —     |   |   |   | — |   |   | (201 | ) |   |   |   |   |
| Balance at December 31, 2003                 |       |       | 72         |                |       |                   | 39,375     |         |       |         | (39        | )          |       |                   | 5,725      |   |   |   | (1,235 | ) |   | 43,898 |   |   |   |   |   |
| Net income                                        |       |       | —     |                |       |                   | —     |         |       |         | —     |       |       |                   | 8,664      |   |   |   | — |   |   | 8,664 |   |   | $ | 8,664 |   |   |
| Foreign exchange contract                         |       |       | —     |                |       |                   | —     |         |       |         | (84        | )          |       |                   | —     |   |   |   | — |   |   | (84 | ) |   | (84 | ) |   |
| Gain on swap agreement                            |       |       | —     |                |       |                   | —     |         |       |         | 26         |       |       |                   | —     |   |   |   | — |   |   | 26 |   |   | 26 |   |   |
| Total comprehensive income                        |       |       |       |                |       |                   |       |         |       |         |       |       |       |                   |       |   |   |   |   |   |   |   |   |   | $ | 8,606 |   |   |
| Exercise of stock options                         |       |       | —     |                |       |                   | 38         |         |       |         | —     |       |       |                   | —     |   |   |   | 322 |   |   | 360 |   |   |   |   |   |
| Contribution to 401(k) plan                  |       |       | —     |                |       |                   | 28         |         |       |         | —     |       |       |                   | —     |   |   |   | 30 |   |   | 58 |   |   |   |   |   |
| Escheatment of preferred  stock                   |       |       | —     |                |       |                   | (71        | )            |       |         | —     |       |       |                   | —     |   |   |   | — |   |   | (71 | ) |   |   |   |   |
| Stock option compensation                         |       |       | —     |                |       |                   | 242        |         |       |         | —     |       |       |                   | —     |   |   |   | — |   |   | 242 |   |   |   |   |   |
| Balance at December 31, 2004                 |       |       | 72         |                |       |                   | 39,612     |         |       |         | (97        | )          |       |                   | 14,389     |   |   |   | (883 | ) |   | $ | 53,093 |   |   |   |   |   |
| Net income                                        |       |       | —     |                |       |                   | —     |         |       |         | —     |       |       |                   | 7,323      |   |   |   | — |   |   | 7,323 |   |   | $ | 7,323 |   |   |
| Public stock offering                             |       |       | 34         |                |       |                   | 57,549     |         |       |         | —     |       |       |                   | —     |   |   |   | — |   |   | 57,583 |   |   | — |   |   |
| Foreign exchange contract                         |       |       | —     |                |       |                   | —     |         |       |         | 126        |       |       |                   | —     |   |   |   | — |   |   | 126 |   |   | 126 |   |   |
| Termination of swap  agreement                    |       |       | —     |                |       |                   | —     |         |       |         | (26        | )          |       |                   | —     |   |   |   | — |   |   | (26 | ) |   | (26 | ) |   |
| Total comprehensive income                        |       |       |       |                |       |                   |       |         |       |         |       |       |       |                   |       |   |   |   |   |   |   |   |   |   | $ | 7,423 |   |   |
| Exercise of stock options                         |       |       | —     |                |       |                   | 597        |         |       |         | —     |       |       |                   | —     |   |   |   | 704 |   |   | 1,301 |   |   |   |   |   |
| Contribution to 401(k) plan                  |       |       | —     |                |       |                   | 41         |         |       |         | —     |       |       |                   | —     |   |   |   | 25 |   |   | 66 |   |   |   |   |   |
| Distribution from preferred  stocksettlement fund |       |       | —     |                |       |                   | 76         |         |       |         | —     |       |       |                   | —     |   |   |   | — |   |   | 76 |   |   |   |   |   |
| Stock buy-back program                            |       |       | —     |                |       |                   | —     |         |       |         | —     |       |       |                   | —     |   |   |   | (1 | ) |   | (1 | ) |   |   |   |   |
|                                                   |            |            |            |                     |            |                        |            |              |            |              |            |            |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
| Balance at  December 31, 2005 |   |   | $ | 106 |   |   |   | $ | 97,875 |   |   |   | $ | 3 |   |   |   | $ | 21,712 |   |   |   | $ | (155 | ) |   | $ | 119,541 |   |   |   |   |   |
|------------------------------------|--------|--------|---|-----|--------|--------|--------|---|--------|--------|--------|--------|---|---|--------|--------|--------|---|--------|--------|--------|--------|---|------|---|--------|---|---------|--------|--------|--------|--------|--------|

 

See accompanying notes to consolidated financial statements.

F-6

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**AXSYS TECHNOLOGIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except per share data)**

**December 31, 2005**

**Note 1—Summary of Significant Accounting Policies**

*Businessoverview.*   The accompanying consolidatedfinancial statements include the accounts of Axsys Technologies, Inc. andits wholly-owned subsidiaries (collectively “Axsys”, “Company”, “we”, “our” or “us”).

Axsys is a leading designer and manufacturer ofprecision optical solutions for defense, aerospace, homeland security andhigh-performance commercial applications. These sophisticated solutions aretypically found in applications that demand the finest optical surfaces,highest accuracy and tightest motion control tolerances. In addition to opticalsolutions, we distribute precision ball bearings used in a variety ofindustrial and commercial applications.

*Principlesof consolidation.**  *Theconsolidated financial statements include the results of Axsys and itswholly-owned subsidiaries. All significant inter-company balances andtransactions have been eliminated in consolidation.

*Revenuerecognition.**  *Revenueis recognized in accordance with the Securities and Exchange Commission StaffAccounting Bulletin (“SAB”) No. 104. SAB No. 104 requires that fourbasic criteria must be met before revenue can be recognized:  (1) persuasive evidence of anarrangement exists; (2) delivery has occurred or services rendered; (3) thefee is fixed and determinable; and (4) collectibility is reasonablyassured. Shipping and handling costs, such as freight to customers, areclassified in cost of sales.

Our policy is to recognize revenues when product iseither shipped to or received by the customer based on the terms of thespecific sale. However, certain long-term contracts are accounted for under thepercentage-of-completion model. Revenues and estimated gross profit arerecognized as work is performed based on the percentage that incurred costsbear to estimated total costs. Cost estimates include direct and indirect costssuch as labor, materials and overhead. These contracts require judgmentrelative to assessing risks, estimating, and making assumptions for scheduleand technical issues. Contract changes are included when the costs can bereasonably estimated.  We may receiveprogress payments that exceed costs incurred on these long-term contracts. Suchadvances are recognized as billings in excess of costs and are included inaccrued expenses and other current liabilities on our consolidated balancesheets.

Certain contracts are accounted for under the servicecontract model.  Under these contracts,revenues are deferred and recognized on a straight-line basis over the contractperiod, as services are performed.

Due to the build-to-order nature of our products,except for the distribution of ball bearings, we do not offer price protectionand generally do not offer discounts. To the extent discounts are offered, theyare reflected at the time of the sale as a reduction in revenues. The price isfixed upon acceptance of the purchase order. When customer change orders occur,any pricing changes are reflected in a revised purchase order.

Provisions for estimated losses on contracts arerecognized when losses become evident. These estimates are subject to changeand could result in adjustments to contracts in progress.

*Cashand cash equivalents.*   Cash and cash equivalentsinclude highly liquid investments with a maturity of three months or less atthe date of purchase.

F-7

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**AXSYS TECHNOLOGIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data)**

**Note 1—Summaryof Significant Accounting Policies (Continued)**

*Financialinstruments.**  *We usederivative instruments, in the form of forward exchange contracts and interestrate swap agreements, to manage certain foreign currency and interest rateexposures. We view derivative instruments as risk management tools, and we donot use them for trading or speculative purposes. Derivatives used for hedgingpurposes are designated as an effective hedge of the identified risk exposureat the inception of the contract. Accordingly, changes in fair value of thederivative contract must be highly correlated with changes in the fair value ofthe underlying hedged item at inception of the hedge and over the life of thehedge contract.

All derivative instruments are recorded in the balancesheet at fair value. Derivatives used to hedge forecasted cash flows associatedwith foreign currency sales and interest rate fluctuations are accounted for ascash flow hedges. Gains and losses on derivatives designated as cash flowhedges are recognized in accumulated other comprehensive income (loss) and inearnings in a manner that matches the timing of the earnings impact of the hedgedtransactions. The ineffective portion of all hedges, if any, is recognizedcurrently in earnings. At December 31, 2005, we had one forward exchangecontract outstanding with a total gain position of $3, which was included inother current assets. We did not have any interest rate swap agreementsoutstanding at  December 31, 2005.

Thetable below presents the fair value of those derivative instruments at December 31:

| ** **                    | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|
| Forward exchange  contracts   |       |     | $          | 3        |       |   | $ | (123 | ) |
| Interest rate swap  agreement |       |     | —     |     |       | 26 |   |
|                               |            |          |            |          |            |  |  |  |  |

 

The carrying amounts of our other financialinstruments, which include cash equivalents, accounts receivable and accountspayable approximate their fair value due to the short-term nature of suchinstruments. In addition, the carrying value of long-term debt approximatesfair value due to the variable interest rate it bears.

*Accountsreceivable.*   Receivables consist of amountsbilled and currently due from customers, and unbilled costs and accrued profitsprimarily related to revenues on long-term contracts that have been recognizedfor accounting purposes but not yet billed to customers. Credit is extended tocustomers, typically on net 30-day terms. We do not require collateral.

*Allowancefor doubtful accounts.*   We periodically reviewthe aging of our accounts receivable over ninety days to identify potentiallyuncollectible accounts and establish reserves based on experience anddiscussion with customers. Actual write-offs could differ from our allowancefor doubtful accounts. If circumstances change (i.e., higher than expecteddefaults or an unexpected material adverse change in a customer’s ability tomeet its financial obligations), our estimates of recoverability of amounts dueto us could be reduced by a material amount. Accounts receivable are writtenoff only when all reasonable collection efforts are exhausted.

*Research,development and engineering.**  *Significantcosts are incurred each year in connection with research and developmentprograms and administrative engineering costs (“R&D”). Such costs areincluded in operating expenses as incurred. In situations where the customerreimburses the cost of the R&D effort, the revenue generated is recognizedas sales and the expense is included in cost of sales. 

F-8

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**AXSYS TECHNOLOGIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data)**

**Note 1—Summaryof Significant Accounting Policies (Continued)**

Research and developmentexpenses, exclusive of engineering costs, were $2,730 in 2005, $1,571 in 2004and $756 in 2003.

*Inventory.**  *We value our inventory at the lower of the actualcost to purchase and/or manufacture the inventory or the current estimatedmarket value of the inventory with cost generally determined using the firstin, first out method. A provision for excess or obsolete inventory is recordedbased upon an analysis that considers current inventory levels, historicalusage patterns and future sales expectations.

In November 2004, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”)No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4,” toclarify that abnormal amounts of idle facility expense, freight, handling costsand wasted material (spoilage) should be recognized as current period charges,and that fixed production overheads should be allocated to inventory based onnormal capacity of production facilities. This statement is effective for Axsys’fiscal year 2006 and is not expected to have a material impact on our financialposition or results of operations.

*Property,plant and equipment.**  *Property,plant and equipment are stated at cost, less accumulated depreciation andamortization, which includes the depreciation of assets recognized undercapital leases. Depreciation is provided primarily by the straight-line methodusing estimated lives for buildings and improvements of 20 to 25 years and from3 to 8 years for machinery and equipment. Repair and maintenance costs areexpensed as incurred.

*Goodwilland other intangibles.*   Goodwill (representingthe excess of the amount paid to acquire a company over the estimated fairvalue of the net assets acquired) and intangible assets with indefinite usefullives are not amortized but instead are tested for impairment annually, or whenevents or circumstances indicate that its value may have declined. Impairmentexists when the carrying amount of goodwill exceeds its fair market value. TheCompany’s goodwill impairment test is performed by comparing the net presentvalue of projected cash flows to the carrying value of goodwill. The Companyutilizes discount rates determined by management to be similar with the levelof risk in its current business model. The Company performs the annualimpairment testing during the second quarter of each fiscal year and hasdetermined that, to date, no impairment of goodwill exists. Although no changesare expected, if the actual results of the Company are less favorable than theassumptions the Company makes regarding estimated cash flows, the Company maybe required to record an impairment charge in the future.

Definite-lived intangible assets acquired as part ofbusiness combinations are amortized over their estimated useful lives. Formaterial business combinations, amounts recognized related to purchasedintangibles are determined with the assistance of independent valuations.

*Commitmentsand contingencies.*   We are self-insured forcertain losses related to general liability, workers’ compensation and medicalclaims. Our liability represents an estimate of the ultimate cost of claimsincurred as of the balance sheet date. The estimated liability is establishedbased on an analysis of historical data and is reviewed by management on aquarterly basis to ensure that the liability is appropriate. While we believethat our estimates are reasonable based on the information currently available,if actual trends, including the severity and frequency of claims, medical costinflation or fluctuations in premiums, differ from our estimates, our resultsfrom operations could be impacted.

F-9

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**AXSYS TECHNOLOGIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data)**

**Note 1—Summaryof Significant Accounting Policies (Continued)**

*Deferredincome.**  *Deferredincome primarily results from the advance billings to our customers formilestone payments for either progress billings or for material billings. Materialbillings primarily occur when customers advance us the cost of beryllium onlong lead-time orders.

*Warranty.*   Weprovide warranties for certain of our products. Provisions for estimatedexpenses related to product warranties are made at the time products are sold. Theseestimates are established using historical information on the nature,frequency, and average cost of warranty claims.

Thefollowing table summarizes product warranty activity:

| Balance at  January 1, 2003   |   |   | $    | 722    |   |   |
|------------------------------------|--------|--------|------|--------|--------|--------|
| Provision                          |   |   | 140  |   |   |
| Payments                           |   |   | (229 | )      |   |
| Balance at  December 31, 2003 |   |   | 633  |   |   |
| Provision                          |   |   | 360  |   |   |
| Payments                           |   |   | (279 | )      |   |
| Reserve of  acquired subsidiary    |   |   | 36   |   |   |
| Balance at  December 31, 2004 |   |   | 750  |   |   |
| Provision                          |   |   | 468  |   |   |
| Payments                           |   |   | (479 | )      |   |
| Reserve of  acquired subsidiary    |   |   | 403  |   |   |
| Balance at  December 31, 2005 |   |   | $    | 1,142  |   |   |

 

*Losscontract reserves.**  *Generally,our customer contracts are completed within one year of receiving the order. However,occasionally, longer lead-time orders are received and we monitor thesecontracts periodically to determine if our actual costs are comparable to ourcost estimates used at the time of order acceptance. If we determine that ouractual costs are  exceeding our originalestimates, we will record a loss contract reserve. Currently, one contract iscovered by a loss contract reserve. We accrued for this contract based on thecontract price and the current cost structure, including estimated costincreases.

*Environmentalcontingencies.**  *We arecurrently involved in several environmental remediation projects.  We accrue for environmental contingencies when(1) responsibility for cleanup is determined and (2) costs areprobable and can be reasonably estimated. When costs are not probable or cannotbe reasonably estimated, no accrual is made. We have accrued our estimate ofthe  costs for the resolution of the openclaims. These estimates have been developed in consultation with outsideenvironmental consultants handling these matters and are based upon an analysisof the anticipated remediation plans. We do not anticipate these projects willhave a material adverse effect on our consolidated financial position. It ispossible, however, that future results of operations could be materially affectedby changes in our assumptions.

*Incometaxes.**  *Weaccount for income taxes in accordance with SFAS No. 109, “Accounting forIncome Taxes”. As such, deferred income taxes are determined based on thedifferences between the 

F-10

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**AXSYS TECHNOLOGIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data)**

**Note 1—Summaryof Significant Accounting Policies (Continued)**

financial statement andtax basis of assets and liabilities at enacted income tax rates in effect inthe year in which the differences are expected to reverse. Valuation allowancesare established, when necessary, to reduce deferred income tax assets toestimated amounts expected to be realized. Realizability of net deferred incometax assets are evaluated on an ongoing basis. We consider future taxableincome, our most recent operating results and various income tax planningstrategies in assessing the need for a valuation allowance.

*Earningsper share.**  *Basicearnings per share have been computed by dividing net income or loss by theweighted-average number of common shares outstanding. The dilutive effect ofstock options on the weighted-average number of common shares outstanding was349,371 shares for the year ended December 31, 2005, 269,253 shares forthe year ended December 31, 2004 and 88,248 shares for the year ended December 31,2003.

Diluted earnings per share for 2005 exclude 131,538potential common shares related to our stock compensation plans because theoption exercise price was greater than the average market price of our commonstock for the period.

*Stock-basedcompensation.**  *We haveadopted the disclosure-only provisions of SFAS No. 123, “Accounting forStock-Based Compensation” as amended by SFAS No. 148, “Accounting forStock-Based Compensation—Transition and Disclosure” and account for stock-basedcompensation under the provisions of Accounting Board Opinion No. 25, “Accountingfor Stock Issued to Employees” using the intrinsic value method. The exerciseprice on stock options is either greater than or equal to the closing marketprice on the day of grant and, accordingly, no compensation cost has beenrecognized. We do not grant stock options with exercise prices below marketvalue. Pro forma information regarding net income and net income per share isrequired by SFAS No. 148 for awards as if we had accounted for such awardsunder the fair value method.

Thefollowing table illustrates the effect on net income and income per share if wehad applied the fair value recognition provisions of SFAS No. 123:
|                                                                | ** ** | **2005**  | ** ** | **2004**  | ** ** | **2003**  | ** ** |
|----------------------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| Reported net income                                            |       | $         | 7,323      |      | $          | 8,664     |       | $ | 4,998 |   |
| Stock  option-related employee compensation expense            |       | (736      | )          | (770      | )          | (755      | )          |
| Pro forma net  income                                          |       | $         | 6,587      |      | $          | 7,894     |       | $ | 4,243 |   |
| Pro forma basic income per share                               |       | $         | 0.82       |      | $          | 1.12      |       | $ | 0.61 |   |
| Weighted-average basic and diluted common shares  outstanding  |       | 8,006,029 |       | 7,020,184 |       | 6,986,094 |       |
| Pro forma diluted income per share                             |       | $         | 0.80       |      | $          | 1.11      |       | $ | 0.62 |   |
| Weighted-average  basic and diluted common shares  outstanding |       | 8,212,284 |       | 7,114,686 |       | 6,853,276 |       |
|                                                                |            |           |            |           |            |           |            |  |  |  |  |  |  |  |  |  |  |

 

The fair value of each option granted in 2005, 2004and 2003 was estimated on the date of grant using the Black-Scholesoption-pricing model with the following assumptions: expected volatility of 42%of 2005, 43% in 2004 and 68% in 2003; risk-free interest rate of 4.39% in 2005,4.24% in 2004 and 4.27% in 2003; 

F-11

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**AXSYS TECHNOLOGIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data)**

**Note 1—Summaryof Significant Accounting Policies (Continued)**

expected lives of 6 years;and no dividend yield. Using this model, the weighted-average fair value ofoptions granted was $9.47 during 2005, $5.34 during 2004 and $4.45 during 2003.For pro forma purposes, the estimated fair value of the our Company’s stockincentive awards to employees is amortized on a straight-line basis over theoptions’ vesting period, which is generally five years.  The Black-Scholes option valuation model wasdeveloped for use in estimating the fair value of traded options, which have novesting restrictions and are fully transferable. In addition, the Black-Scholesmodel requires the input of highly subjective assumptions including theexpected stock price volatility.

In December 2004, the FASB issued SFAS No. 123(revised 2004), or SFAS No. 123 (R), “Share-Based Payment,” which revisedSFAS No. 123, “Accounting for Stock-Based Compensation”. The revisedstatement addresses the accounting for share-based payment transactions withemployees and other third parties, eliminates the ability to account forshare-based compensation transactions using APB 25 and requires that thecompensation costs relating to such transactions be recognized in theconsolidated statement of operations. SFAS No. 123 (R) must beadopted no later than January 1, 2006. Early adoption is permitted. Weexpect to adopt the statement effective January 1, 2006, as required. Theimpact of adoption of SFAS No. 123 (R) cannot be predicted at thistime because it will depend on levels of share-based payments granted in thefuture. However, had we adopted SFAS No. 123 (R) in prior periods,the annual impact of that standard would have approximated the impact of SFAS No. 123as described in the disclosure of pro forma net income (loss) and net income(loss) per share above*.*

*Estimatesand assumptions.*   The preparation of financialstatements in conformity with generally accepted accounting principles requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period. Actual results could differ fromthose estimates.

Certain amounts inpreviously issued annual financial statements were reclassified to conform tothe 2005 presentation.

**Note 2—Acquisitions**

On May 2, 2005, Axsys acquired all of the capitalstock of Diversified Optical Products, Inc. (“DiOP”), a manufacturer ofhigh-end thermal camera systems and lenses, for $55,200 in cash plus $1,900 oflegal, audit and other acquisition related costs incurred in connection withthe acquisition. The acquisition of DiOP brought us new, high valuetechnologies, leveraged our existing infrared and motion control technologies,and provided us with a new base of customers. Further, the combination of DiOPand Axsys positioned us as a leading independent infrared lens manufacturer. Atthe time of the acquisition, DiOP employed approximately 120 people at itsSalem, New Hampshire headquarters. DiOP is doing business as Axsys TechnologiesIR Systems and the financial results are included in our Optical Systems Group.

F-12

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**AXSYS TECHNOLOGIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data)**

**Note 2—Acquisitions(Continued)**

The acquisition has beenaccounted for by the purchase method of accounting and, accordingly, theconsolidated statements of operations include the results of DiOP from the dateof acquisition.  The assets acquired andthe liabilities assumed were recorded at estimated fair values as determined byAxsys management and a valuation firm based on information available and oncurrent assumptions as to future operations.

| Fair value:                    |   |   |   |
|--------------------------------|--------|--------|--------|
| Cash                           |   | $      | 2,009  |   |
| Accounts receivable            |   | 2,297  |   |
| Inventories, net               |   | 5,581  |   |
| Other assets                   |   | 1,900  |   |
| Liabilities assumed            |   | (9,085 | )      |
| Amortizable intangible assets  |   | 9,150  |   |
| Goodwill                       |   | 45,218 |   |
| **Purchase  price**            |   | 57,070 |   |
| Cash acquired                  |   | (2,009 | )      |
| Debt repayment                 |   | 2,309  |   |
| Repayment of DiOP officer loan |   | (142   | )      |
| Accrued acquisition costs      |   | (90    | )      |
| **Net cash paid**              |   | $      | 57,138 |   |

 

At closing, an officer of DiOP paid Axsys $142 for hisoutstanding loan balance. Immediately after closing, there were no outstandingofficer loans. Goodwill acquired through the purchase of DiOP is deductible forincome tax purposes.

On April 8, 2004, we acquired all of the capitalstock of Telic Optics, Inc. (“Telic”), a manufacturer of infrared opticsand optical assemblies. Telic’s broad infrared optics capabilities increase ourproduct offerings and complement our strong position in reflective opticalsolutions. In addition, Telic’s products are typically used in ground-andsea-based programs. This complements our historical focus on air- andspace-based programs and expands our overall market and program penetration. Finally,the complementary addition of Telic’s technical capabilities to our coretechnical strengths is expected to increase our competitive advantage bybroadening our technical offering to prime contractors who are seeking tooutsource the fulfillment of their optical requirements.

The initial purchase price of this acquisition, aftera working capital adjustment of $15, was $14,423 with an additional earn outpayment of up to $4,000 over 36 months following the closing date based on theachievement of certain revenue goals. During 2005, $2,817 of the earn out wasearned, which increased the purchase price to $17,240. The additional purchaseprice will be paid during 2006. If remaining revenue goals are achieved, over thenext 15 months the earn out could increase the total purchase price to$18,423. Included in the purchase price was $438 of legal, audit and otheracquisition related expenses that were incurred in connection with theacquisition. We funded the purchase price and associated transaction coststhrough a combination of existing cash balances and outside bank financing.

F-13

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**AXSYS TECHNOLOGIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data)**

**Note 2—Acquisitions(Continued)**

The acquisition has beenaccounted for according to the purchase method of accounting and, accordingly,the consolidated statements of operations include the results of Telic sincethe date of the acquisition.  The assetsacquired and the liabilities assumed were recognized at their estimated fairvalues within our Optical Systems Group.

| Fair value:                   | ** ** | ** ** | ** ** |
|-------------------------------|------------|------------|------------|
| Assets acquired               |       | $          | 3,084      |   |
| Liabilities assumed           |       | (274       | )          |
| Amortizable intangible assets |       | 2,200      |       |
| Goodwill                      |       | 12,230     |       |
| **Purchase  price**           |       | 17,240     |       |
| Cash acquired                 |       | (695       | )          |
| Accrued earn out              |       | (2,817     | )          |
| **Net cash paid**             |       | $          | 13,728     |   |

 

Goodwill acquired through the purchase of Telic isdeductible for income tax purposes.

Theresults of DiOP’s and Telic’s operations from the date of acquisition areincluded in our Optical Systems Group. Unaudited pro forma results ofoperations for the years ended December 31, 2005, 2004 and 2003, as ifAxsys had purchased DiOP and Telic as of the beginning of each year, arepresented below. The pro forma results include estimates and assumptions whichour management believes are reasonable. However, the pro forma results do notinclude any cost savings or other effects of the planned integration of DiOPand Telic, and are not necessarily indicative of the results which would haveoccurred if the business combination had been in effect on the dates indicated,or which may result in the future.

| ** **                  | ** ** | **As  Originally  Reported  2005** | ** ** | **(Unaudited)Pro Forma**2005 | ** ** | **As  Originally  Reported  2004** | ** ** | **(Unaudited)Pro Forma**2004 | ** ** | **As  Originally  Reported  2003** | ** ** | **(Unaudited)Pro Forma**2003 | ** ** |
|-----------------------------|------------|------------------------------------|------------|-----------------------------------|------------|------------------------------------|------------|-----------------------------------|------------|------------------------------------|------------|-----------------------------------|------------|
| Net sales                   |       | $                                  | 133,543    |                              |       | $                                  | 140,813    |                              |       | $                                  | 103,530    |                              |       | $ | 127,281 |   |   |   | $ | 85,109 |   |   |   | $ | 110,078 |   |   |
| Net income                  |       | 7,323                              |       |                              | 7,652      |                               |       | 8,664                             |       |                               | 10,122     |                              |       |   | 4,998 |   |   |   | 5,525 |   |   |
| Earnings per common  share: |       |                               |       |                              |       |                               |       |                              |       |                               |       |                              |       |   |   |   |   |   |   |   |   |
| Basic                       |       | $                                  | 0.91       |                              |       | $                                  | 0.96       |                              |       | $                                  | 1.23       |                              |       | $ | 1.44 |   |   |   | $ | 0.72 |   |   |   | $ | 0.79 |   |   |
| Diluted                     |       | $                                  | 0.88       |                              |       | $                                  | 0.92       |                              |       | $                                  | 1.19       |                              |       | $ | 1.39 |   |   |   | $ | 0.71 |   |   |   | $ | 0.78 |   |   |

 

F-14

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**AXSYS TECHNOLOGIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data)**

**Note 3—Balance SheetInformation**

Thedetails of certain balance sheet accounts are as follows:

| ** **                            | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|---------------------------------------|------------|------------|------------|------------|------------|
| Accounts receivable:                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Trade receivables                     |       | $          | 18,477     | ** ** | $          | 16,400 |   |
| Unbilled costs  and accrued profits   |       | 1,211      | ** ** | —     |       |
| Gross accounts  receivable            |       | 19,688     | ** ** | 16,400     |       |
| Less allowance  for doubtful accounts |       | (867       | )          | (685       | )          |
| Accounts receivable, net              |       | $          | 18,821     | ** ** | $          | 15,715 |   |

 

All ofthe December 31, 2005 unbilled costs and accrued profits are expected tobe billed in 2006.

| ** **        | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-------------------|------------|------------|------------|------------|------------|
| Inventories:      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Raw materials     |       | $          | 12,638     |       | $          | 6,431 |   |
| Work-in-process   |       | 19,138     |       | 18,371     |       |
| Finished goods    |       | 11,165     |       | 9,888      |       |
| Gross inventories |       | 42,941     |       | 34,690     |       |
| Less reserve      |       | (5,075     | )          | (4,992     | )          |
| Inventories, net  |       | $          | 37,866     |       | $          | 29,698 |   |

 

| ** **                                     | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|------------------------------------------------|------------|------------|------------|------------|------------|
| Property, plant and  equipment:                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Land                                           |       | $          | 291        |       | $          | 291 |   |
| Buildings and improvements                     |       | 5,862      |       | 5,653      |       |
| Machinery and equipment                        |       | 30,266     |       | 25,437     |       |
| Property, plant  and equipment                 |       | 36,419     |       | 31,381     |       |
| Less accumulated depreciation and amortization |       | (21,068    | )          | (18,044    | )          |
| Property, plant and  equipment, net            |       | $          | 15,351     |       | $          | 13,337 |   |

 

| ** **                                            | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-------------------------------------------------------|------------|------------|------------|------------|------------|
| Accrued expenses  and other current liabilities:      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Compensation and related benefits                     |       | $          | 4,245      |       | $          | 4,548 |   |
| Income taxes                                          |       | 4,234      |       | 970        |       |
| Accrued acquisition costs—earn out               |       | 2,817      |       | —     |       |
| Warranty                                              |       | 1,142      |       | 750        |       |
| Professional fees                                     |       | 975        |       | 392        |       |
| Liabilities of discontinued operations                |       | 410        |       | 922        |       |
| Other                                                 |       | 3,012      |       | 1,931      |       |
| Total accrued expenses  and other current liabilities |       | $          | 16,835     |       | $          | 9,513 |   |

 

F-15

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**AXSYS TECHNOLOGIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data)**

**Note3—Balance Sheet Information (Continued)**

| ** **                                   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|----------------------------------------------|------------|------------|------------|------------|------------|
| Other long-term  liabilities:                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Deferred income taxes                        |       | $          | 2,455      |       | $          | 1,656 |   |
| Loss contract reserve, less current portion  |       | 1,219      |       | 1,595      |       |
| Defined benefit pension and health insurance |       | 638        |       | 649        |       |
| Liabilities of discontinued operations       |       | 363        |       | 405        |       |
| Workers’ compensation                   |       | 94         |       | 199        |       |
| Other                                        |       | —     |       | 200        |       |
| Total other long-term  liabilities           |       | $          | 4,769      |       | $          | 4,704 |   |

 

**Note 4—Goodwill andIntangible Assets**

Duringthe fiscal years ended December 31, 2005, 2004 and 2003, the Company didnot recognize any goodwill impairments in accordance with SFAS No.142. As of December 31,2005, total goodwill was $61,048. Goodwill increased during 2004 and 2005 asfollows:

| Balance at  January 1, 2004   |   | $      | 3,600  |   |
|------------------------------------|--------|--------|--------|--------|
| Telic acquisition                  |   | 9,413  |   |
| Balance at  December 31, 2004 |   | 13,013 |   |
| DiOp acquisition                   |   | 45,218 |   |
| Telic earn out                     |   | 2,817  |   |
| Balance at  December 31, 2005 |   | $      | 61,048 |   |

 

During 2005, we recorded goodwill of $45,218 inconjunction with the acquisition of DiOP. When determining the purchase priceof this acquisition and the related goodwill, we evaluated the synergies thatthis business would bring to our existing business. DiOP nearly perfectlycomplements our 2004 acquisition of Telic. Telic manufactures precision lensesalmost exclusively on a customer specification basis. DiOP, on the other hand,manufactures very high quality, high performance lenses, but is able to scaleits production to much higher volumes. This ability to rapidly scale themanufacturing will provide us with significant future benefits due tosynergies.

When determining thepurchase price of the Telic acquisition and the related goodwill, we evaluatedthe additional breadth of products that this acquisition would add to ourexisting aspheric and flat optical lens product lines. Telic manufacturesprecision infrared lenses almost exclusively on a customer specification basis.This product offering enabled us to broaden our family of products andvertically integrate our processes with those of Telic. The acquisition broughtus new optical design and manufacturing capabilities, infrared lensmanufacturing capabilities and provided us with broader penetration into groundand sea-based programs. We purchased Telic for $14,423 with an additional earnout payment of up to $4,000 over 36 months following the closing date based onthe achievement of certain revenue goals. During 2005, Telic exceeded its  revenue goals, resulting in additionalgoodwill of $2,817, bringing the total goodwill associated with thisacquisition to $12,230.

F-16

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**AXSYS TECHNOLOGIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data)**

**Note 4—Goodwill andIntangible Assets (Continued)**

**Intangible Assets**

In conjunction with the DiOP acquisition, we recordedintangible assets of $9,150, including $5,800 for customer relationships and $3,350of other intangible assets. Customer relationships included customers from thelens and coating segments of DiOP’s business. These relationships are not contract-based but exist due to the ongoingsales and regular contact with the customers. At the time of acquisition, DiOPhad approximately 20 customers representing the majority of its lens assemblyand coating revenues over the prior four years. The majority of these 20customers have been long-term customers of DiOP and, based on the nature of theproduct supplied and anticipated future requirements, we believe that theselong-term relationships will continue. Revenue attributable to customerrelationships was based on 2004 revenue from its lens and coating segments. Revenueattributable to the order backlog was subtracted from the forecast, as it wasincluded in a separately identified intangible asset. Given DiOP’s long-termhistory with its major customers, the life of the entire customer base, asdetermined by the independent valuation firm and deemed reasonable by Axsysmanagement, is 13-18 years.

In conjunction with the Telic acquisition, we recordedintangible assets of $2,200 for customer relationships. Telic had several majorcustomer relationships at the time of the acquisition. These were not contract-basedbut existed due to the ongoing sales and regular contact with the customers.Most of the relationships were in existence for 10 to 20 years, with some asold as 30 years. The fair value of these customer relationships was determinedby estimating the free cash flows attributable to the customer relationships byusing a form of the income approach called the excess earnings method. Themethod assumes that the remaining cash flows after adjusting for operatingexpenses, taxes and capital charges is attributable to the customerrelationships.

For the valuation of the customer relationships, wefocused primarily on Telic’s 11 major customers as of the valuation date. Thesecustomers accounted for the majority of Telic’s revenue in 2003.  Given Telic’s long-term history with its majorcustomers, the life of the entire customer base, as determined by theindependent valuation firm and deemed reasonable by Axsys management, is 20-25years. It was determined that the value of these customer relationships was $2,200.

Thecomponents of intangible assets related to both acquisitions are as follows:

| ** **              | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net Carrying  Amount** | ** ** | **Weighted-Average  Life** | ** ** |
|-------------------------|------------|---------------------------------|------------|-------------------------------|------------|-------------------------------|------------|----------------------------|------------|
| Customer  relationships |       |                            | $          | 8,000                         |       |                          |       | $                          | (389       | ) |   |   | $ | 7,611 |   |   |   | 19  years |   |   |
| Camera technology       |       |                            | 2,600      |                          |       |                          | (216       | )                          |       |   | 2,384 |   |   |   | 8  years |   |   |
| Backlog                 |       |                            | 400        |                          |       |                          | (267       | )                          |       |   | 133 |   |   |   | 1  year |   |   |
| Service contract        |       |                            | 200        |                          |       |                          | (9         | )                          |       |   | 193 |   |   |   | 5  years |   |   |
| Developed  software     |       |                            | 150        |                          |       |                          | (10        | )                          |       |   | 140 |   |   |   | 9  years |   |   |
| Amortizable intangibles |       |                            | $          | 11,350                        |       |                          |       | $                          | (889       | ) |   |   | $ | 10,461 |   |   |   | 16 years |   |   |

 

F-17

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**AXSYS TECHNOLOGIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data)**

**Note 4—Goodwill andIntangible Assets (Continued)**

Amortizationexpense of $816 in 2005 and $73 in 2004 was included in selling, general andadministrative expenses.  Estimatedamortization expense for each of the five succeeding years is as follows:

| ** **                         | ** ** | **Amount** | ** ** |
|------------------------------------|------------|------------|------------|
| Year ended  December 31, 2006 |       |       | $          | 954 |   |   |
| Year ended  December 31, 2007 |       |       | 814        |   |   |
| Year ended  December 31, 2008 |       |       | 807        |   |   |
| Year ended  December 31, 2009 |       |       | 801        |   |   |
| Year ended  December 31, 2010 |       |       | 769        |   |   |

 

**N**ote5—Capital Lease Obligations

| ** **                 | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|
| Capital lease  obligations |       | $        | —     |     | $          | 518 |   |
| Less current  portion      |       | —   |       | (368     | )          |
|                       |       | $        | —     |     | $          | 150 |   |

 

At December 31, 2005,there were no assets under capital lease obligations. The capital lease waspaid in full in 2005 with proceeds from an equity offering. At December 31,2004, the cost of assets under capital lease obligations was $1,521, withaccumulated depreciation of $544.

**Note 6—Long-Term Debt**

***2005******Financing Activities:***   OnMay 2, 2005, we entered into a Credit Facility (“Credit Facility”) withFleet Bank (“Bank”) in conjunction with the acquisition of DiOP. The CreditFacility included a $20,000 five-year term loan facility (“term loan A”), a$35,000 two-year term loan facility (“term loan B”) and a $15,000 three-yearrevolving credit facility (“revolving credit facility”).  On September 27, 2005, we prepaid thetwo term loans in full and terminated the related interest rate swap. Wecontinue to maintain the revolving credit facility. Amounts borrowed under theCredit Facility are secured by a lien on all of our assets and the assets ofour subsidiaries, including a pledge of the stock of all of our subsidiaries.

The term loan A wasscheduled to mature in May 2010, subject to optional and mandatoryprepayment in accordance with its terms, with quarterly principal payments of$1,000, which began in August 2005. The term loan A bore interest at arate per annum equal to the three-month LIBOR rate plus a margin of 100 to 275basis points, depending on our consolidated funded debt-to-consolidated EBITDAratio.

The term loan B wasscheduled to mature in May 2007, subject to optional prepayment inaccordance with its terms. We were required to use the net proceeds of anequity offering to repay all amounts outstanding under the term B loan. If thisoffering was not completed, quarterly principal payments of $500 would havebegun in February 2006 with a final installment of $32,500 due onMay 2, 2007. The term loan B bore interest at a rate per annum equal tothe LIBOR rate plus a margin of 100 to 275 basis points, depending on ourconsolidated funded debt-to-consolidated EBITDA ration.

F-18

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**AXSYS TECHNOLOGIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per shares data)**

**Note 6—Long-Term Debt (Continued)**

Under the terms of theinterest rate swap, we received payments based on the 3-month LIBOR rateand made payments based upon a fixed rate of 4.46%. The notional amount of theinterest rate swap at inception was $20,000 and it was to expire inMay 2010.  The notional amount wasto decrease as principal payments were made on the term loan. This interestrate swap agreement was terminated in 2005 when the corresponding debt wasrepaid.

In conjunction with ourprepayment of the principal and accrued interest on the $20,000 term loan A andthe $35,000 term loan B during 2005, we incurred a charge of $421 for the losson extinguishment of debt related to the write off of loan origination feesand  $59 for the early termination of therelated interest rate swap agreement.

The $15,000 revolvingcredit facility remains available through May 2008, subject to optionalprepayment in accordance with its terms. Up to $2,000 of the revolving creditfacility may be utilized to issue letters of credit. We may elect to have anyborrowing under the revolving credit facility bear interest either at the Bank’sprime rate or the LIBOR rate plus a margin of 100 to 275 basis points,depending on our consolidated funded debt-to-consolidated EBITDA ratio. We havethe option of selecting the 1-month, 2-month, 3-month or 6-monthLIBOR rate. On December 31, 2005, there were no borrowings outstandingunder the revolving credit facility. However, as of December 31, 2005,$1,007 of the revolving credit facility was utilized for outstanding letters ofcredit.

***2004******Financing Activities:****  *On April 8, 2004, inconnection with the acquisition of Telic, we entered into an unsecured CreditFacility (“Former Credit Facility”) with Bank of America (“Bank”). This FormerCredit Facility was prepaid on May 2, 2005. The Former Credit Facility wascomprised of a $5,000 two-year Revolving Credit Facility (“Former RevolvingCredit Facility”) and a $5,000 five-year Term Loan Facility (“Former Term Loan”). Repayments of amounts under the FormerCredit Facility were guaranteed by all of our subsidiaries.

The $5,000 RevolvingCredit Facility was available through April 8, 2006, subject to optionalprepayment in accordance with its terms. In conjunction with the prepayment ofthe Former Credit Facility, we terminated this Revolving Credit Facility. Borrowingunder the Former Revolving Credit Facility bore interest either at the Bank’sprime rate or the 1-month LIBOR rate plus a margin of 100 to 150 basispoints, depending on our consolidated funded debt-to-consolidated EBITDA ratio,as defined. At December 31, 2004, there were no borrowings outstandingunder the $5,000 Revolving Credit Facility. However, as of December 31,2004, $680 of the Former Revolving Credit Facility was utilized for outstandingletters of credit.

Under the terms of theFormer Revolving Credit Facility, we were required to pay certain fees,including an unused commitment fee ranging from 20 to 40 basis points per annumon the average daily-unused portion of the Former Revolving Credit Facility. Theunused commitment fee, which varied depending on our consolidated fundeddebt-to-consolidated EBITDA ratio, as defined, was payable quarterly, inarrears.

The Former Term Loan wasscheduled to mature on April 8, 2009, subject to optional prepayment inaccordance with its terms, with annual principal payments totaling  $1,000.The Former Term Loan bore interest at a rate per annum equal to the 1-monthLIBOR rate plus a margin of 100 to 150 basis points, 

F-19

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**AXSYS TECHNOLOGIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per shares data)**

**Note 6—Long-Term Debt (Continued)**

dependingon our consolidated funded debt-to-consolidated EBITDA ratio. The interest rateon the Former Term Loan was 3.06% as of December 31, 2004. We paid a $40commitment fee for the Former Term Loan. As of December 31, 2004, thebalance of the Former Term Loan was $4,333.

On April 8, 2004, weentered into an interest rate swap agreement with the Bank to hedge interestrate fluctuations on the Former Term Loan. The interest rate swap had beendesignated as a cash flow hedge. The interest rate swap was terminated on May 2,2005. Under the terms of the interest rate swap, we received payments based onthe 1-month LIBOR rate and made payments based upon a fixed rate of 3.2%.The notional amount of the interest rate swap at inception was $5,000 and itwas set to expire on April 8, 2009.

**Note 7—EnvironmentalContingencies**

We are currently involvedin two environmental remediation projects and a third site, which is in thefinal stage of monitoring. We accrue for environmental contingencies on an undiscountedbasis when responsibility for clean up is determined and costs, including legalfees, are probable and can be reasonably estimated.  We are the primary responsible party (“PRP”)at sites located in Bedford, Ohio and St. Petersburg, Florida. Pursuant toremediation plans approved by each state’s environmental protection agency, weinvestigated soils and groundwater and conducted certain remedial work,including soil removal. The clean up of each site is currently in process. Wehave incurred costs of $91 in 2005 and approximately $1,700 to date related tothese sites. We anticipate remediation costs for theses sites to continuethrough 2009, including estimated expenditures of $123 in 2006.

As of December 31,2005, we have an accrual of $463 for future costs related to the Ohio andFlorida sites. These estimates have been developed in consultation with outsideenvironmental and legal consultants handling these matters and are based uponan analysis of the anticipated remediation plans. We do not anticipate thesematters will have a material adverse effect on our consolidated financialposition. It is possible, however, that future results of operations could bematerially affected by changes in our assumptions.

In addition, in 2001, wewere notified by the United States Environmental Protection Agency, or the EPA,that it considers us a PRP for the US Cap and Jacket site in Prospect,Connecticut. Our former subsidiary, which was merged into us in 1979, operateda screw machine shop at this location from 1961 to 1978. The EPA demandedreimbursement for its costs incurred in connection with a time-critical removalaction at the site in 2001. In April 2004, the EPA notified us that thetotal amount of these costs was approximately $650, including indirect costsand interest accrued through that date. We advised the EPA of our position thatthe contamination must have occurred after our ownership of the site and that,accordingly, we are not responsible for the EPA’s costs or the remediation ofthe site. The EPA continued its investigation of the site, including serving uswith a formal request for information under Section 104(e) of CERCLAin July 2004 (to which we responded). The EPA designated no other PRPs. TheEPA informed us that it was prepared to commence a CERCLA cost-recovery actionagainst us if we were unable to amicably resolve the matter. On July 18,2005, we signed a settlement agreement with the EPA, settling this matter for$175, plus accrued interest from this date through the date of payment. We haveno further responsibility to the EPA as it relates to the EPA’s 2001 removalaction at this site. During 2005, we recognized a after tax charge of $150 indiscontinued operations for the settlement costs and legal expenses associatedwith the settlement of this matter.

F-20

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**AXSYS TECHNOLOGIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data)**

**Note 8—Litigation**

During 2004, we were named as a co-defendant in thecase Parker, et al v. Brush Wellman, Inc. et al., a putative class actionlawsuit brought by a group of named plaintiffs who are employees, formeremployees, or family members of employees and former employees, of LockheedMartin Corporation.  The plaintiffs claimthat they have suffered personal injuries or are at an increased risk ofdeveloping personal injuries as a result of exposure to beryllium-containingmaterials used at Lockheed’s facility. The plaintiffs purport to represent aclass of persons whom they claim are similarly situated. The defendants includeLockheed and various other companies, including Axsys, who are alleged to havesupplied beryllium-containing materials used at the facility. We filed a motionto dismiss based on a lack of personal jurisdiction. We were notified inApril 2005 that the United States District Court for the Northern Districtof Georgia granted our request for dismissal. In April 2005, theplaintiffs filed an amended complaint, which no longer named us as defendantsin this lawsuit.

During 2004, we settled anaction, which was filed in the Court of Chancery in the State of Delaware onMay 30, 1997, against us and three of our directors on behalf of a purportedclass of persons who purchased our preferred stock. The plaintiff challengedour decision to redeem all of our outstanding shares of the preferred stock.The plaintiff claimed that the defendants (1) breached fiduciary duties insetting the redemption price too low and unfairly seeking to advantage holdersof common stock and (2) breached contractual duties as set forth in theCertificate of Designation governing the preferred stock, as well as an impliedcovenant of good faith and fair dealing. In 2004, we paid $201 to settle thisclaim and reflected the charge as a reduction to paid-in-capital in 2003.During the first quarter of 2005, the settlement fund was closed and $76 ofunpaid claims were returned to us. The cash received is reflected as anincrease to paid-in-capital in 2005.

**Note 9—Shareholders’Equity**

*Public*StockOffering:***  *OnSeptember 27, 2005, Axsys issued and sold 3,450,000 shares of common stockat the public offering price of $18.00 per share. We received all of the net proceeds from the offering after payment ofunderwriting discounts and commissions as follows:

| Gross proceeds                                        |   | $      | 62,100 |   |
|-------------------------------------------------------|--------|--------|--------|--------|
| Underwriting  commissions                             |   | (3,726 | )      |
| Offering expenses                                     |   | (791   | )      |
| **Net  proceeds**                                     |   | 57,583 |   |
| Accrued offering  expenses                            |   | 37     |   |
| **Net cash received through  December 31, 2005** |   | $      | 57,620 |   |

 

*Stock**Repurchase:**  *During 2004, our Board of Directorsauthorized the repurchase, from time to time, on the open market or otherwise,of up to 200,000 shares of the Axsys common stock at prevailing market pricesor at negotiated prices.  We plan to usethe repurchased shares for general corporate purposes, including thesatisfaction of commitments under our employee benefit plans and the exerciseof stock option grants. As of December 31, 2005, we repurchased 45 sharesunder this authorization.

*Stock**Split:**  *The Board of Directors declared, onJune 1, 2004, a 3:2 stock split to be effected as a stock dividend payableon June 30, 2004 to stockholders of record on June 15, 2004.Stockholders received 

F-21

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**AXSYS TECHNOLOGIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data)**

**Note 9—Shareholders’Equity (Continued)**

a dividend of oneadditional share of Axsys 0.01 par value common stock for every two sharesowned on the record date. Fractional shares were not issued; rather cashpayments were made to shareholders in lieu of fractional shares onJune 30, 2004. The cash paid for fractional shares was de minimis.****In conjunction with the stock split, we issued anadditional 2,395,578 shares resulting in a total of 7,186,734 issued shares ofAxsys $0.01 par value stock on June 30, 2004. We reclassified an amount equalto the par value of the number of shares issued to common stock from retainedearnings. All share information, including the basic and dilutedweighted-average number of shares and net income per share information, for allreporting periods have been restated retroactively to reflect the effects ofthe stock split.

*Paid**in Capital:**  *During 2004, we recognized $242 ofcompensation expense related to the modification of certain existing stockoptions pursuant to the terms of a severance arrangement.

*Treasury**Stock:**  *We use treasury stock shares forgeneral corporate purposes, including the satisfaction of commitments under theemployee benefit plans and the exercise of stock options.  During 2005, we received 10,600 shares of Axsys$0.01 par value common stock as payment in lieu of cash for the exercise ofincentive stock options.

Changesin treasury stock were as follows:

| **Number of shares**        | ** ** | ** ** | ** ** | **Shares** | ** ** | **Amount** | ** ** | ** ** |
|---------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|
| Balance at  December 31, 2002    |       | 208,482    |       |       | $          | 1,293      |       |       |   |
| Exercise of stock  options            |       | (900       | )          |       | (5         | )          |       |       |
| Contribution to  the 401(k) plan |       | (8,552     | )          |       | (53        | )          |       |       |
| Balance at  December 31, 2003    |       | 199,030    |       |       | 1,235      |       |       |       |
| Exercise of stock options, net        |       | (64,108    | )          |       | (322       | )          |       |       |
| Contribution to  the 401(k) plan |       | (4,718     | )          |       | (30        | )          |       |       |
| Repurchase of  stock                  |       | 12         |       |       | —     |       |       |       |
| Balance at December 31,  2004    |       | 130,216    |       |       | 883        |       |       |       |
| Exercise of stock options, net        |       | (107,878   | )          |       | (704       | )          |       |       |
| Contribution to  the 401(k) plan |       | (3,464     | )          |       | (25        | )          |       |       |
| Repurchase of  stock                  |       | 33         |       |       | (1         | )          |       |       |
| Balance at  December 31, 2005    |       | 18,907     |       |       | $          | 155        |       |       |   |

 

***Common Stock:*****  **Shares of common stock authorized and issuedwere 10,636,734 at the end of 2005 and 7,186,734 at the end of 2004. Changes incommon stock were as follows:

| Balance at  December 31, 2003 and 2004 |   | 7,186,734  |   |
|---------------------------------------------|--------|------------|--------|
| Stock offering in 2005                      |   | 3,450,000  |   |
| Balance at  December 31, 2005          |   | 10,636,734 |   |

 

F-22

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**AXSYS TECHNOLOGIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data)**

**Note 10—Supplemental CashFlow Information**

Supplementalcash flow information from continuing operations for the years endedDecember 31, 2005, 2004 and 2003 is summarized as follows:

| ** **                                 | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Cash received/(paid)  during the year for: |       |     |       |     |       |     |       |
| Interest paid                              |       | $(1,529  | )          | $(177    | )          | $(108    | )          |
| Interest received                          |       | 159      |       | 99       |       | 118      |       |
| Income tax payments                        |       | (3,666   | )          | (1,558   | )          | (429     | )          |
| Income tax  refunds                        |       | —   |       | 566      |       | 1,522    |       |

 

**Note 11—Income Taxes**

Theincome tax provision (benefit) from continuing operations consists of:

| ** **                            | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Current income taxes:                 |       |     |       |     |       |     |       |
| U.S. Federal                          |       | $        | 2,682      |     | $          | 1,097    |       | $ | — |   |
| State and local                       |       | 471      |       | 376      |       | 236      |       |
|                                  |       | 3,153    |       | 1,473    |       | 236      |       |
| Deferred income taxes:                |       |     |       |     |       |     |       |
| U.S. Federal                          |       | 1,238    |       | (1,216   | )          | (195     | )          |
| State and local                       |       | 95       |       | (265     | )          | 195      |       |
|                                  |       | 1,333    |       | (1,481   | )          | —   |       |
| Total income tax  provision (benefit) |       | $        | 4,486      |     | $          | (8       | )          | $ | 236 |   |

 

In 2004 and 2003, the deferred federal and stateincome tax benefits reflect the utilization of a valuation allowance.

Thedifference between the provision (benefit) for income taxes and the amountcomputed by applying the statutory federal income tax rate to Income fromContinuing Operations Before Income Taxes is as follows:

| ** **                                           | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Federal statutory  rate                              |       | 35       | %          | 35       | %          | 35       | %          |
| Computed expected  income tax provision              |       | $        | 4,186      |     | $          | 3,203    |       | $ | 1,832 |   |
| Increase (decrease) in  income taxes resulting from: |       |     |       |     |       |     |       |
| Net change in valuation allowance                    |       | —   |       | (3,236   | )          | (1,395   | )          |
| State and local taxes, net of federal tax benefit    |       | 410      |       | 355      |       | 348      |       |
| Tax benefit of credits and net operating losses      |       | (47      | )          | —   |       | (434     | )          |
| Net alternative minimum tax activity                 |       | —   |       | —   |       | 245      |       |
| Adjustment to tax accrual                            |       | (28      | )          | (345     | )          | (318     | )          |
| Other                                                |       | (35      | )          | 15       |       | (42      | )          |
| Actual tax provision  (benefit)                      |       | $        | 4,486      |     | $          | (8       | )          | $ | 236 |   |

 

F-23

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**AXSYS TECHNOLOGIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data)**

**Note 11—IncomeTaxes (Continued)**

We reduced previouslyrecorded valuation allowances of  $1,395in 2003 and $3,236 in 2004 as deferred income tax assets were realized. As of December 31,2005, we have determined that a valuation allowance is not required as it ismore likely than not that the net deferred income tax assets will be realizedin the future.

At December 31, 2005,we had reserves totaling $3,870, primarily for various state income tax issues.

Deferred income taxesreflect the net federal and state tax effects of temporary differences betweenthe carrying amounts of assets and liabilities for financial reporting purposesand the amounts used for income tax purposes.

Significantcomponents of deferred income taxes are as follows:

| ** **                            | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Deferred income  tax assets:          |       |                  |       |   |   |
| Inventories                           |       | $                     | 2,439      |   | $ | 2,361 |   |
| Tax credit carry-forward              |       | —                |       | 403 |   |
| Loss contract reserve                 |       | 573                   |       | 720 |   |
| Exit costs of discontinued operations |       | 117                   |       | 318 |   |
| Environmental reserves                |       | 224                   |       | 235 |   |
| Allowance for doubtful accounts       |       | 331                   |       | 254 |   |
| Pension accruals                      |       | 311                   |       | 296 |   |
| Warranty reserves                     |       | 188                   |       | 193 |   |
| Other, net                            |       | 186                   |       | 23 |   |
| Total deferred  income tax assets     |       | 4,269                 |       | 4,803 |   |
| Deferred income  tax liabilities:     | ** ** | ** **            |       | ** ** | ** ** |
| Property, plant and equipment         |       |   (1,335         | )          |   (1,464 | ) |
| Intangibles                           |       | (1,120                | )          | (192 | ) |
| Total deferred income tax liabilities |       | (2,455                | )          | (1,656 | ) |
| Net deferred  income taxes            |       | $                     | 1,814      |   | $ | 3,147 |   |

 

** **

Deferred income taxes areincluded in the Consolidated Balance Sheets as follows:

| ** **                                                                           | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                           | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Current deferred  income tax assets                                                  |       | $                     | 3,256      |   | $ | 3,553 |   |
| Noncurrent  deferred income tax assets, included in other assets                     |       | 1,013                 |       | 1,250 |   |
| Noncurrent  deferred income tax liabilities, included in other long-term liabilities |       | (2,455                | )          | (1,656 | ) |
|                                                                                 |       | $                     | 1,814      |   | $ | 3,147 |   |

 

F-24

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**AXSYS TECHNOLOGIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data)**

**Note 12—PensionArrangements**

As of December 31, 2005, we had one pension planfor which benefits and participation have been frozen. The plan, which has anaccrued benefit cost of $425 at December 31, 2005, is an unfunded planwith an annual payout of approximately $105 until such time as the soleparticipant becomes ineligible.

We also sponsor a401(k) plan under which eligible employees may elect to contribute apercentage of their earnings. We match employee contributions to this plan inamounts ranging from 3% to 5% of the employees’ gross earnings. Our matchingcontributions, were $1,118 in 2005, $918 in 2004, and $719 in 2003, of which aportion was provided in Axsys stock.

**Note 13—Stock Options**

In May 2005, our stockholders approved amendmentsto, and a restatement of, our Long-Term Stock Incentive Plan (the “Plan”)which, among other things, increased the number of shares of common stockauthorized for issuance under the Plan by 350,000. As of December 31,2005, the total number of shares of common stock authorized for issuance underthe Plan was 1,550,000 shares, of which 356,422 shares of common stock remainavailable for grant under the Plan. The Compensation Committee of the Board ofDirectors (the “Committee”) administers the Plan. The Committee selectsparticipants from among those executives and other employees of Axsys and thesubsidiaries who materially contribute to the success of our Company. TheCommittee determines the amounts, times, forms, terms and conditions of grants.Grants may be in the form of options to purchase shares of common stock, stockappreciation rights, restricted stock and performance units (collectively,“Stock Incentives”). Generally, each grant vests 20 percent per year for fiveyears, is exercisable upon vesting and expires in ten years.

During2004, we modified the stock option grants of a former officer, which resultedin compensation expense of $242. A summary of all outstanding stock options ispresented in the table below:

| ** **                             | ** ** | **Stock**   | ** ** | **Weighted-average**    | ** ** |
|----------------------------------------|------------|-------------|------------|-------------------------|------------|
| ** **                             | ** ** | **Options** | ** ** | **Exercise Price** | ** ** |
| Outstanding at  December 31, 2003 |       | 691,687     |       |                    | $          | 8.54 |   |   |
| Granted                                |       | 210,278     |       |                    | 11.36      |   |   |
| Forfeited/cancelled                    |       | (14,850     | )          |                    | (10.47     | ) |   |
| Exercised                              |       | (76,009     | )          |                    | (7.17      | ) |   |
| Outstanding at  December 31, 2004 |       | 811,106     |       |                    | $          | 9.36 |   |   |
| Granted                                |       | 224,288     |       |                    | $          | 19.71 |   |   |
| Forfeited/cancelled                    |       | (17,950     | )          |                    | (11.83     | ) |   |
| Exercised                              |       | (118,478    | )          |                    | (12.69     | ) |   |
| Outstanding at December 31, 2005  |       | 898,966     |       |                    | $          | 11.45 |   |   |
| Exercisable at  December 31, 2005 |       | 390,641     |       |                    | $          | 10.17 |   |   |

 

F-25

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**AXSYS TECHNOLOGIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data)**

**Note 13—StockOptions (Continued)**

The following tablesummarizes information about stock options outstanding at December 31,2005:

| ** **               | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|--------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **               | ** ** | ** **                   | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted-** | ** ** |
| ** **               | ** ** | ** **                   | ** ** | **Weighted-**                | ** ** | **Weighted-average** | ** ** | ** ** | ** ** | **average** | ** ** |
| **Range of**        | ** ** | **Number of **     | ** ** | **average **            | ** ** | **Exercise** | ** ** | **Number of ** | ** ** | **Exercise** | ** ** |
| **Exercise Prices** | ** ** | ** **                   | ** ** | **Options**                  | ** ** | **Remaining Life** | ** ** | **Price** | ** ** | **Options** | ** ** | **Price** | ** ** |
| $2.72 to $5.43           |       |                         | 198,900    |                         |       |   | 6.4 |   |   |   | $ | 4.65 |   |   |   | 86,700 |   |   |   | $ | 4.62 |   |   |
| $5.44 to $8.15           |       |                         | 182,635    |                         |       |   | 5.6 |   |   |   | 6.82 |   |   |   | 123,298 |   |   |   | 6.89 |   |   |
| $8.16 to $10.87          |       |                         | 113,025    |                         |       |   | 7.6 |   |   |   | 9.93 |   |   |   | 31,725 |   |   |   | 9.80 |   |   |
| $10.88 to $13.58         |       |                         | 80,746     |                         |       |   | 3.6 |   |   |   | 11.92 |   |   |   | 54,196 |   |   |   | 12.32 |   |   |
| $13.59 to $16.30         |       |                         | 56,250     |                         |       |   | 8.5 |   |   |   | 14.29 |   |   |   | 11,850 |   |   |   | 14.31 |   |   |
| $16.31 to $19.02         |       |                         | 110,872    |                         |       |   | 7.3 |   |   |   | 18.01 |   |   |   | 59,122 |   |   |   | 17.82 |   |   |
| $19.03 to $21.73         |       |                         | 125,288    |                         |       |   | 8.3 |   |   |   | 20.15 |   |   |   | 12,500 |   |   |   | 20.13 |   |   |
| $21.74 to $24.45         |       |                         | 31,250     |                         |       |   | 4.4 |   |   |   | 22.88 |   |   |   | 11,250 |   |   |   | 24.00 |   |   |
| $2.72 to $24.45          |       |                         | 898,966    |                         |       |   | 6.6 |   |   |   | $ | 11.45 |   |   |   | 390,641 |   |   |   | $ | 10.17 |   |   |
|                          |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Note 14—Commitments andContingencies**

Future minimum payments under non-cancelable operatingleases (exclusive of property expenses and net of sublease rental income) as ofDecember 31, 2005, are as follows:

| 2006                 |   | $     | 1,673  |   |
|----------------------|--------|-------|--------|--------|
| 2007                 |   | 1,190 |   |
| 2008                 |   | 1,207 |   |
| 2009                 |   | 1,179 |   |
| 2010 and  thereafter |   | 217   |   |
|                 |   | $     | 5,466  |   |

 

Rent expense under such leases, net of sublease rentalincome, amounted to $1,754 in 2005, $1,598 in 2004 and $1,400 in 2003.  As of December 31, 2005, we werecontingently liable for $1,007 under outstanding letters of credit. We haveissued letters of credit for certain business transactions including insuranceprograms and building lease security deposits.

In the normal course of business, we are liable forcontract completion and product performance. In the opinion of management, suchobligations will not significantly affect our financial position or annualresults of operations.

**Note 15—DiscontinuedOperations**

During 2005, we recognized a after tax charge of $150related to legal and consulting expenses in conjunction with an environmentalclean-up site of a discontinued operation. (See Note 7 of the ConsolidatedFinancial Statements.)  During 2004, werecognized a after tax charge of $74 related to legal and consulting expensesin conjunction with the same environmental clean-up site.

F-26

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**AXSYS TECHNOLOGIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data)**

**Note 15—DiscontinuedOperations (Continued)**

During 2002, Axsys disposed of the Automation Group,which included facilities in Wilmington, Massachusetts (“Wilmington”) andPittsburgh, Pennsylvania (“Pittsburgh”). As part of the terms of the sale, weremain obligated under the operating leases for these facilities. ThePittsburgh lease was renegotiated and final settlement was reached and paid in2005. The Wilmington lease expires in 2006 and we anticipate our remainingcommitment to be $284 thousand. In 2004, we recognized an additional lossreserve in conjunction with the 2002 sale of the Automation Group. The aftertax charge of $421 represents rental expenses for these two facilities.

Theloss from discontinued operations, net of tax, recognized in the consolidatedstatements of operations includes the following:

| ** **                                              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Automation Group—operating  leases                 |       | $        | —     |     | $          | (421     | )          | $ | — |   |
| Environmental  charges for previously divested business |       | (150     | )          | (74      | )          | —   |       |
| Loss from discontinued  operations                      |       | $        | (150       | )        | $          | (495     | )          | $ | — |   |

 

We had cash outflows of$907 in 2005, $140 in 2004 and $1,261 in 2003 related to legal, consulting andlease commitment expenses for our discontinued operations.

**Note 16—Segment Data**

We are organized into two businesses: the OpticalSystems Group and the Distributed Products Group.

The Optical Systems Group designs, manufactures andsells highly precise systems, sub-subsystems and components that are typicallyused in surveillance, long-range observation, tracking and targeting andhigh-performance imaging applications. Customers include both government andcommercial organizations.

Our thermal camera systems are typically used forborder surveillance, perimeter security and public safety, while sub-systemsand components are usually designed for integration into our customers’high-performance optical systems. Products can be grouped into four primaryareas: reflective optical products, infrared products, motion control productsand precision optical and mechanical structures. However, customer requirementssometimes demand an optical solution that combines products from several ofthese areas. Our defense products are often designed to be integrated intostabilized optical platforms, which are highly accurate optical positioningmechanisms. Stabilized optical platforms are essential in applications such asmilitary targeting and imaging systems.

The Optical Systems Group has design and manufacturingfacilities in San Diego, California, Cullman, Alabama, Rochester Hills,Michigan, North Billerica, Massachusetts and Salem, New Hampshire.

The Distributed Products Group distributes precisionball bearings, spherical plain bearings and bushings, which are acquired fromvarious domestic and international sources, to OEMs and maintenance repairorganizations, or MROs. The bearings and bushings are used in a variety ofindustrial automation and commercial markets. Additionally, the DistributedProducts Group designs, manufactures and sells 

F-27

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**AXSYS TECHNOLOGIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data)**

**Note 16—SegmentData (Continued)**

mechanical-bearingsubassemblies for a variety of customers. The Distributed Products Group iscomprised of the AST Bearings Division located in Montville, New Jersey, with asatellite distribution center in Irvine, California.

Thefollowing tables present financial data for each segment:

| ** **                                              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Sales from continuing operations:                       |       |     |       |     |       |     |       |
| Optical Systems Group                                   |       | $        | 108,666    |     | $          | 78,189   |       | $ | 63,246 |   |
| Distributed Products  Group                             |       | 24,877   |       | 25,341   |       | 21,863   |       |
| Total sales                                             |       | $        | 133,543    |     | $          | 103,530  |       | $ | 85,109 |   |
| Income from continuing operations before income  taxes: |       |     |       |     |       |     |       |
| Optical Systems Group                                   |       | $        | 17,670     |     | $          | 11,063   |       | $ | 7,063 |   |
| Distributed Products  Group                             |       | 1,853    |       | 2,566    |       | 1,900    |       |
| Non-allocated expenses                                  |       | (7,564   | )          | (4,478   | )          | (3,729   | )          |
| Income from continuing operations before income  taxes  |       | $        | 11,959     |     | $          | 9,151    |       | $ | 5,234 |   |

 

| Capital expenditures of continuing operations: |   |   |   |   |   |   |   |
|------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|
| Optical Systems Group                          |   | $      | 3,311  |   | $      | 4,062  |   | $ | 2,908 |   |
| Distributed Products  Group                    |   | 171    |   | 149    |   | 103    |   |
| Corporate                                      |   | 51     |   | 28     |   | 16     |   |
| Total capital expenditures                     |   | $      | 3,533  |   | $      | 4,239  |   | $ | 3,027 |   |

 

| Depreciation and  amortization of continuing operations: |   |   |   |   |   |   |   |
|----------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|
| Optical Systems Group                                    |   | $      | 2,798  |   | $      | 2,251  |   | $ | 2,422 |   |
| Distributed Products  Group                              |   | 163    |   | 154    |   | 219    |   |
| Corporate                                                |   | 187    |   | 269    |   | 279    |   |
| Total depreciation                                       |   | 3,148  |   | 2,674  |   | 2,920  |   |
| Amortization of  intangibles                             |   | 816    |   | 73     |   | — |   |
| Total depreciation and amortization                      |   | $      | 3,964  |   | $      | 2,747  |   | $ | 2,920 |   |

 

| ** **                  | ** ** | **December 31,** | ** ** |
|-----------------------------|------------|-----------------------|------------|
| ** **                  | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Identifiable assets:   |       |                  |       |   |   |
| Optical Systems Group       |       | $                     | 131,853    |   | $ | 61,552 |   |
| Distributed Products  Group |       | 12,485                |       | 12,787 |   |
| Non-allocated assets        |       | 11,870                |       | 11,476 |   |
| Total assets                |       | $                     | 156,208    |   | $ | 85,815 |   |
| Goodwill:                   |       |                  |       |   |   |
| Optical Systems Group       |       | $                     | 59,608     |   | $ | 11,573 |   |
| Distributed Products  Group |       | 1,440                 |       | 1,440 |   |
| Total goodwill              |       | $                     | 61,048     |   | $ | 13,013 |   |

 

F-28

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**AXSYS TECHNOLOGIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data)**

**Note 16—Segment Data(Continued)**

Included in non-allocated expenses are generalcorporate expense, interest expense, and other income and expense. Identifiableassets by segment consist of those assets that are used in the segment’soperations. Non-allocated assets are comprised primarily of short-terminvestments, cash and cash equivalents, corporate assets and net deferredincome tax assets.

Thefollowing table presents the non-allocated identifiable assets:

| ** **                          | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Non-allocated assets:               |       |                  |       |   |   |
| Cash and cash equivalents           |       | $                     | 7,079      |   | $ | 6,000 |   |
| Income taxes—deferred          |       | 3,256                 |       | 3,553 |   |
| Long-term deferred income tax asset |       | 1,013                 |       | 1,250 |   |
| Other corporate assets              |       | 522                   |       | 673 |   |
| Total assets                        |       | $                     | 11,870     |   | $ | 11,476 |   |

 

Thetable below presents sales from continuing operations for specific geographicregions. Substantially all of our assets are located within the United States.

| ** **    | ** ** | **Years Ended December 31,** | ** ** |
|---------------|------------|---------------------------------------------|------------|
| ** **    | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| United States |       | $                                           | 118,218    |   | $ | 91,069 |   | $ | 73,051 |   |
| Europe        |       | 10,026                                      |       | 8,672 |   | 8,991 |   |
| Other foreign |       | 5,299                                       |       | 3,789 |   | 3,067 |   |
| Total sales   |       | $                                           | 133,543    |   | $ | 103,530 |   | $ | 85,109 |   |

 

Sales to Raytheon represented 12.3% of ourconsolidated sales in 2005, 18.9% in 2004 and 15.5% in 2003. Sales to Raytheonalso represented 15% in 2005, 25% in 2004 and 21% in 2003 of our sales withinthe Optical Systems Group.   As ofDecember 31, 2005, no individual customer represented more than 10% of ouraccounts receivable balance. As of December 31, 2004, Raytheon accountedfor 28.9% of our outstanding accounts receivable.

Within our Optical Systems Group, we had aggregatesales, both military and non-military, directly to the U.S. government,including its agencies and departments, of $4,564 in 2005, $2,367 in 2004, and$3,397 in 2003. In addition, sales of $75,118 in 2005, $47,574 in 2004, and$36,633 in 2003 were derived from subcontracts with U.S. governmentcontractors. The majority of these contracts are subject to termination at theconvenience of the U.S. government, and certain contracts are also subject torenegotiation. Currently, we are not aware of any proposed termination orrenegotiation of such contracts that would have a material adverse effect onour business.

The raw materials and components that we purchase aregenerally available from multiple suppliers. However, beryllium, a material weuse extensively within our Optical Systems Group, is only available from BrushWellman, Inc., the sole U.S. supplier. Historically, we have had anexcellent relationship with Brush Wellman and have not encountered problems inobtaining our supply requirements. However, the partial or complete loss ofBrush Wellman as a supplier of beryllium, or production shortfalls orinterruptions that 

F-29

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**AXSYS TECHNOLOGIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data)**

**Note 16—SegmentData (Continued)**

otherwise impair thesupply of beryllium, would have a material adverse effect on our business,financial condition and results of operations. If such conditions were tooccur, it is uncertain whether alternative sources could be developed.  We paid Brush Wellman $6,500 in 2005, $9,660in 2004 and $5,855 in 2003.

In addition, within ourDistributed Products Group, we purchase a substantial amount of ball bearingsfrom two foreign suppliers. While we believe that we could obtain alternatesources of supply, any interruption in the flow of products from thesesuppliers, or significant increases in the cost of these products, could havean adverse effect on our business, financial condition and results ofoperations. We paid these two suppliers $5,820 in 2005, $6,406 in 2004 and$5,438 in 2003.

**Note 17—Related Party**

A senior management employee is a major partner in KFNRealty, Inc., the previous landlord for our manufacturing facility inSalem, New Hampshire, which was acquired on May 2, 2005. The current leaseexpires in December 2006. The aggregate rent paid, including real estatetaxes, to the related party amounted to $120 from the date of acquisitionthrough November 26, 2005. KFN Realty sold the building to an unrelatedparty in November 2005.

**Note 18—Subsequent Event**

On February 15, 2006, Axsys signed a definitiveagreement to purchase a 78,000 square foot building and 10.5 acres of land inNashua, New Hampshire for $3,800. We expect to close on this transaction on May 3,2006.

This facility will becomethe new consolidated manufacturing facility for our Axsys Technologies IRSystems division, currently operating out of facilities in New Hampshire andMassachusetts. We anticipate the relocation will be completed in 2006.

**Note 19—Selected Quarterly Financial Data (Unaudited)**

Selectedquarterly financial data for the years ended December 31, 2005 and 2004 issummarized as follows (in thousands, except per share data):

| ** **                                                   | ** ** | **Quarters Ended (Unaudited) :** | ** ** |
|--------------------------------------------------------------|------------|-------------------------------------------------|------------|
| **Statement of Operations Data:**             | ** ** | **April 2,  2005**                         | ** ** | **July 2,  2005** | ** ** | **October 1,  2005(2)** | ** ** | **December 31,  2005** | ** ** |
| Sales                                                        |       | $                                               | 28,648     |   | $ | 33,384 |   |   | $ | 35,571 |   |   |   | $ | 35,940 |   |   |
| Gross profit                                                 |       | 8,456                                           |       | 10,334 |   |   | 11,202 |   |   |   | 11,654 |   |   |
| Income from  continuing operations                           |       | 1,607                                           |       | 1,702 |   |   | 1,650 |   |   |   | 2,514 |   |   |
| Net income                                                   |       | 1,607                                           |       | 1,552 |   |   | 1,650 |   |   |   | 2,514 |   |   |
| Diluted net  income per share from continuing  operations(1) |       | $                                               | 0.22       |   | $ | 0.23 |   |   | $ | 0.22 |   |   |   | $ | 0.23 |   |   |
| Diluted weighted-average  common shares outstanding          |       | 7,450                                           |       | 7,476 |   |   | 7,632 |   |   |   | 10,949 |   |   |

 

F-30

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**AXSYS TECHNOLOGIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data)**

**Note 19—Selected Quarterly Financial Data (Unaudited)(Continued)**

| ** **                                               | ** ** | **Quarters Ended (Unaudited) :** | ** ** |
|----------------------------------------------------------|------------|-------------------------------------------------|------------|
| **Statement of Operations Data:**         | ** ** | **April 3,  2004**                         | ** ** | **July 3,  2004** | ** ** | **October 2,  2004** | ** ** | **December 31,  2004** | ** ** |
| Sales                                                    |       | $                                               | 23,406     |   | $ | 25,729 |   |   | $ | 26,356 |   |   |   | $ | 28,039 |   |   |
| Gross profit                                             |       | 6,781                                           |       | 7,821 |   |   | 7,949 |   |   |   | 8,105 |   |   |
| Income from  continuing operations                       |       | 1,613                                           |       | 1,975 |   |   | 1,927 |   |   |   | 3,644 |   |   |
| Net income                                               |       | 1,613                                           |       | 1,975 |   |   | 1,927 |   |   |   | 3,149 |   |   |
| Diluted net  income per share from continuing operations |       | $                                               | 0.23       |   | $ | 0.27 |   |   | $ | 0.27 |   |   |   | $ | 0.43 |   |   |
| Diluted weighted-average  common shares outstanding      |       | 7,117                                           |       | 7,224 |   |   | 7,241 |   |   |   | 7,408 |   |   |

----

(1)          Diluted net income pershare is computed independently for each of the quarters presented. Therefore,the sum of the quarterly amounts may not necessarily equal the total for theyear.

(2)          Inconjunction with our prepayment of the principal and accrued interest on ourformer credit facility, we incurred a charge of $421 for the loss onextinguishment of debt related to the write-off of loan origination fees and $59for the early termination of the related interest rate swap agreement in thesecond quarter of 2005.

F-31

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**AXSYS TECHNOLOGIES, INC.**

**SCHEDULE II**

**VALUATIONAND QUALIFYING ACCOUNTS**

| **COL. A**                     | ** **         | **COL.B**             | ** ** | **COL. C**     | ** ** | **COL. D**     | ** ** | **COL. E** | ** ** | **COL. F**       | ** ** |
|-------------------------------------|--------------------|-----------------------|------------|---------------------|------------|---------------------|------------|-----------------|------------|-----------------------|------------|
| ** **                          | ** **         | ** **            | ** ** | **Additions**       | ** ** | ** **          | ** ** | ** **      | ** ** |
| ** **                          | ** **         | **Balance at**   | ** ** | **Charged to** | ** ** | **Charged to** | ** ** | ** **      | ** ** | **Balance **     | ** ** |
| ** **                          | ** **         | **Beginning of** | ** ** | **Costs and**  | ** ** | **Other**           | ** ** | ** **      | ** ** | **at End ** | ** ** |
| ** **                          | **Classification** | ** **            | ** ** | **Year**            | ** ** | **Expenses**        | ** ** | **Accounts**    | ** ** | **Deductions**        | ** ** | **of Year** | ** ** |
| Year ended  December 31, 2005: |               |                  |       |                |       |                |       |            |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| Inventory  Valuation Reserve        |               |                  | $          | 4,992               |       |                |       | $               | 499        |                  |       |   | 265 | (b) |   |   | $ | 681 |   |   |   | $ | 5,075 |   |   |
| Allowance for  Doubtful Accounts    |               |                  | 685        |                |       |                | 206        |            |       |                  | 14         |   |   |   | 38 | (a) |   |   | 867 |   |   |
| Year ended  December 31, 2004: |               |                  |       |                |       |                |       |            |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| Inventory  Valuation Reserve        |               |                  | $          | 3,917               |       |                |       | $               | 1,164      |                  |       |   | 88 | (b) |   |   | $ | 177 |   |   |   | $ | 4,992 |   |   |
| Allowance for  Doubtful Accounts    |               |                  | 653        |                |       |                | 119        |            |       |                  | —     |   |   |   | 87 | (a) |   |   | 685 |   |   |
| Year ended  December 31, 2003: |               |                  |       |                |       |                |       |            |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| Inventory  Valuation Reserve        |               |                  | $          | 3,593               |       |                |       | $               | 512        |                  |       |   | $ | 70 | (b) |   |   | $ | 258 |   |   |   | $ | 3,917 |   |   |
| Allowance for  Doubtful Accounts    |               |                  | 509        |                |       |                | 234        |            |       |                  | —     |   |   |   | 90 | (a) |   |   | 653 |   |   |
|                                     |                    |                       |            |                     |            |                     |            |                 |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(a)           Un-collectible accountswritten off, net of recoveries.

(b)          Relates to adjustmentsto cost accounting standards, which increased gross inventory as well asinventory reserve.

F-32

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**EXHIBIT INDEX**

| ExhibitNumber | ** ** | **Description**                                                                                                                                                                                                                                                                                                         |
|---------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1           |       | Restated Certificate of  Incorporation of Axsys (filed as Exhibit 3(4) to Axsys’ Amendment  No. 2 to Registration Statement on Form S-1, dated  October 17, 1997 (File No. 333-36027) (the “Form S-1”)  and incorporated herein by reference).                        |
| 3.2           |       | By-Laws of Axsys (filed as Exhibit 2 to the  Form 8-A dated August 8, 1991 (file No. 000-16182)  and incorporated herein by reference).                                                                                                                                                             |
| 10.1          |       | Form of Incentive Stock Option Agreement, dated  as of September 30, 1991 (filed as Exhibit 10(17) to Axsys’ Annual  Report on Form 10-K for the fiscal year ended December 30,  1991(File No. 000-16182)and incorporated herein by reference).*                                     |
| 10.2          |       | Severance Protection Agreement between Axsys and  Stephen W. Bershad dated as of February 11, 1999 (filed as  Exhibit 10(1) to Axsys’ Form 10-Q, dated May 11,  1999, for the fiscal quarter ended March 31, 1999 (File No. 000-16182)  and incorporated herein by reference).* |
| 10.3          |       | Amendment to Axsys Technologies, Inc. Long-Term  Stock Incentive Plan (filed as Exhibit A to Axsys’ Proxy Statement dated  April 24, 2000 (File No. 000-16182) and incorporated herein  by reference).*                                                                                        |
| 10.4          |       | Employment Agreement, dated as of October 12,  2000, between Axsys and Stephen W. Bershad (filed as Exhibit 10(27) to  the December 31, 2000 Form 10-K (File No. 000-16182)  and incorporated herein by reference). *                                                                          |
| 10.5          |       | Form of Indemnification Agreement for all  Directors and Officers of Axsys (filed as Exhibit 10(17) to the  December 31, 2001 Form 10-K (File No. 000-16182)  and incorporated herein by reference).*                                                                                          |
| 10.6          |       | Letter Agreement between David A. Almeida and Axsys  dated as of November 14, 2001 (filed as Exhibit 10(18) to the  December 31, 2001 Form 10-K (File No. 000-16182)  and incorporated herein by reference). *                                                                                 |
| 10.7          |       | Severance Protection Agreement between Axsys and  David A. Almeida dated as of May 13, 2003 (filed as Exhibit 10.2 to  the June 28, 2003 Form 10-Q (File No. 000-16182)  and incorporated herein by reference).*                                                                               |
| 10.8          |       | Letter Agreement between Stephen W. Bershad and  Axsys dated August 4, 2005, extending term of initial period of the  Employment Agreement. (filed as Exhibit 10.1 to the October 26,  2005 Form 10-Q (File No. 000-16182) and incorporated  herein by reference).*                            |
| 10.9          |       | Severance Protection Agreement between Axsys and  Scott B. Conner dated as of December 3, 2004 (filed as Exhibit 10.9  to the December 31, 2004 Form 10-K (File No. 000-16182)  and incorporated herein by reference).*                                                                        |
| 10.10         |       | Summary of Management Incentive Plan. (filed as  Exhibit 10.10 to the December 31, 2004 Form 10-K (File  No. 000-16182) and incorporated herein by reference).*                                                                                                                                     |
| 10.11         |       | Purchase and Sale Agreement filed as  Exhibit 99.1 to Form 8-K on February 16, 2006                                                                                                                                                                                                                      |
| 21            |       | Subsidiaries of the Registrant                                                                                                                                                                                                                                                                                          |

F-33

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| 23   |   | Consent of Ernst and Young LLP                                                                             |
|------|--------|------------------------------------------------------------------------------------------------------------|
| 31.1 |   | Certification pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002—Chief Executive Officer |
| 31.2 |   | Certification pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002—Chief Financial Officer |
| 32.1 |   | Certification pursuant  to 18 U.S.C. Section 1350—Chief Executive Officer                        |
| 32.2 |   | Certification pursuant  to 18 U.S.C. Section 1350—Chief Financial Officer                        |

 

*                    Indicatesmanagement contracts or compensatory plans or arrangements.

F-34

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