**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

**(Mark One)**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe fiscal year ended December 31, 2006**

**or**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe transition period from                                           to                                                       **

**Commissionfile number 0-8771**

**EVANS & SUTHERLAND COMPUTER CORPORATION**

(Exact name of registrantas specified in its charter)

| **Utah**                                   |   | **87-0278175**      |
|--------------------------------------------|--------|---------------------|
| (State or other jurisdiction of            |   | (I.R.S. Employer    |
| Incorporation or organization)             |   | Identification No.) |
| **770 Komas Drive, Salt Lake  City, Utah** |   | **84108**           |
| (Address of principal executive offices)   |   | (Zip Code)          |

 

Registrant’s telephone number, including area code:**801-588-1000**

Securitiesregistered pursuant to Section 12(b) of the Act:

**NONE**

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

|                                      | **Title of  Each Class** | ** **               |   | ** ** | **Name of  Exchange on Which Registered** | ** ** |
|--------------------------------------|--------------------------|--------------------------|--------|------------|-------------------------------------------|------------|
| Common Stock, $0.20 par  value       |                     | The NASDAQ Global Market |
| Preferred Stock Purchase Plan Rights |                     | The NASDAQ Global Market |

 

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

Indicate by check mark if the registrant is notrequired to file reports pursuant to Section 13 or 15(d) of the Act. o Yes  x No

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

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of the registrant’s knowledge, in definitive proxyor information statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K. o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

| Large accelerated  filer o |   | Accelerated filer o |   | Non-accelerated filer x |
|---------------------------------|--------|--------------------------|--------|------------------------------|

 

Indicate by check mark whether the registrant is ashell company (as defined by Rule 12b-2 of the Act). o Yes  x No

The aggregate market value of the voting andnon-voting common stock of the registrant held by non-affiliates of theregistrant as of June 30, 2006, the last business day of the registrantsmost recently completed second fiscal quarter was approximately $28,455,655,based on the closing market price of the common stock on such date as reportedby The Nasdaq Stock Market.

The number of shares ofthe registrant’s Common Stock outstanding as of March 27, 2007 was11,089,166.

 

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**EVANS & SUTHERLAND COMPUTER CORPORATION**

**FORM 10-K**

**FORTHE YEAR ENDED DECEMBER 31, 2006**

| **PART I**   |
|-------------------|
| ITEM 1.           |   | BUSINESS |   | 3 |
| ITEM  1A.         |   | RISK FACTORS |   | 7 |
| ITEM 2.           |   | PROPERTIES |   | 11 |
| ITEM  3.          |   | LEGAL PROCEEDINGS |   | 11 |
| ITEM 4.           |   | SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS |   | 11 |
| **PART II**  |
| ITEM 5.           |   | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED  STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |   | 12 |
| ITEM  6.          |   | SELECTED  FINANCIAL DATA |   | 14 |
| ITEM 7.           |   | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL  CONDITION AND RESULTS OF OPERATIONS |   | 16 |
| ITEM 7A.          |   | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET  RISK |   | 30 |
| ITEM 8.           |   | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |   | 31 |
| ITEM 9.           |   | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND  ACCOUNTING AND FINANCIAL DISCLOSURE |   | 65 |
| ITEM 9A.          |   | CONTROLS AND PROCEDURES |   | 65 |
| ITEM  9B.         |   | OTHER  INFORMATION |   | 65 |
| **PART III** |
| ITEM 10.          |   | DIRECTORS, EXECUTIVE OFFICERS AND CORPORTATE  GOVERNANCE |   | 66 |
| ITEM 11.          |   | EXECUTIVE COMPENSATION |   | 66 |
| ITEM 12.          |   | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND  MANAGEMENT AND RELATED STOCKHOLDER MATTERS |   | 66 |
| ITEM 13.          |   | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND  DIRECTOR INDEPENDENCE |   | 67 |
| ITEM 14.          |   | PRINCIPAL ACCOUNTANT FEES AND SERVICES |   | 67 |
| **PART IV**  |
| ITEM 15.          |   | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES |   | 68 |
| SIGNATURES        |   | 73 |

 

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**PART I**

**ITEM 1.**                BUSINESS

Throughout this document Evans & SutherlandComputer Corporation may be referred to as “Evans & Sutherland,” “E&S,”“we,” “us,” “our” or the “Company.”  Alldollar amounts are in thousands unless otherwise indicated.

Evans & Sutherlandwas incorporated in the state of Utah on May 10, 1968. Our principaloffices are located at 770 Komas Drive, Salt Lake City, Utah 84108, and ourtelephone number is (801) 588-1000. Through a link on our website,www.es.com, we make available, free of charge, our annual report on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-K,and amendments to those reports filed or furnished pursuant to Section 13(a) or15(d) of the Exchange Act as soon as reasonably practicable after suchmaterial is electronically filed with or furnished to the Securities andExchange Commission (the “SEC”). We make our website content available forinformational purposes only. The information provided on our website is notincorporated by reference into this Form 10-K. The above reports andother information are also available, free of charge, at www.sec.gov. Alternatively,the public may read and copy any materials we file with the SEC at the SEC’sPublic Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Informationon the operation of the Public Reference Room may be obtained by callingthe SEC at 1-800-SEC-0330.

**Sale of BusinessUnit**

On May 26, 2006, we completed the sale ofsubstantially all of the assets and certain liabilities primarily related toour commercial and military simulation businesses and related serviceoperations (the “Simulation Business”) to certain subsidiaries of RockwellCollins, Inc., a Delaware corporation (“Rockwell Collins”), pursuant to anasset purchase agreement (the “Asset Purchase Agreement”), dated as of February 7,2006, by and between the Company and Rockwell Collins. In connection with thecompletion of the sale of the Simulation Business, on May 26, 2006 theCompany entered into a laser projection systems agreement (the “Laser Agreement”)with Rockwell Collins and Rockwell Collins Simulation & TrainingSolutions LLC, pursuant to which the Company has agreed to provide, and grantexclusive and non-exclusive intellectual property licenses to use and sell,laser projection systems in connection with the Simulation Business and certainrelated businesses of Rockwell Collins.

Further informationconcerning the sale of the Simulation Businesses is provided in Note 2 of Item8 “Financial Statements and Supplementary Data” and in Item 7 “Management’sDiscussion and Analysis of Financial Position and Results of Operations”included in Part II of this annual report on Form 10-K.

**Acquisition**

On April 28, 2006, the Company completed theacquisition of Spitz, Inc. (“Spitz”) by acquiring all outstanding sharesof Spitz common stock from Transnational Industries, Inc. (“Transnational”)pursuant to a stock purchase agreement (the “Stock Purchase Agreement”), datedas of February 7, 2006, by and between the Company and Transnational. Spitz  designs, manufactures and supportsoptical-mechanical and digital visual systems for planetariums, science centersand entertainment venues. Spitz also produces unique domes and curvedstructures for specialized architectural applications. We believe that theSpitz visual system products and domes along with its customer base complementthe digital theater products of Evans & Sutherland and will enhanceour capabilities to serve the markets we target.

Further informationconcerning the acquisition of Spitz is provided in Note 3 of Item 8 “FinancialStatements and Supplementary Data” and in Item 7 “Management’s Discussion andAnalysis of Financial Position and Results of Operations” included in Part IIof this annual report on Form 10-K.

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**General**

Since the sale of the Simulation Business and theacquisition of Spitz, Evans & Sutherland focuses on the production ofhigh-quality visual systems, advanced displays including the laser projector(ESLP), dome projection screens, dome architectural treatments, and uniquecontent for planetariums, science centers, other educational institutions, andentertainment venues. With a 38-year history in computer graphics, we arewidely regarded as both a pioneer and a leader in providing the world’s mostcompelling visual systems. With the acquisition of Spitz and its over 50-yearhistory as a leading supplier of planetarium systems and other dome displays,E&S now supplies premier total system solutions for its digital theatermarkets as well as customized domes and other curved structures in thearchitectural market.

We continue to maintain asignificant share of the overall planetarium and digital theater market. Weestimate that our market share has ranged from 35% to 70%, depending on thespecific market and time period. We estimate that the size of the market fordigital theater and planetarium systems is approximately $65 million annually.

**Description ofProducts**

E&S offers a range ofproducts and services for digital theater, planetarium, and educationalinstitutions. These products include state of the art image generators, domes,and display systems some of which feature our unique laser projector (ESLP)that provides a seamless high resolution display from a single projector. Additionally,we produce unique content both for our own library which we license tocustomers and for specific customer requirements.

**Description ofMarkets**

We are an industry leaderin providing visual systems to an international customer base in the digitaltheater, planetarium, and educational markets. Through our Spitz subsidiary, wealso supply dome projection screens and dome architectural treatments to majortheme parks, casinos, world expositions, and military defense contractors. Ineach of these markets we face highly competitive conditions. In all our marketswe compete on features, performance, and responsiveness to customer needs aswell as on price. E&S is unique among its competitors by virtue of itscapability as a single source that can directly supply and integrate all of theequipment in the planetarium theater, including the projection system, sound,lighting, computer control system and domed projection screen. We believe ourrange of visual systems and services at various price and performance levels,our research and development investments and capabilities, our responsivenessto customers, and our ability to design and manufacture value-added visualsystems enable us to compete effectively.

***Digital Theater***

In the digital theatermarket our products compete with traditional optical-mechanical products anddigital display systems offered by GOTO Optical Mfg. Co., Konica-MinoltaPlanetarium Co. Ltd., Carl Zeiss Inc., and Sky-Skan, Inc. During 2006 ourshare of this market increased modestly from revenue contributed by our newlyacquired subsidiary Spitz. We expect this market share to increase as wecomplete the integration of Spitz and realize a full year of results for thenew combined business.

***Advanced Displays***

We began work in 1997 tobuild a new generation of projection technology with specifications beyond anyother technology either available or likely in the foreseeable future. Thisgoal evolved into the production of a revolutionary projector using lasers forillumination and micro-electro-mechanical systems (MEMS) to modulate the laserlight and create an image. The result is the Evans & Sutherland Laser 

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Projector(ESLP). The first ESLP systems were delivered late in 2005, with additionalunits delivered in 2006. The first units have been supplied to our traditionalsimulation  and digital theater customerswho continue to order systems with the new projection technology. We believethat the ESLP also has application to other markets in the future whereultra-high resolution, high efficiency, excellent image quality, and lowlife-cycle cost are important considerations.

***Domed Structures***

Our subsidiary Spitz isthe world’s leading producer of domed projection screens. Spitz designs,manufactures, and installs domed projection screens which are used inplanetarium theaters and a variety of other applications such as ridesimulators, special or large format film theaters, simulation training systemsand architectural treatments. Spitz’s experience enables it to advise on thearchitectural integration of domed projection screens and solve complex opticalproblems involving reflectivity and image distortion on compound curvedsurfaces. The Company believes that these skills are important to buyers ofdomed projection screens. The principal customers in Spitz’s dome business areentities in the entertainment, educational and commercial and militarysimulation markets. Customers include major theme parks, casinos, worldexpositions, museums, schools, and military defense contractors. There iscurrently one known domestic competitor that manufactures domed projectionscreens. In addition, construction or metal fabrication contractors willoccasionally supply domed projection screens, particularly in foreign markets.

**Backlog**

On December 31, 2006,our backlog was $20,408 compared with $16,548 on December 31, 2005adjusted for the discontinued operations of the Simulation Business. Weanticipate that approximately 85% of the 2006 backlog will be converted tosales in 2007.

**SignificantCustomers**

Worldwide customers using our products includemuseums, planetariums, science centers, theme parks, casinos, aerospacecompanies, and international armed forces. We measure and identify oursignificant customers based on direct sales.

Sales to no singlecustomer represented more than 10% of total sales during 2006. Sales to twocustomers represented 12% and 11% of total sales during 2005. Sales to twocustomers represented 13% and 11% of total sales during 2004.

**IntellectualProperty**

We own a significantnumber of patents and trademarks and we are a licensee under several others. Ourportfolio of patents and trademarks is, as a whole, material to our business. However,no one piece of intellectual property is critical to our business, thus noindividual piece of our intellectual property is separately discussed. In theU.S. and internationally, we hold active patents that cover many aspects of ourvisualization technology. Several patent applications are presently pending inthe U.S., Japan and several European countries, and other patent applicationsare in preparation. We actively pursue patents on our new technology and weintend to vigorously protect our patent rights. We routinely copyrightsoftware, documentation and chip masks designed by us and institute copyrightregistration when appropriate. During the history of the Company we have beenawarded 86 patents, of which 59 are still active. The sale of the SimulationBusiness transferred certain patents and other intellectual property rightsprimarily related to the Simulation Business to Rockwell Collins. Also, weacquired rights to the intellectual property of Elumens Corporation in itsbankruptcy liquidation. The rights to the Elumens intellectual property protectthe application of certain processes in the use of the Company’s visual displayproducts.

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**Research &Development**

We consider the timely development and improvement ofour technology to be essential to maintain our competitive position and tocapitalize on market opportunities. We continue to fund essentially allresearch and development (“R&D”) efforts internally.

A significant focus forour R&D in 2006 was the continued development of our laser projector, theESLP. We delivered ESLP’s in the fourth quarter of 2005 to the Air Force andbegan delivery of the ESLP to planetariums in January 2006. Efforts toimprove production process, performance and reliability of the laser projectorwill continue through 2007. In addition we are exploring the potentialapplication of the ESLP technology in new markets through partnering andlicensing arrangements.

**Dependence onSuppliers**

Most of our current partsand assemblies are readily available through multiple sources in the openmarket; however, a limited number are available only from a single source. Inthese cases, we either stock adequate inventory to cover future productdemands, obtain the agreement of the vendor to maintain adequate stock forfuture demands, or develop alternative components or sources where appropriate.

**Foreign Sales**

Foreign sales arecalculated based on the location of the purchasing customer and were $7,984 in2006, $5,814 in 2005, and $6,223 in 2004 adjusted for the discontinuedoperations of the Simulation Business. Foreign sales accounted forapproximately 53%, 38%, and 66% of total sales in 2006, 2005 and 2004, respectively.We believe that any inherent risk that may exist in our foreign operations isnot material.

**Employees**

As of December 31,2006, Evans & Sutherland and its subsidiaries employed a total of 118persons compared to 268 employees as of December 31, 2005. The changein number of employees was attributable principally to the discontinuedoperations of the Simulation Business and the acquisition of Spitz. Followingthe completion of the sale of the Simulation Business, we retained 64 employeesand gained 54 employees from our Spitz acquisition. We believe our relationswith our employees are good. None of our employees are subject to collectivebargaining agreements.

**EnvironmentalStandards**

We believe our facilitiesand operations are within standards fully acceptable to the EnvironmentalProtection Agency and that all facilities and procedures are operated inaccordance with environmental rules and regulations, and international,federal, state and local laws.

**StrategicRelationships**

In the normal course of businesswe develop and maintain various types of relationships with key customers andtechnology partners. In 2006, we entered into a limited number of teamingagreements and product development agreements. The teaming agreements are withindustry partners and are intended to improve our overall competitive position.The product development agreements enhance our products by the cooperativedevelopment of new features and capabilities necessary to maintain our industryleading position. These activities will continue in 2007.

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**Forward-LookingStatements and Associated Risks**

This annual report,including all documents incorporated herein by reference, includes certain “forward-lookingstatements” within the meaning of that term in Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the Exchange Act of1934, as amended, including, among others, those statements preceded by,followed by or including the words “estimates,” “believes,” “expects,” “anticipates,”“plans,” “projects,” “intends,” “predicts,” “may,” “will,” “could,” “would,” “potential”and similar expressions or the negative of such terms. See Item 7 “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”included in Part II of this annual report on Form 10-K for alist of some of the forward-looking statements included in this Form 10-K.See Item 1A “Risk Factors” below for factors that may affect theseforward-looking statements.

**EXECUTIVE OFFICERSOF THE REGISTRANT**

Thefollowing sets forth certain information regarding the executive officers ofE&S as of March 28, 2007.

| **Name**         | ** ** | ** ** | ** ** | **Age**                                                    | ** ** | **Position** |
|------------------|------------|------------|------------|------------------------------------------------------------|------------|--------------|
| David H. Bateman |       | 64         |       | President and Chief  Executive Officer                     |
| Paul L. Dailey   |       | 50         |       | Chief Financial Officer  and Corporate Secretary           |
| Bob Morishita    |       | 55         |       | Vice President Human  Resources                            |
| Kirk D. Johnson  |       | 45         |       | Vice President and  General Manager of Digital Theater     |
| Allen H. Tanner  |       | 53         |       | Vice President and  General Manager of Advanced Displays   |
| Jonathan A. Shaw |       | 50         |       | President and Chief Executive Officer of  Spitz, Inc. |

 

David H. Bateman was appointed President and ChiefExecutive Officer of E&S in February 2007. Mr. Bateman joinedE&S as Director of Business Operations in May 1998. He was appointedVice President—Business Operations in March 2000 and Interim President andChief Executive Officer and a member of the Board of Directors in June 2006.

Paul L. Dailey was appointed Chief Financial Officerand Corporate Secretary of E&S in February 2007. He became anexecutive officer of E&S in August 2006 when he was appointed ActingChief Financial Officer and Corporate Secretary. Prior to his appointments atE&S, Mr. Dailey served as Executive Vice President, Chief FinancialOfficer and Corporate Secretary of E&S subsidiary, Spitz Inc. where hestarted as Controller in 1983. Mr. Dailey is a Certified PublicAccountant.

Bob Morishita was appointed Vice President of HumanResources in 2000. He joined E&S as Compensation Manager in 1982 and wasappointed Human Resources Director in 1997.

Kirk Johnson was appointed Vice President and GeneralManager of Digital Theater in January 2002. He joined E&S in April 1990and has held various engineering and management positions throughout hisservice at E&S.

Allen H. Tanner was appointed Vice President andGeneral Manager of Advanced Displays in January 2000. He has held variousengineering and management positions throughout his service at E&S since1996.

Jonathan A. Shaw wasappointed President and Chief Executive Officer E&S subsidiary, Spitz Inc. inNovember 2001 where he held various management positions since 1985.

**ITEM 1A.**        RISKFACTORS

 Our domestic and international businessesoperate in highly competitive markets that involve a number of risks, some ofwhich are beyond our control. The sale of the Simulation Business to Rockwell 

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Collinson May 26, 2006, has significantly changed our business. As a result,there are new risks and uncertainties that should be considered in evaluatingour business. The following discussion highlights some risks and uncertaintiesthat should be considered in evaluating our growth outlook.

***Our Business Model Has Changed and May NotProduce Consistent Earnings Which Could Adversely Affect Our Business***

With the sale of ourSimulation Business to Rockwell Collins, our business model has significantlychanged. Our business is now based on digital theaters and laser projectors. Asignificant portion of our future success will depend on completing and sellingour laser projector, and future products based on this technology. There is noguarantee that the laser projector or any future products based on thistechnology will be successful in the market or that we can develop them. If weare unable to develop our laser projector, our business will be adverselyaffected.

***We May Experience Difficulty in Identifying, Formingand Maintaining New Business Opportunities That Are Important To theDevelopment of Our Business***

We have invested, andexpect to continue to invest, significant capital in new products,technologies, and business opportunities. We cannot assure you that we will beable to continue to identify suitable opportunities to expand our business inthe future. The failure to form or maintain new business opportunities couldsignificantly limit our ability to expand our operations and sales. Moreover,these new opportunities or investments require significant management time,involve a high degree of risk and will present significant challenges. Wecannot assure you that these activities will be successful or that we willrealize appropriate returns on these activities.

***Our Laser Projectors are New and have Limited MarketPenetration***

Our laser projectors havelimited market penetration. Our future success will depend in significant parton our ability to generate demand for our laser projectors and to develop additionalcommercial applications that incorporate our laser projector technology. Wecannot be certain that our product will succeed in the market, and if we failto generate increased sales, our future results of operations will be adverselyaffected.

***We May be Unable to Adequately Respond to RapidChanges in Technology***

The market for our laserprojectors is characterized by rapidly changing technology, evolving industrystandards and frequent product introductions. The introduction of products andservices embodying new technology and the emergence of new industry standardsmay render our existing laser projectors obsolete and unmarketable if we areunable to adapt to change. A significant factor in our ability to grow and toremain competitive is our ability to successfully introduce new products andservices that embody new technology, anticipate and incorporate evolvingindustry standards and achieve levels of functionality and prices acceptable tothe market. If our laser projectors are unable to meet our customers’ needs orwe are unable to keep pace with technological changes in the industry, ourlaser projectors could eventually become obsolete. We may be unable to allocatethe funds necessary to improve our current products or introduce new productsto address our customers’ needs and respond to technological change. If othercompanies develop more technologically advanced products, our competitiveposition relative to such companies would be harmed.

***Competitors or Third Parties May Infringe E&SIntellectual Property***

Throughout its historyE&S has been awarded numerous patents. While competitors or third partieshave not materially infringed our patents, we are entering the production stageof a new product, the 

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ESLP. Wehave a number of patents either issued or pending on this technology, but itrepresents a new field for us and may attract competitors with a risk ofinfringement and costly legal processes to defend our intellectual propertyrights which could adversely affect our business.

***Delays in New Product Introductions Could NegativelyAffect Financial Performance***

During 2006 and into 2007,we have introduced and intend to introduce several important new products,including the ESLP. Further delays in introducing and delivering these productscould reduce planned sales and profit contribution.

***Our Industry Is Undergoing Rapid TechnologicalChanges, And Our Failure To Keep Up With Such Changes Could Cause Us To LoseCustomers And Impede Our Ability To Attract New Customers***

Our success depends on our ability to compete in anindustry that is highly competitive, with rapid technological advances andproducts that require constant improvement in both price and performance. Weexpect this trend to continue. If our competitors are more successful than weare in developing technology and products, then our revenues and growth ratescould decline.

Our industry is subject torapid and significant changes in technology as well as customer requirementsand preferences, and our failure to keep up with such changes could cause us tolose customers and impede our ability to attract new customers. Newtechnologies could reduce the competitiveness of our theater and projectorproducts. We may be required to select one technology over another, but at atime when it would be impossible to predict with any certainty which technologywill prove to be the most economic, efficient or capable of attracting customerusage. Subsequent technological developments may reduce the competitiveness ofour products and require upgrades or additional products that could beexpensive or unfeasible. If we fail to adapt successfully to technologicalchanges or customer preferences, we could lose market share or impede ourability to attract new customers and retain current customers.

***Resistance By Potential New Customers To Accept OurProducts May Reduce Our Ability To Increase Our Revenue***

The expansion of ourbusiness will be dependent upon, among other things, the willingness ofadditional customers to accept our products and technologies. We cannot assureyou that we will be successful in overcoming the resistance of potentialcustomers to change their current projectors or theater technologies, and toexpend the capital necessary to purchase and implement our products andtechnology. The lack of customer acceptance would reduce our ability toincrease our revenue.

***Our Sales Could Decline Substantially as a Result ofTerrorist Attacks and Other Activities that Reduce the Willingness of OurCustomers to Purchase Products***

The demand for ourproducts and services is dependent upon new orders from customers operatingvarious public attractions. If terrorist attacks or other activities decreasethe attendance for our customers’ venues, the demand or willingness of ourcustomers to purchase our products may decline and our revenue may declinesubstantially.

***Our Shareholders May Not Realize CertainOpportunities Because of the Anti-Takeover Effect of State Law***

The Utah Control SharesAcquisition Act provides that any person who acquires 20% or more of theoutstanding voting shares of a publicly held Utah corporation will not havevoting rights with respect to the acquired shares unless a majority of thedisinterested shareholders of the corporation votes to grant such rights. Thiscould deprive shareholders of opportunities to realize takeover premiums fortheir shares or other advantages that large accumulations of stock wouldprovide because anyone interested in acquiring 

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E&Scould only do so with the cooperation of our board of directors and a majorityof disinterested shareholders.

***Your Ability to Sell Your Stock May beSubstantially Limited***

If we fail to meet any ofthe continued listing standards of the Nasdaq National Market, our common stockmay be delisted from the Nasdaq National Market. If we are delisted from theNasdaq National Market, we expect our common stock will be traded on the NasdaqCapital Market if we meet the listing standards of that market or we willattempt to be traded on the OTC Bulletin Board or “pink sheets” maintained bythe National Quotation Bureau, Inc. The OTC Bulletin Board and pink sheetsare generally considered less efficient markets than the Nasdaq National Marketand the Nasdaq Capital Market.

***We May receive none or little of theremaining $5 Million in Escrow Related to the Sale of Assets to RockwellCollins and the Laser Projector Agreement***

As part of the Asset Purchase Agreement and LaserAgreement, a total $5,000 remains in an escrow account to secure ourindemnification obligations under the Asset Purchase Agreement and our deliveryobligations under the Laser Agreement. There is no guarantee that we willreceive these funds and if Rockwell Collins becomes entitled to a penalty underthe Laser Agreement or indemnification under the Asset Purchase Agreement, wemay receive none or little of the $5,000 remaining in escrow, which will reducethe amount of cash we have available in the future.

If we do not deliver amotion-based ESLP to Rockwell Collins by December 31, 2007, RockwellCollins has the right to begin accelerating monthly withdrawals from the escrowaccount in accordance with a formula prescribed by the Laser Agreement. Underthe formula, the monthly withdrawals will total $1,000 over the year following December 31,2007. If we do not deliver a motion-based ESLP by December 31, 2008,Rockwell Collins will have the right to withdraw up to an additional $2,000from the escrow account.

***We Continue to be Exposed to Contingent LiabilitiesRelating to the Sale of our Simulation Business, Which Could Adversely AffectOur Financial Condition***

In connection with thesale of our Simulation Business, we agreed to indemnify Rockwell Collins forany losses from breaches of the representations, warranties or covenants wemade in the Asset Purchase Agreement that occur within certain periods afterthe closing. We have also agreed that certain indemnification obligations willbe capped at certain amounts. For example, an indemnification claim by RockwellCollins could result if Rockwell Collins suffers any damages arising out of theinaccuracy of any of our representations or if we fail to comply with acovenant or other agreement in the Asset Purchase Agreement. In addition, wehave agreed to retain all liabilities relating to the Simulation Business thatare not being expressly assumed by Rockwell Collins, and to indemnify RockwellCollins for any claims or damages arising from such retained liabilities. Thepayment of any such indemnification obligations could adversely impact our cashresources following the completion of the sale of our simulator business andour ability to pursue other opportunities, including the development of ourdigital theater and laser projector businesses.

***We May Not Be Able to Fully Integrate Spitz intoOur Operations Successfully***

We may experiencedifficulties in fully integrating Spitz’s business with ours. This could resultin additional costs and loss of productivity that could materially affect ouroperations and financial results.

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***If We are Unable to Retain Certain Key Personnel andHire New Highly Skilled Personnel, We May Not Be Able to Execute OurBusiness Plan***

We are substantiallydependent on the continued services of certain key personnel. These individualshave acquired specialized knowledge and skills with respect to the Company andits operations. The loss of any of these individuals could harm our business.Our business is also dependent on our ability to retain, hire and motivatetalented, highly skilled personnel. If we do not succeed in retaining andmotivating our existing key employees and in attracting new key personnel, wemay be unable to meet our business plan and as a result, our stock price maydecline.

**ITEM 2.**                PROPERTIES

Our principal executive, engineering, manufacturingand operations facilities are located in the University of Utah Research Parkin Salt Lake City, Utah, where we own three buildings totaling approximately68,000 square feet. The buildings are located on land leased from theUniversity of Utah with an initial term of 40 years or longer.

Spitz owns and occupies an approximately 47,000square-foot building on approximately 15.2 acres in Chadds Ford, Pennsylvania.The property serves as collateral under Spitz’s debt agreements through amortgage granted to First Keystone Bank.

We believe that theseproperties are suitable for our immediate needs and we do not currently plan toexpand our facilities or relocate to other facilities.

**ITEM 3.**                LEGALPROCEEDINGS

In the normal course ofbusiness, we may have various legal claims and other contingent matters. We knowof no legal claims or other contingent matters outstanding that would have amaterial adverse effect on our consolidated financial condition, liquidity orresults of operations.

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

No matters were submitted to a vote of securityholders during the fourth quarter of fiscal year 2006.

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**PART II**

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

Our common stock trades on the Nasdaq Stock Marketunder the symbol “ESCC.”  On March 27,2007, there were 666 holders of record of our common stock. Because brokers andother institutions hold many of our shares on behalf of shareholders, we areunable to estimate the total number of shareholders represented by these recordholders.

We have never paid a cash dividend on our common stockand have used retained earnings for the operation and expansion of our business.Currently we have an accumulated deficit. For the foreseeable future, we intendto follow our policy of retaining any future earnings to finance thedevelopment and growth of our business.

Additional information required by this item isincorporated by reference to  the tablecaptioned *Securities Authorized for Issuance Under EquityCompensation Plans as of December 31, 2006* in Item 12 “SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters” of Part III of this annual report on Form 10-K.

Thetable below presents the high and low bids per share on the Nasdaq Stock Marketby quarter for 2006, and 2005. The quotations reflect inter-dealer prices,without retail mark-up, mark-down, or commission and may not necessarilyrepresent actual transactions.

| ** **     | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------|------------|----------|------------|----------|------------|
| ** **     | ** ** | **High** | ** ** | **Low**  | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | $        | 7.91       |     | $          | 4.69 |   | $ | 7.99 |   | $ | 5.50 |   |
| Second Quarter |       | 6.50     |       | 4.85     |       | 6.88 |   | 4.38 |   |
| Third Quarter  |       | 5.60     |       | 4.06     |       | 6.22 |   | 4.50 |   |
| Fourth Quarter |       | 4.60     |       | 3.65     |       | 6.25 |   | 4.57 |   |
|                |            |          |            |          |            |  |  |  |  |  |  |  |  |

 

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Thefollowing graph presents a five-year comparison of total cumulative shareholderreturn on Evans & Sutherland’s common stock for the period December 31,2001 through December 31, 2006 with the total cumulative return on the (a) Russell2000 Index,  (b) S&P ElectronicEquipment & Instruments and (c) S&P Aerospace &Defense Index. As a result of the sale of the Simulation Business and our exitfrom the military and defense industry, we have determined that the S&PAerospace & Defense Index is no longer applicable to our business, andwe have determined to use the S&P Electronic Equipment &Instruments Index. In accordance with SEC rules, we are required to includebelow a comparison to the historic and new industry index. The comparisonassumes the investment of $100 on December 31, 2001 in stock or index,including reinvestment of dividends. Total shareholder returns for priorperiods are not an indication of future investment returns.

| ** **                                                      | ** ** | **Cumulative Total Return** | ** ** |
|-----------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                      | ** ** | **12/01**                             | ** ** | **12/02** | ** ** | **12/03** | ** ** | **12/04** | ** ** | **12/05** | ** ** | **12/06** | ** ** |
| **Evans &  Sutherland Computer Corp.**                 | ** ** | **$**                                 | **100**    | ** ** |   | **$** | **94** | ** ** |   | **$** | **68** | ** ** | **$** | **105** | ** ** | **$** | **74** | ** ** | **$** | **63** | ** ** |
| **Russell  2000**                                               | ** ** | **100**                               | ** ** |   | **80** | ** ** |   | **117** | ** ** | **139** | ** ** | **145** | ** ** | **171** | ** ** |
| **S &  P Aerospace & Defense**                | ** ** | **100**                               | ** ** |   | **95** | ** ** |   | **117** | ** ** | **135** | ** ** | **157** | ** ** | **197** | ** ** |
| **S & P Electronic  Equipment & Instruments** | ** ** | **100**                               | ** ** |   | **50** | ** ** |   | **88** | ** ** | **75** | ** ** | **78** | ** ** | **77** | ** ** |
|                                                                 |            |                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**ITEM 6.**                SELECTEDFINANCIAL DATA

Thefollowing selected consolidated financial data for the most recent five fiscalyears ended December 31, 2006, have been derived from our consolidatedfinancial statements. The financial information shown as of December 31,2006 and 2005, and for the years ended December 31, 2006, 2005 and 2004,has been derived from our consolidated financial statements as of such datesand for such years. The financial information shown as of December 31,2004, 2003 and 2002, and for the years ended December 31, 2003 and 2002,has not been audited and reflects our previously issued financial informationreclassified to conform to our current presentation. The data presented belowshould be read in conjunction with Item 7 “Management’s Discussion and Analysisof Financial Condition and Results of Operations” and Item 8 “FinancialStatements and Supplementary Data” of this annual report on Form 10-K.

| **For the Years Ended December 31,** | ** ** | ** **                                                            | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**        | ** ** | **2003**        | ** ** | **2002** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|------------|------------|------------|------------|-----------------|------------|-----------------|------------|----------|------------|
| ** **                                                    | ** ** | ** **                                                            | ** ** | ** ** | ** ** | ** ** | ** ** | **(Unaudited)** | ** ** | **(Unaudited)** | ** ** |
| ** **                                                    | ** ** | **(in thousands, except per share amounts)** | ** ** |
| Sales                                                         |       | $                                                                     | 15,048     |       | $          | 15,111     |       |            | $          | 9,479           |       |     |       | $ | 7,428 |   |   |   | $ | 3,421 |   |   |
| Net loss from  continuing operations                          |       | (9,480                                                                | )          | (3,523     | )          |       | (7,277     | )               |       |            | (2,563     | )        |       |   | (5,061 | ) |   |
| Net income (loss)                                             |       | 21,985                                                                |       | (1,134     | )          |       | (8,729     | )               |       |            | (35,337    | )        |       |   | (12,050 | ) |   |
| Net income (loss) per  common share—basic:               |       |                                                                  |       |       |       |       |       |            |       |            |       |     |       |   |   |   |   |
| Loss per share from continuing operations                     |       | $                                                                     | (0.88      | )          | $          | (0.34      | )          |            | $          | (0.69           | )          |     |       | $ | (0.24 | ) |   |   | $ | (0.49 | ) |   |
| Net income (loss) per share                                   |       | $                                                                     | 2.03       |       | $          | (0.11      | )          |            | $          | (0.83           | )          |     |       | $ | (3.37 | ) |   |   | $ | (1.16 | ) |   |
| Basic weighted  average common shares outstanding             |       | 10,826                                                                |       | 10,523     |       |       | 10,498     |            |       |            | 10,471     |     |       |   | 10,422 |   |   |
| Net income (loss) per  common share—diluted:             |       |                                                                  |       |       |       |       |       |            |       |            |       |     |       |   |   |   |   |
| Loss per share from continuing operations                     |       | $                                                                     | (0.87      | )          | $          | (0.34      | )          |            | $          | (0.69           | )          |     |       | $ | (0.24 | ) |   |   | $ | (0.49 | ) |   |
| Net income (loss) per share                                   |       | $                                                                     | 2.03       |       | $          | (0.11      | )          |            | $          | (0.83           | )          |     |       | $ | (3.37 | ) |   |   | $ | (1.16 | ) |   |
| Diluted weighted average  common shares outstanding           |       | 10,847                                                                |       | 10,523     |       |       | 10,498     |            |       |            | 10,471     |     |       |   | 10,422 |   |   |

 

| **As of December 31,** | ** ** | ** **                                                            | ** ** | **2006**   | ** ** | **2005**        | ** ** | **2004**        | ** ** | **2003**        | ** ** | **2002** | ** ** |   |
|---------------------------------------|------------|-----------------------------------------------------------------------|------------|------------|------------|-----------------|------------|-----------------|------------|-----------------|------------|----------|------------|--------|
| ** **                            | ** ** | ** **                                                            | ** ** | ** ** | ** ** | **(Unaudited)** | ** ** | **(Unaudited)** | ** ** | **(Unaudited)** | ** ** |     |
| ** **                            | ** ** | **(in thousands, except per share amounts)** | ** ** |       |
| Cash                                  |       | $                                                                     | 15,549     |       | $          | 14,606          |       |            | $          | 10,147          |       |     |       | $      | 9,714 |   |   |   | $ | 7,375 |   |   |
| Total assets                          |       | 55,381                                                                |       | 68,050     |       |            | 73,615     |            |       |            | 94,824     |     |       |   | 127,509 |   |   |
| Long-term debt,  less current portion |       | 2,845                                                                 |       | —     |       |            | —     |            |       |            | —     |     |       |   | 2,670 |   |   |
| Stockholders’ equity  (deficit)  |       | 22,382                                                                |       | (6,455     | )          |            | (948       | )               |       |            | 10,717     |     |       |   | 47,863 |   |   |
|                                       |            |                                                                       |            |            |            |                 |            |                 |            |                 |            |          |            |        |  |  |  |  |  |  |  |  |  |  |  |

 

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**Quarterly FinancialData (Unaudited)**

Thefollowing selected consolidated quarterly financial data for the most recenttwo fiscal years ended December 31, 2006 reflects the presentation ofdiscontinued operations and accordingly, some amounts presented have changedfrom previously reported amounts. Further information concerning the sale ofthe Simulation Businesses is provided in Note 2 of Item 8 “Financial Statementsand Supplementary Data” and in Item 7 “Management’s Discussion and Analysis ofFinancial Position and Results of Operations” included in Part II of thisannual report on Form 10-K.

*(In thousands,except per share information)*

| ** **                                                        | ** ** | **Quarter Ended** | ** ** |
|-------------------------------------------------------------------|------------|------------------------|------------|
| **2005**                                                          | ** ** | ** **             | ** ** | **April 1** | ** ** | **July 1** | ** ** | **Sep. 30(3)** | ** ** | **Dec. 31(2)** | ** ** |
| Sales                                                             |       | $                      | 2,794      |   | $ | 4,231 |   |   | $ | 4,190 |   |   |   | $ | 3,896 |   |   |
| Gross profit                                                      |       | 1,570                  |       | 1,954 |   |   | 1,697 |   |   |   | 1,373 |   |   |
| Net income (loss)  from continuing operations before income taxes |       | (688                   | )          | (437 | ) |   | (2,351 | ) |   |   | (41 | ) |   |
| Net income (loss)                                                 |       | (5,978                 | )          | (1,494 | ) |   | (1,238 | ) |   |   | 7,576 |   |   |
| Basic and diluted income  (loss) per share(1)                     |       | $                      | (0.57      | ) | $ | (0.14 | ) |   | $ | (0.12 | ) |   |   | $ | 0.72 |   |   |
|                                                                   |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

| ** **                                                        | ** ** | **Quarter Ended** | ** ** |
|-------------------------------------------------------------------|------------|------------------------|------------|
| **2006**                                                          | ** ** | ** **             | ** ** | **March 31** | ** ** | **June 30** | ** ** | **Sep. 29(4)** | ** ** | **Dec. 31** | ** ** |
| Sales                                                             |       |                   | $          | 3,767 |   |   | $ | 2,546 |   |   | $ | 4,427 |   |   | $ | 4,308 |   |
| Gross profit                                                      |       |                   | 1,343      |   |   | 437 |   |   | 1,619 |   |   | 207 |   |
| Net income (loss)  from continuing operations before income taxes |       |                   | (1,569     | ) |   | (5,995 | ) |   | (3,352 | ) |   | (4,474 | ) |
| Net income (loss)                                                 |       |                   | $          | (5,869 | ) |   | $ | 35,136 |   |   | $ | (2,964 | ) |   | (4,318 | ) |
| Basic and diluted income  (loss) per share(1)                     |       |                   | $          | (0.56 | ) |   | $ | 3.24 |   |   | $ | (0.27 | ) |   | $ | (0.39 | ) |
|                                                                   |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Net income (loss) pershare is computed independently for each of the quarters presented andtherefore may not sum to the total for the year.

(2)          In the fourth quarter of2005, we recorded a gain of $8,000 on an insurance settlement and a gain of$2,745 on the sale of a building.

(3)          Net loss from continuingoperations was previously reported as $1,550; the increase to the loss of $801was due to reclassification of operating expense from continuing operations todiscontinued operations.

(4)          Net loss from continuingoperations was previously reported as $2,963; the increase of $389 was due toreclassification of a gain on sale of a building from continuing operations todiscontinued operations.

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

The following discussionand analysis provides information which management believes is relevant to anassessment and understanding of our consolidated results of operations andfinancial condition. The discussion should be read in conjunction with ourconsolidated financial statements and notes included in Item 8 “FinancialStatements and Supplementary Data” of this annual report on Form 10-K.Information set forth in “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” includes forward-looking statements thatinvolve risks and uncertainties. Many factors could cause actual results todiffer materially from those contained in the forward-looking statements. See “Forward-LookingStatements” below and Item 1A “Risk Factors” in Part I of this annualreport on Form 10-K for additional information concerning theseitems. All dollar amounts are in thousands unless otherwise indicated.

**Executive Summary**

The past year was a significant transition in theexistence of Evans & Sutherland. On April 28, 2006, we completedthe acquisition of Spitz, Inc. (“Spitz”) with the goal of enhancing ourcapabilities to serve the digital theater markets we target. On May 26,2006, we sold our commercial and military simulation businesses (the “SimulationBusiness”) and entered into an agreement with the buyer to provide futureproducts and intellectual property licenses to use and sell our laserprojection systems in the Simulation Business. We realized a significant gainon the sale of the Simulation Business which improved our financial positionand provided significant funding for the continued development of our laserprojector products. These two events resulted in a major change in our focus,structure, and direction. Significant effort was expended during the year ondealing with post closing and transition matters related to the sale of theSimulation Business. These activities are largely completed along with theassociated management distraction. In 2007 the Company expects to be betterpositioned to focus on current and future business opportunities.

We continued to make progress in the development forour laser projector and the delivery of these projectors to our digital theatercustomers; however, this continues to be a challenging endeavor. The transitionto production of laser projectors has not been completed due to delays indelivery of certain key components and the need to refine other components. Thesefactors delayed the recognition of revenue from some Digital Theater customers.Results for 2006 were negatively impacted by the delayed recognition of revenueand additional costs for support of pre-production laser projectors that havebeen delivered to initial customers. Some progress has been made on thesecomponent issues and deliveries of improved items are beginning. We expectthese improvements will continue through 2007. We also made progressintegrating Spitz into our company and harmonizing Spitz products with thedigital theater products.

Late in the year we began to explore potentialopportunities for our laser technology in new markets. These activities haveshown some promising opportunities and efforts will continue in this area in2007.

We expect 2007 to providea better opportunity to operate and assess the new business in a steady state.The ongoing activities will be focused on completion of the laser projector andassuring timely customer deliveries. Parallel with product developmentactivities will be efforts aimed at identifying opportunities for thistechnology in new markets. The success of our new technology will also ensurethat we maintain our lead and provide growth opportunities in our traditionaldigital theater markets. Improving financial performance and reducing costs,where practicable, are key areas of management focus.

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**Acquisition ofSpitz, Inc.**

On April 28, 2006,the Company completed the acquisition of Spitz, Inc. (“Spitz”) byacquiring all outstanding shares of Spitz common stock from TransnationalIndustries, Inc. (“Transnational”) pursuant to a stock purchase agreement(the “Stock Purchase Agreement”), dated as of February 7, 2006, by andbetween the Company and Transnational. Consideration under the Stock PurchaseAgreement consisted of 412,500 unregistered shares of the Company’s CommonStock, $0.20 par value, subject to a post-closing share adjustment depending onthe average trading price of the Company’s common stock for the 60-dayperiod prior to registration of the shares issued at closing. Pursuant to aRegistration Rights Agreement between the Company, Spitz, and Transnational,E&S was required to use its best efforts to register those shares of stockissued as consideration for the outstanding stock of Spitz. Registration of theshares issued to Transnational became effective on November 9, 2006 andthe Company issued an additional 84,948 shares in accordance with thepost-closing adjustment. Based on the average closing price of the Company’scommon stock for the period two days prior and two days after the day theagreement was announced, the value of the total shares issued is $2,814. Transactioncosts were $70 and stock registration costs were $30. The purchase price wasdetermined in arms-length negotiations between the Company and Transnationaland we believe it is a nontaxable transaction. The Company plans to continue tooperate Spitz as a wholly owned subsidiary. Spitz designs, manufactures andsupports visual systems for planetariums, science centers and entertainmentvenues and provides unique domes and similarly shaped structures forspecialized architectural applications.

**Sale of SimulationBusiness**

On May 26, 2006, we sold substantially all of theassets and certain liabilities primarily related to our commercial and militarysimulation businesses and related service operations (the “Simulation Business”)to certain subsidiaries of Rockwell Collins, Inc., a Delaware corporation(“Rockwell Collins”), pursuant to an asset purchase agreement (the “AssetPurchase Agreement”), dated as of February 7, 2006, by and between theCompany and Rockwell Collins. In connection with the completion of the sale ofthe Simulation Business, on May 26, 2006 the Company entered into a laserprojection systems agreement (the “Laser Agreement”) with Rockwell Collins andRockwell Collins Simulation & Training Solutions LLC, pursuant towhich the Company has agreed to provide, and grant exclusive and non-exclusiveintellectual property licenses to use and sell, laser projection systems inconnection with the Simulation Business and certain related businesses ofRockwell Collins. The transaction contemplated by the Asset Purchase Agreementand the Laser Agreement (the “Transaction”) was approved by the Company’sshareholders at a combined annual and special meeting of shareholders held on May 25,2006.

The aggregate consideration contemplated in theTransaction was $71,500 in cash, consisting of the $66,500 purchase price underthe Asset Purchase Agreement (the “Asset Purchase Price”) for the assetsprimarily related to the Simulation Business and $5,000 under the LaserAgreement. On May 26, 2006, the closing of the sale of the SimulationBusiness, Rockwell Collins paid the Company $59,500 under the terms of theAsset Purchase Agreement, and deposited $10,000 (consisting of the remaining$7,000 of the Asset Purchase Price and $3,000 under the Laser Agreement) inescrow pursuant to an escrow agreement (the “Escrow Agreement”), dated as of May 26,2006, by and between the Company, Rockwell Collins and U.S. Bank NationalAssociation, as escrow agent. The Laser Agreement requires Rockwell Collins topay the remaining $2,000 of consideration in the Transaction directly to theCompany upon the completion of certain performance milestones by the Company. Underthe terms of the Escrow Agreement, the deposited amount will be held in escrowto secure (i) any post-closing reduction in the Asset Purchase Price underthe Asset Purchase Agreement, (ii) the Company’s indemnification obligationsunder the Asset Purchase Agreement and (iii) the Company’s obligations(not to exceed $3,000 of the escrowed funds) to meet specified milestones underthe Laser Agreement. The escrowed funds will be released in installments as setforth in the Escrow Agreement, subject to the passage of time and the Company 

17

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fulfilling requirements ofthe Escrow Agreement. In connection with the sale of our Simulation Business,we agreed to indemnify Rockwell Collins for any losses from breaches of therepresentations, warranties or covenants we made in the Asset PurchaseAgreement that occur within certain periods after the closing.

The Asset Purchase Agreement provides for anadjustment to the Asset Purchase Price based on the value, calculated inaccordance with the terms of the Asset Purchase Agreement, of the net assetsdelivered at the closing date (the “Closing Net Assets”). Based on the value ofthe Closing Net Assets calculated by the Company and Rockwell Collins under theprocedures set forth in the Asset Purchase Agreement, the Asset Purchase Pricehas been adjusted by $4,800 resulting in an  adjusted Asset Purchase Priceof $61,700. In accordance with the terms of the Escrow Agreement, in March 2007,$200 of the $7,000 held for the Asset Purchase Price was released to theCompany and $4,800 was released to Rockwell Collins. The remaining $2,000 heldfor the Asset Purchase Price is scheduled to be released under the EscrowAgreement on July 1, 2007.

As of December 31, 2006, the Company has recordedproceeds of $59,700 from the Transaction, representing the funds it receivedthrough March 2007. We will record additional gain on the Transaction whenand to the extent that the remaining amounts to be paid by Rockwell Collins andthe remaining amounts held in escrow are released to the Company.

The sale of assets by theCompany pursuant to the Asset Purchase Agreement was a taxable transaction forincome tax purposes. Accordingly, we recognized a gain with respect to the saleof assets pursuant to the Asset Purchase Agreement in an amount equal to thedifference between the amount of the consideration received for each asset overthe adjusted tax basis in the asset sold. As all tax information is not yetavailable we have made estimates for certain items in computing the tax gainuntil final information becomes available. Although the asset sale resulted intaxable gain to the Company, a substantial portion of the taxable gain will beoffset by current year losses from operations, and available net operating lossand tax credit carryforwards. As a result in 2006 we have recorded a net gainof $35,643 from the sale of the Simulation Business.

**Results ofOperations**

***Consolidated Sales***

Thefollowing table summarizes our consolidated sales for fiscal year:

| ** ** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------|------------|----------|------------|----------|------------|----------|------------|
| Sales      |       | $        | 15,048     |     | $          | 15,111   |       | $ | 9,479 |   |
|            |            |          |            |          |            |          |            |  |  |  |

 

Sales remained relatively flat from 2005 to 2006decreasing less than 1%. This resulted from a decrease in revenue from theEvans & Sutherland Laser Projector (ESLP) which was mostly offset bythe revenue reported by Spitz since being acquired on April 28, 2006. Thedecrease in ESLP revenue was caused by supply delays relating to certain systemcomponents, the need to refine other components, and the resulting unexpectedincreases in project costs which negatively impacted revenue recognition onpercent complete contracts. Efforts continue to resolve the issues related todelivery of the ESLP and we expect ESLP revenue to recover in 2007, althoughthere is no assurance that we will achieve the desired results.

Sales in 2005 increased 59% from 2004. This wasprimarily the result of revenue on the ESLP.

While our overall salesdecreased in 2006, year end backlog increased by 23% from $16,548 to $20,408.The increase in the backlog was attributable to backlog acquired through Spitz.New bookings started strong in 2007 for all digital theater products as well asSpitz domes. This is expected to lead to higher sales levels in 2007; however,much will depend on the success of the ESLP.

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***Gross Margin***

Thefollowing table summarizes our gross margin and the percentage to total salesduring fiscal year:

| ** **              | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------|------------|----------|------------|----------|------------|----------|------------|
| Gross margin            |       | $        | 3,606      |     | $          | 6,594    |       | $ | 3,134 |   |
| Gross margin percentage |       | 24       | %          | 44       | %          | 33       | %          |
|                         |            |          |            |          |            |          |            |  |  |  |

 

The decrease in grossmargin from 2005 to 2006 was driven primarily by additional costs to completeongoing ESLP projects that are accounted for under the percentage of completionmethod. Also, 2006 gross margin was reduced by lower than normal gross margindue to an increase in under absorbed overhead from lower manufacturing volume. Theincrease in gross margin from 2004 to 2005 was attributable to a higher volumeof successful digital theater projects.

***Selling, General &Administrative Expenses***

| ** **                                                  | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Selling, general  and administrative (“SG&A”) |       | $        | 10,129     |     | $          | 6,128    |       | $ | 5,198 |   |
|                                                             |            |          |            |          |            |          |            |  |  |  |

 

SG&A expensesincreased 65% from 2006 compared to 2005 due primarily to $1,394 of chargesrelated to the separation agreement entered into with our prior Chief ExecutiveOfficer, $1,650 in increases due to the acquisition of Spitz and $982 ofcharges related to options being expensed under Statement of FinancialAccounting Standards No. 123(R) (see discussion of stock compensationin Note 1 “Nature of Operations and Summary of Significant Accounting Policies”of Item 8 “Financial Statements and Supplementary Data” in this annual reporton Form 10-K. No such costs were incurred in the 2005. SG&Aexpenses increased 18% from 2005 compared to 2004 due to increased legal feesdue to the sale of the Simulation Business of $1,462 partially offset bycollection of a $435 receivable we had previously reserved. We expect SG&Ato run about 13% lower in 2007 as a result of reductions in the overallcorporate infrastructure.

***Research andDevelopment Expenses***

| ** **                                      | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Research and  development (“R&D”) |       | $        | 9,071      |     | $          | 7,233    |       | $ | 5,410 |   |
|                                                 |            |          |            |          |            |          |            |  |  |  |

 

R&D expense increased25% in 2006 compared to 2005 primarily due to $1,720 of expense under acontract for outside R&D services related to the laser projector. R&Dexpenses increased 34% in 2005 compared to 2004 primarily due to theconsumption of an additional $1,144 of laser projector materials over the prioryear, $310 of expense under a contract for outside R&D services related tothe laser projector and $528 increase in labor over 2004. We expect R&D expenseto increase about 15% in 2007 due to efforts to improve and expand thecapabilities of our laser projection technology with the goal of reaching newmarkets.

***Gains***

Thefollowing table summarizes other accounting gains during fiscal year:

| ** **                           | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Gain on sale of  assets              |       | $        | —     |     | $          | —   |       | $ | 155 |   |
| Gain (loss) on assets  held for sale |       | (12      | )          | 2,745    |       | —   |       |
|                                      |            |          |            |          |            |          |            |  |  |  |

 

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In 2004, we recognizedadditional gain on the sale of assets of our REALimage Solutions Group thatclosed in 2002. In 2005, we recognized a gain on the sale of a building and itsrelated asset group of $2,745. In 2006, we adjusted the gain on the sale of abuilding recognized in 2005 for additional costs incurred in 2006.

***Other Income and Expense***

Thefollowing table summarizes our other income and expense during fiscal year:

| ** **                         | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Interest income                    |       | 926      |       | 31       |       | 6        |       |
| Interest expense                   |       | (370     | )          | (159     | )          | —   |       |
| Other income  (expense)            |       | (340     | )          | 633      |       | 112      |       |
| Total other income  (expense), net |       | $        | 216        |     | $          | 505      |       | $ | 118 |   |
|                                    |            |          |            |          |            |          |            |  |  |  |

 

Interest income in 2006increased $895 compared to 2005 due to the significant increase of cash wereceived from the proceeds of the sale of the Simulation Business. Interestexpense in 2006 increased $211 compared to 2005, primarily due to the interestexpense from Spitz mortgage note and line of credit. In 2006, other expenseincluded $366 of loss on disposal of property, plant and equipment, bankingfees of $177 and proceeds from class action lawsuit of $23. In 2005 otherincome included gain on sale of a marketable security of $691, loss on thewrite-down of a non-marketable security of $37, loss on disposal of property,plant and equipment of $28, proceeds from class action lawsuit of $23 andbanking fees of $33. In 2004 other income included a gain on disposal ofproperty, plant and equipment of $105.

***Income Taxes***

Incometax (expense) consisted of the following:

| ** **                                                       | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Income tax  (expense) benefit from continuing operations         |       | $        | 5,910      |     | $          | (6       | )          | $ | (76 | ) |
| Income tax  (expense) benefit from discontinued operations       |       | 2,775    |       | 436      |       | (36      | )          |
| Income tax  expense from gain on sale of discontinued operations |       | (9,057   | )          | —   |       | —   |       |
| Tax expense (benefit)                                            |       | $        | (372       | )        | $          | 430      |       | $ | (112 | ) |

 

The income tax expense of$372 for 2006 is primarily attributable to estimated tax on the gain from thesale of the Simulation Business. The income tax benefit of $430 for 2005 is primarilyattributable to favorable resolution of certain income tax contingencies. Theincome tax expense of $112 for 2004 is primarily attributable to foreign incometaxes.

**Liquidity andCapital Resources**

Summaryinformation concerning our financial position as of fiscal year-end:

| ** **                           | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|
| Cash and cash  equivalents           |       | $        | 15,549     |     | $          | 14,606 |   |
| Restricted cash                      |       | 633      |       | 1,099    |       |
| Capitalized lease  obligations       |       | (8       | )          | —   |       |
| Current portion  of long-term debt   |       | (85      | )          | —   |       |
| Line of credit                       |       | (700     | )          | —   |       |
| Net short term  cash                 |       | $        | 15,389     |     | $          | 15,705 |   |
| Stockholders’ equity  (deficit) |       | $        | 22,382     |     | $          | (6,455 | ) |

 

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***Outlook***

In 2006, we significantly improved our liquidity andmaintained our ability to issue letters of credit, mainly due to proceeds fromthe sale of the Simulation Business.

In July 2007, we expect to receive additionalproceeds escrowed from the sale of the Simulation Business. We expect theseescrowed proceeds and our existing cash to fund our cash requirements in 2007. Receiptof these escrowed funds is subject to our agreement to indemnify RockwellCollins for any losses from breaches of the representations, warranties orcovenants we made in the Asset Purchase Agreement that occur within the escrowperiod.

Circumstances that could materially affect liquidityin 2007 include, but are not limited to: (i) failure to receive theremaining escrowed funds from the sale of the Simulation Business (ii) successfullydelivering new technologies and products, (iii) meeting 2007 forecastedsales levels, and (iv) our ability to continue to reduce costs andexpenses.

We expect cash  from operations and  the sale of the Simulation Business to fundour planned needs in the short term as we invest in research and developmentrelated to our laser projector products. For the long term, we believe thatimproved cash from operations will fund our planned needs. However, we operatein a rapidly evolving and often unpredictable business environment that maychange the timing or amount of expected future cash receipts and expenditures.Accordingly, there can be no assurance that our sources of funds will besufficient to meet our liquidity needs or that we will not be required to raiseadditional funds to meet those needs, including future business expansion,through the sale of equity or debt securities or from credit facilities withlending institutions.

***Cash Flow***

| ** **                             | ** ** | **Year ended December 31** | ** ** |
|----------------------------------------|------------|-------------------------------------------|------------|
| ** **                             | ** ** | **2006**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net cash provided  by (used in):       |       |                                      |       |   |   |   |   |
| Operating activities                   |       | $                                         | 21,345     |   | $ | (467 | ) | $ | (3,541 | ) |
| Investing activities                   |       | (1,017                                    | )          | 4,830 |   | 11,535 |   |
| Financing activities                   |       | (19,385                                   | )          | 96 |   | (7,562 | ) |
| Increase in cash and  cash equivalents |       | $                                         | 943        |   | $ | 4,459 |   | $ | 432 |   |

 

Cash and cash equivalentsincreased $943 to $15,549 during fiscal year 2006, primarily as a result ofcash provided by operating activities. Cash of $15,549 as of December 31,2006 was due to cash proceeds from the sale of the Simulation Business of$59,093 less $18,015 for the redemption of convertible subordinated notes,$11,348 of funding for the pension plan, and $5,550 to establish a trust tofund future SERP benefit payments. Cash of $14,606 as of December 31,2005, was due to the sale of a building which had been held for sale and thereceipt of an insurance settlement and the release of additional cash that wasrestricted at the end of 2004.

*OperatingActivities*

Operating activities provided $21,345 of cash during 2006.This resulted primarily from net cash provided by discontinued operations of$48,719. Net cash used by continuing operating activities was $27,374, which isprimarily attributable to the following: the decrease in prepaid pension andretirement asset of $9,178  and theincrease in the accrued pension and retirement liability of $9,230 (whichreflected $11,348 of funding for the pension plan and $5,550 of funding  for the SERP with proceeds from the sale ofthe Simulation Business), net loss from continuing operations of $6,229(decreased for non-cash items of $3,251), and a decrease in working capital of$2,737. Accounts receivable increased due to several large contract billingsoutstanding as of the end of 2006. Inventories have increased due to costsincurred on 

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several customer contractsat the end of the year and an increase in purchases of laser projectorcomponents in 2006. Accounts payable decreased in 2006 due to non-recurringaccounts payable outstanding at 2005 including legal fees related to the saleof the Simulation Business, the net settlement of a sales tax audit andsignificant contract costs incurred at the end of 2005. Accrued liabilitiesincreased primarily due to accrued contractual damages and accrued severance forthe former CEO. Customer deposits also increased in 2006 due to the timing ofcontract payments received during the year.

Operating activities used $467 of cash during 2005,primarily due to $668 of cash provided by discontinued operating activitiesoffset by net cash used in continuing operating activities of $1,135. Net cashused in continuing operating activities was primarily due to net loss fromcontinuing operations of $5,766 (increased for non-cash items of $2,243), anincrease in accrued pension and retirement liabilities of $940 due torecognition of net periodic pension cost, and an increase in working capital of$3,691. Accounts receivable decreased due to improved collections. Inventoriesincreased due to purchases related to our ESLP for deliveries to our digitaltheater customers that occurred in 2006. Net costs and estimated earnings inexcess of billings on uncompleted contracts increased due to decreased revenuerecognition on percent complete contracts compared to billings on percent completecontracts. Customer deposits increased due to the excess of cash received oncompleted contracts compared to revenue recognized during the period.

Operating activities used$3,541 of cash during 2004 due to $1,740 of cash provided by discontinued operatingactivities offset by net cash used in continuing operating activities of $5,281.Net cash used in continuing operating activities was primarily due to net lossfrom continuing operations of $6,252 (decreased for non-cash items of $1,025),an increase in accrued pension and retirement liabilities of $702 due torecognition of net periodic pension cost, and an increase in working capital of$269. Accounts receivable increased due to several large contract billingsoutstanding as of the end of 2004. Inventory decreased due to timing ofshipments on customer contracts and a decrease in purchases. Net costs andestimated earnings in excess of billings on uncompleted contracts decreased dueto increased revenue recognition on percent complete contracts compared tobillings on percent complete contracts. Prepaid expenses and deposits decreaseddue to receipt of a reimbursable settlement charge in 2004 recorded in prepaidsin  2003. Accounts payable increased dueto an increase in certain general and administrative expenses as well asmaterial purchases at the end of 2004. Accrued liabilities decreased due to thesatisfaction of an accrued settlement fee related to the sale of assets in2002, a decrease in the executive savings plan liability of $745, a decrease inaccrued commissions and a decrease in a liability related to an operatinglease. Customer deposits increased due to the excess of cash received oncompleted contracts compared to revenue recognized during the period.

*InvestingActivities*

Investing activities used $1,017 of cash during 2006primarily due to purchases of property, plant and equipment of $2,024,partially offset by cash provided by discontinued investing activities of$1,056. The purchases of property, plan and equipment of $2,024 includedacquisition of information technology infrastructure and software andremodeling of the new corporate offices.

Investing activities provided $4,830 of cash during2005. This resulted primarily from the sale of one of our office buildings forproceeds of $6,277, as well as proceeds from the sale of a marketable securityof $778. These cash inflows were partly offset by property, plant and equipmentpurchases of $1,417 and cash used by discontinued investing activities of $650.

Investing activities provided$11,535 of cash during 2004. This resulted primarily from cash provided bydiscontinued investing activities of $11,459. Also, we sold an investment for$633 in cash, offset by purchases of property, plant and equipment of $620.

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*FinancingActivities*

Financing activities used $19,385 of cash during 2006primarily due to discontinued financing activities of $18,015, which reflectsthe redemption of convertible subordinated notes with proceeds from the sale ofthe Simulation Business. Other financing activities included $1,525 of netrepayments on the line of credit and long-term debt partially offset by $251 ofproceeds of common stock from the exercise of stock options.

Financing activities provided $96 of proceeds fromissuance of common stock due to the exercise of stock options during 2005.

Financing activities used$7,562 of cash during 2004 primarily due to the pay down of our lines of creditduring 2004.

***CreditFacilities***

On April 28, 2006, Spitz entered into a Line ofCredit Agreement (the “Credit Agreement”) and a Line of Credit Note (the “Note”)with a commercial bank continuing a $3,000 line of credit for working capitalpurposes, with E&S executing as a co-borrower and guarantor of bothagreements. Under the Note, the outstanding balance will bear a per annuminterest rate of one-half percent (0.5%) above the Wall Street Prime rate andthe Note matures June 30, 2007. The Note is secured by Spitz real andpersonal property, a guaranty agreement (the “Guaranty Agreement”) entered intoby E&S on April 28, 2006, and a pledge agreement (the “PledgeAgreement”) entered into by E&S and the commercial bank on April 28,2006. Two business days after entering into the Credit Agreement, the maximumline of credit decreased to $2,500 per the Credit Agreement. Under the CreditAgreement, Spitz is required to, among other terms and conditions: maintain aminimum tangible net worth of $1,700, determined quarterly; maintain a $200average daily balance, measured quarterly, in its deposit accounts; andmaintain an aggregate daily balance of Spitz deposit accounts with thecommercial bank of not less than $100 for any consecutive five day period.Under the Guaranty Agreement, E&S has guaranteed the payment andperformance of the conditions of the Note. Under the Pledge Agreement E&Shas granted to the commercial bank a first priority security interest and lienin and to all of the outstanding shares of Spitz common stock to secure theNote. On July 28, 2006, the Credit Agreement was modified. Among otherchanges, the maximum line of credit was reduced to $1,100; the firstmeasurement date of the Tangible Net Worth covenant was moved to September 29,2006; and amounts E&S loans to Spitz are not counted in the Tangible NetWorth covenant. As of December 31, 2006, the Company was in compliancewith the tangible net worth covenant and other covenants of the line of credit. As of December 31, 2006, theoutstanding balance of the line of credit was $700.

The ability to issue letters of credit and bankguarantees is important to our business as sales in countries other than inNorth America and Western Europe have increased. In many countries, letters ofcredit and bank guarantees are required as part of all sales contract. Lettersof credit and bank guarantees are issued to ensure our performance to thirdparties.

The Company has a finance arrangement whichfacilitates the issuance of letters of credit and bank guarantees. Under theterms of the arrangement, we are required to maintain a balance in a specificcash account equal to or greater than the outstanding value of all letters ofcredit issued, plus other amounts necessary to adequately secure ourobligations with the financial institution. The arrangement provides a firstpriority security interest in the specific cash account. Certain of the termsof the arrangement prohibit us from creating, incurring, assuming or permittingto exist any indebtedness or liabilities resulting from borrowings, loans oradvances; merging into, consolidating with any other entity, or making anysubstantial change in the nature of our business; or making new loans oradvances to or investments in any other entity without prior written consentfrom the financial institution. We received written consent from the financialinstitution for both the acquisition and disposition completed in the secondquarter of 2006. In addition, 

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Spitz has the capabilityof issuing letters of credit through their financial institution which requiresa cash-secured guarantee.

As of December 31,2006, we had outstanding letters of credit and bank guarantees of $633. Lettersof credit that expire in 2007 total $633.

***Mortgage Note***

As of December 31,2006 there was a $2,930 obligation under a mortgage note payable (“MortgageNote”) issued on January 14, 2004 by Spitz. The Mortgage Note requiresrepayment in monthly installments of principal and interest over twenty years.The monthly installment for the first three years was $23 and included interestat 5.75% per annum. On January 14, 2007 and each third year thereafter, theinterest rate will be adjusted to the greater of 5.75% or 3% over theThree-Year Constant Maturity Treasury Rate published by the United StatesFederal Reserve (“3YCMT”). The 3YCMT as of January 14, 2007 was 4.83%. Themonthly installment will be recalculated on the first month following a changein the interest rate. The recalculated monthly installment will be equal to themonthly installment sufficient to repay the principal balance, as of the dateof the change in the interest rate, over the remaining portion of the originaltwenty-year term. As of February 2007, the new monthly installment amountis $26.The Mortgage Note is secured by the real property acquired with theproceeds of the note pursuant to a Mortgage and Security Agreement. TheMortgage Note and Credit Agreement contain cross default provisions whereby thedefault of either agreement will result in the default of both agreements. On March 30,2007, E&S executed a Guarantee of Spitz’ obligation under the Mortgage Notein consideration for the replacement of the requirement of annual auditedfinancial statements of Spitz under the Mortgage Note and Credit Agreement withthe annual audited financial statements of E&S.

***6%Convertible Subordinated Debentures***

As of December 31,2005, there was $18,015 of 6% Convertible Subordinated Debentures outstanding(the “6% Debentures”), classified as long-term liabilities related todiscontinued operations. The 6% Debentures, due in 2012, were unsecured andwere convertible at each bondholder’s option into shares of our common stock ata conversion price of $42.10 per share for an aggregate of 428,000 shares ofour common stock if all outstanding 6% Debentures were converted, subject toadjustment. Prior to the sale of the Simulation Business, the 6% Debentureswere redeemable at our option, in whole or in part, at par. The 6% Debenturesrequired redemption upon the sale of the Simulation Business. Accordingly, allof the 6% Debentures were redeemed on June 26, 2006.

***Rental Guarantees***

In December 2005,E&S sold a building with a net book value of $3,820, for proceeds of$6,277, net of closing costs. Werecognized a gain on the sale of $2,745 in 2005. As part of the sale, weentered into a 21 month lease agreement with the buyer obligating us to make certain monthly payments through September 2007depending on the remaining space available for lease in the building sold. Evans &Sutherland is required to pay a monthly pro rata share of operating expensesnot to exceed $319 over the twenty-one month lease term. As of December 31, 2006, we had amaximum remaining guarantee related to these obligations of $468 recorded as anaccrued liability. The maximum rental guarantee may decrease as available spaceis leased, based on terms of the rental guarantee. To the extent the maximumrental guarantee is reduced, additional gain will be realized.

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***Other***

In 2007, we expect capital expenditures to be slightlyless than 2006, or approximately $1,500 to $2,000. There were no materialcapital expenditure commitments at the end of 2006, nor do we anticipate anyover the next several years.

Our Board of Directors has authorized the repurchaseof 1,600,000 shares of our common stock. As of March 16, 2007, 463,500shares remained available for repurchase under the plans approved by the Boardof Directors. No shares were repurchased during 2006, 2005, or 2004. Stock maybe acquired on the open market or through negotiated transactions depending onmarket conditions, share price and other factors.

We also maintain trade credit arrangements withcertain of our suppliers. The unavailability of a significant portion of, orthe loss of, these trade credit arrangements from suppliers would have amaterial adverse effect on our financial condition and operations.

If we were unable to make timely deliveries ofproducts pursuant to the terms of various agreements with third parties orcertain of our contracts were adversely impacted for failure to meet deliveryrequirements, we may be unable to meet our anticipated working capital needs,routine capital expenditures, and current debt service obligations on ashort-term and long-term basis.

We believe our existingcash, restricted cash, letter of credit availability under our currentarrangement, and expected cash from future operations will be sufficient tomeet our anticipated working capital needs, routine capital expenditures andcurrent debt service obligations. At December 31, 2006, our totalindebtedness was $3,638 consisting of $2,938 due on a mortgage note and $700due on a line of credit agreement. Our cash and restricted cash, subject tovarious restrictions set forth in this annual report on Form 10-K,are available for working capital needs, capital expenditures, strategicinvestments, mergers and acquisitions, stock repurchases and other potentialcash needs as they may arise

***Effectsof Inflation***

The effects of inflationwere not considered material during fiscal years 2006, 2005, or 2004, and arenot expected to be material for fiscal year 2007.

**ContractualObligations**

Theimpact that our contractual obligations as of December 31, 2006 areexpected to have on our liquidity and cash flow in future periods is asfollows:

| ** **                                    | ** ** | **Payments due by period** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                    | ** ** | ** **                                | ** ** | **Less than** | ** ** | ** ** | ** ** | ** ** | ** ** | **More than** | ** ** |
| ** **                                    | ** ** | **Total**                                 | ** ** | **1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **5 years** | ** ** |
| Long-term debt,  including current portion(1) |       | $                                         | 6,114      |   |   | $ | 1,008 |   |   |   | $ | 622 |   |   |   | $ | 622 |   |   |   | $ | 3,862 |   |   |
| Capital lease  obligations                    |       | 8                                         |       |   | 8 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Operating lease  obligations(2)               |       | 6,614                                     |       |   | 778 |   |   |   | 367 |   |   |   | 382 |   |   |   | 5,087 |   |   |
| Purchase  obligations(3)                      |       | 3,450                                     |       |   | 3,320 |   |   |   | 130 |   |   |   | — |   |   |   | — |   |   |
| Total                                         |       | $                                         | 16,186     |   |   | $ | 5,114 |   |   |   | $ | 1,119 |   |   |   | $ | 1,004 |   |   |   | $ | 8,949 |   |   |

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(1)          Amounts represent theexpected cash payments on our long-term debt, including interest payments, anddo not include any fair value adjustments.

(2)          The majority of theoperating lease obligations are land leases for periods up to 40 years on theland underlying our buildings. Our maximum rental guarantee payments areincluded in operating lease obligations.

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(3)          Purchaseobligations include agreements to purchase goods or services that areenforceable and legally binding on E&S and that specify all significantterms, including fixed or minimum quantities to be purchased and theapproximate timing of the transaction. Purchase obligations exclude agreementsthat are cancelable without penalty.

**Application ofCritical Accounting Estimates**

The application of theaccounting estimates discussed below are considered by management to becritical to an understanding of our financial statements. Their applicationplaces significant demands on management’s judgment, with financial reportingresults relying on estimates about the effect of matters that are inherentlyuncertain. Specific risks for these critical accounting estimates are describedin the following paragraphs. A summary of significant accounting policies canbe found in Note 1 “Nature of Operations and Summary of Significant AccountingPolicies” of Item 8 “Financial Statements and Supplementary Data” in thisannual report on Form 10-K. For all of these policies, managementcautions that future results rarely develop exactly as forecast, and the bestestimates routinely require adjustment.

***RevenueRecognition***

Revenue from long-termcontracts requiring significant production, modification and customization isrecorded using the percentage-of-completion method. This method uses the ratioof costs incurred to management’s estimate of total anticipated costs. Ourestimates of total costs include assumptions, such as man-hours to complete,estimated materials cost, and estimates of other direct and indirect costs. Actualresults may vary significantly from our estimates. If the actual costs arehigher than management’s anticipated total costs, then an adjustment isrequired to reduce the previously recognized revenue as the ratio of costsincurred to management’s estimate was overstated. If actual costs are lowerthan management’s anticipated total costs, then an adjustment is required toincrease the previously recognized revenue as the ratio of costs incurred tomanagement’s estimate is understated. Adjustments for revisions of previousestimates are made in the period they become known.

***Costs and Estimated Earnings in Excess of Billings onUncompleted Contracts and Billings in Excess of Costs and Estimated Earnings onUncompleted Contracts***

Billings on uncompletedlong-term contracts may be greater than or less than incurred costs andestimated earnings. As a result, these differences are recorded as an asset orliability on the balance sheet. Since revenue recognized on these long-termcontracts includes management’s estimates of total anticipated costs, theamounts in costs and estimated earnings in excess of billings on uncompletedcontracts and billings in excess of costs and estimated earnings on uncompletedcontracts also include these estimates.

***Inventories***

Inventory includesmaterials at standard costs, which approximates average costs, as well asinventoried costs on programs (including material, labor, subcontracting costs,as well as an allocation of indirect costs). We periodically review inventoriesfor excess supply, obsolescence, and valuations above estimated realizableamounts, and then provide a reserve we consider sufficient to cover these items.Reserve adequacy is based on estimates of future sales, product pricing, andrequirements to complete projects. Revisions of these estimates would result inadjustments to our operating results.

***Allowancefor Doubtful Accounts***

We specifically analyzeaccounts receivable and consider historical experience, customercreditworthiness, facts and circumstances specific to outstanding balances,current economic trends, and 

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paymentterm changes when evaluating adequacy of the allowance for doubtful accounts. Changesin these factors could result in material adjustments to the expense recognizedfor bad debts.

***IncomeTaxes***

As part of the process ofpreparing our consolidated financial statements we are required to estimate ouractual income taxes in each of the jurisdictions in which we operate. Thisinvolves estimating our actual current tax exposure together with assessingtemporary differences resulting from differing treatments of items, such asaccrued liabilities, for tax and accounting purposes. These differences resultin deferred income tax assets and liabilities, which are included in ourconsolidated balance sheets. We must then assess the likelihood that ourdeferred income tax assets will be recovered from future taxable income and, tothe extent we believe that recovery is not likely, we must establish avaluation allowance. To the extent we establish a valuation allowance orincrease or decrease this allowance in a period, we must include acorresponding adjustment within the income tax provision in the statement ofoperations. Significant judgment by management is required to determine ourprovision for income taxes, our deferred income tax assets and liabilities andany valuation allowance recorded against our net deferred income tax assets.

***Impairmentof Long- Lived Assets***

Long-lived assets are reviewedfor impairment when events or changes in circumstances indicate the book valueof an asset may not be fully recoverable. When this occurs, we review the valueassigned to long-lived assets by analyzing the anticipated, undiscounted cashflows they generate. When the expected future undiscounted cash flows fromthese assets do not exceed their carrying balances, we determine the estimatedfair value of such assets. The amount of impairment recognized is the amount bywhich the carrying amount of the assets exceeds their estimated fair value. Assetsheld for sale are reported at the lower of their carrying amount or fair valueless costs to sell.

***StraightLine Rent and Contingent Obligation***

We recognize scheduledrent increases on a straight-line basis over the lease term, which may includeoptional lease renewal terms, and deferred rent income and expense isrecognized to reflect the difference between the rent paid or received in thecurrent period and the calculated straight-line amount.

**Recent AccountingPronouncements**

In June 2006, the Financial Accounting StandardsBoard (“FASB”) issued FASB Interpretation Number 48 (“FIN 48”), “Accountingfor Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109.”The interpretation contains a two step approach to recognizing and measuringuncertain tax positions accounted for in accordance with SFAS No. 109. Thefirst step is to evaluate the tax position for recognition by determining ifthe weight of available evidence indicates it is more likely than not that theposition will be sustained on audit, including resolution of related appeals orlitigation processes, if any. The second step is to measure the tax benefit asthe largest amount which is more than 50% likely of being realized upon ultimatesettlement. The provisions are effective for the Company beginning in the firstquarter of 2007. The Company is evaluating the impact of FIN 48 on itsconsolidated financial statements.

In September 2006, the FASB issued Statement ofFinancial Accounting Standards No. 157 (“SFAS No. 157”), “Fair ValueMeasurements.” SFAS No. 157 defines fair value, establishes a frameworkfor measuring fair value in accordance with generally accepted accountingprinciples (“GAAP”) and expands disclosures about fair value measurements. Thisstatement will be adopted by the Company for its fiscal years beginning after November 15,2007 and interim periods within those fiscal years. The Company is currentlyevaluating the impact of SFAS No. 157 on its consolidated financialstatements.

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In September 2006,the FASB issued Statement of Financial Accounting Standards No. 158 (“SFASNo. 158”), “Employers’ Accounting for Defined Benefit Pension and OtherPostretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and132-R.”  SFAS No. 158 requiresemployers to recognize on their balance sheets the funded status of pension andother postretirement benefit plans as of the end of the fiscal year endingafter December 15, 2006, for public companies. SFAS No. 158 requiresthat companies recognize actuarial gains and losses, prior service costs, andany remaining transition amounts from the initial application of Statements 87and 106 when recognizing a plan’s funded status, with the offset to accumulatedother comprehensive income. SFAS No. 158 will also require fiscal-year-endmeasurements of plan assets and benefit obligations, eliminating the use ofearlier measurement dates currently permissible. The new measurement-daterequirement will not be effective until fiscal years ending after December 15,2008. The Company has adopted the provisions of this statement as of December 31,2006. The adoption did not have a material impact on the Company’s consolidatedfinancial statements.

**Forward-LookingStatements**

The foregoing contains “forward-looking statements”within the meaning of that term in Section 27A of the Securities Act of1933, as amended, and section 21E of the Securities Exchange Act of 1934, asamended, including among others, those statements preceded by, followed by orincluding the words “estimates,” “believes,” “expects,” “plans,” “projects,”and similar expressions.

These forwardlooking statements include, but are not limited to, the following statements:

·       Ourbelief that we will continue to receive orders for sales of our laserprojectors to Rockwell Collins

·       Ourbelief that the acquisition of Spitz and the continued success of our ESLPproduct will allow us to gain market share in digital theaters and that we maybe able to grow the Spitz dome business in 2007 and future years.

·       Ourbelief that our range of visual systems and services at various price andperformance levels, our research and development investments and capabilities,and our ability to design and manufacture value-added visual systems will enableus to compete effectively.

·       Ourbelief that the ESLP also has application to other markets in the future whereultra-high resolution, high efficiency, excellent image quality, and lowlife-cycle cost are important considerations, which will ultimately result infuture revenues.

·       Ourbelief that our products are performing well, that we will meet all ourdelivery requirements, and as a result we will incur no damages or penaltiesfor late deliveries in 2007.

·       Ourbelief that capital expenditures during 2007 will be less than the capitalexpenditures incurred during 2006.

·       Ourbelief there is no consistent, inherent seasonal pattern to our business.

·       Ourbelief that any inherent risk that may exist in our foreign operations is notmaterial.

·       Ourbelief that our properties are suitable for our immediate needs.

·       Ourbelief that the ultimate disposition of any legal claims asserted against us orother contingent matters will not have a material adverse effect on ourconsolidated financial condition, liquidity or results of operations.

·       Ourbelief that we will perform under the conditions of our letters of credit andtherefore incur no losses with respect to these letters of credit in 2007 orfuture years.

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·       Ourbelief that the effects of inflation will not be material for fiscal year 2007.

·       Ourbelief that any inherent risk that may exist in our in our foreign transactionsis not material.

·       Ourbelief that approximately 85% of our backlog will be converted to sales in2007.

·       Ourbelief that we will see improvements in our 2007 orders.

·       Ourbelief that our SG&A expenses will be reduced from their 2006 levels.

·       Ourbelief that the sale of the Simulation Business and the Spitz transactions willmaterially affect our future financial performance and position as we have solda significant percentage of operational assets related to the SimulationBusiness and acquired additional operational assets related to the digitaltheater simulation group.

·       Ourbelief that the net cash from the sale of the Simulation Business along withcash from operations will fund our requirements in 2007.

·       Ourbelief that for years beyond 2007 cash from operations and net cash from thesale to Rockwell Collins will fund our planned needs in the short term as weinvest in research and development related to our laser projector products andour belief that for the long term, our cash from operations will fund ourplanned needs.

·       Ourbelief that existing cash, restricted cash, letter of credit availability underour current arrangement, and expected cash from future operations will besufficient to meet our anticipated working capital needs, routine capitalexpenditures and current debt service obligations.

Forward-looking statements are inherently subject torisks and uncertainties, some of which cannot be predicted or quantified. Futureevents and actual results could differ materially from those set forth in,contemplated by, or underlying the forward-looking statements. Our actualresults could differ materially from these forward-looking statements. Inaddition to the other risks described in Item 1A “Risk Factors” in Part Iof this annual report on Form 10-K, important factors to consider inevaluating such forward-looking statements include risks of product demand,market acceptance, economic conditions, competitive products and pricing,difficulties in product development, and product delays. In light of theserisks and uncertainties, there can be no assurance that the events contemplatedby the forward-looking statements contained in this annual report will, infact, occur.

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

The principal market risks to which we are exposed arechanges in foreign currency exchange rates and changes in interest rates. Foreignsales accounted for approximately 53%, 38%, and 66% of total sales in 2006,2005 and 2004, respectively. Our foreign sales are concentrated in the UnitedKingdom, Europe, Asia and North America (excluding the United States). Ingeneral, we enter into sale agreements with our foreign customers denominated inU.S. dollars. Foreign currency purchase and sale contracts may be entered intofor periods consistent with related underlying exposures and do not constitutepositions independent of those exposures. We do not enter into foreign currencycontracts for trading purposes and do not use leveraged contracts. As of December 31,2006, we had sales contracts in Euros with approximately €112remaining to collect.

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**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

**CONSOLIDATED BALANCE SHEETS(In thousands, except share data)**
|                                                                                                                     | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                          | ** ** | **2006**              | ** ** | **2005** | ** ** |
| **ASSETS**                                                                                                          | ** ** | ** **            | ** ** | ** ** | ** ** |
| Current assets:                                                                                                     |       |                  |       |   |   |
| Cash                                                                                                                |       | $                     | 15,549     |   | $ | 14,606 |   |
| Restricted cash                                                                                                     |       | 633                   |       | 1,099 |   |
| Accounts receivable, net                                                                                            |       | 5,698                 |       | 1,170 |   |
| Costs and estimated earnings in excess of billings  on uncompleted contracts                                        |       | 1,366                 |       | 2,850 |   |
| Inventories, net                                                                                                    |       | 6,713                 |       | 1,886 |   |
| Prepaid expenses and deposits                                                                                       |       | 1,644                 |       | 1,408 |   |
| Current assets related to discontinued operations                                                                   |       | —                |       | 27,919 |   |
| Total current assets                                                                                                |       | 31,603                |       | 50,938 |   |
| Property, plant  and equipment, net                                                                                 |       | 12,689                |       | 6,637 |   |
| Prepaid pension  and retirement                                                                                     |       | 9,449                 |       | — |   |
| Goodwill                                                                                                            |       | 635                   |       | — |   |
| Intangible  assets, net                                                                                             |       | 950                   |       | 10 |   |
| Other assets                                                                                                        |       | 55                    |       | 619 |   |
| Long-term assets  related to discontinued operations                                                                |       | —                |       | 9,846 |   |
| Total assets                                                                                                        |       | $                     | 55,381     |   | $ | 68,050 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)**                                                             |       |                  |       |   |   |
| Current liabilities:                                                                                                |       |                  |       |   |   |
| Accounts payable                                                                                                    |       | $                     | 2,104      |   | $ | 2,911 |   |
| Accrued liabilities                                                                                                 |       | 6,260                 |       | 3,603 |   |
| Billings in excess of costs and estimated earnings  on uncompleted contracts                                        |       | 1,976                 |       | 2,116 |   |
| Customer deposits                                                                                                   |       | 4,234                 |       | 1,919 |   |
| Current portion of long-term debt                                                                                   |       | 793                   |       | — |   |
| Current liabilities related to discontinued  operations                                                             |       | —                |       | 17,667 |   |
| Total current liabilities                                                                                           |       | 15,367                |       | 28,216 |   |
| Deferred rent  obligation                                                                                           |       | 1,727                 |       | 1,668 |   |
| Long-term debt                                                                                                      |       | 2,845                 |       | — |   |
| Pension and  retirement obligations                                                                                 |       | 13,060                |       | 24,596 |   |
| Long-term  liabilities related to discontinued operations                                                           |       | —                |       | 20,025 |   |
| Total liabilities                                                                                                   |       | 32,999                |       | 74,505 |   |
| Stockholders’ equity  (deficit):                                                                               |       |                  |       |   |   |
| Preferred stock, no par value: 10,000,000 shares  authorized; no shares issued and outstanding                      |       | —                |       | — |   |
| Common stock, $0.20 par value: 30,000,000 shares  authorized; 11,441,666 and 10,884,848 shares issued, respectively |       | 2,288                 |       | 2,177 |   |
| Additional paid-in-capital                                                                                          |       | 53,759                |       | 49,814 |   |
| Common stock in treasury, at cost, 352,500 shares                                                                   |       | (4,709                | )          | (4,709 | ) |
| Accumulated deficit                                                                                                 |       | (21,875               | )          | (43,860 | ) |
| Accumulated other comprehensive loss                                                                                |       | (7,081                | )          | (9,877 | ) |
| Total stockholders’ equity (deficit)                                                                           |       | 22,382                |       | (6,455 | ) |
| Total liabilities  and stockholders’ equity (deficit)                                                          |       | $                     | 55,381     |   | $ | 68,050 |   |

 

See notes to consolidated financial statements.

31

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**CONSOLIDATEDSTATEMENTS OF OPERATIONS(In thousands, except per share data)**
|                                                              | ** ** | **Year ended December 31** | ** ** |
|--------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                   | ** ** | **2006**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Sales                                                        |       | $                                         | 15,048     |   | $ | 15,111 |   | $ | 9,479 |   |
| Cost of sales                                                |       | 11,442                                    |       | 8,517 |   | 6,345 |   |
| Gross profit                                                 |       | 3,606                                     |       | 6,594 |   | 3,134 |   |
| Expenses:                                                    |       |                                      |       |   |   |   |   |
| Selling, general and administrative                          |       | 10,129                                    |       | 6,128 |   | 5,198 |   |
| Research and development                                     |       | 9,071                                     |       | 7,233 |   | 5,410 |   |
| Operating expenses                                           |       | 19,200                                    |       | 13,361 |   | 10,608 |   |
| Gain on sale of  assets                                      |       | —                                    |       | — |   | 155 |   |
| Gain (loss) on  sale of assets held for sale                 |       | (12                                       | )          | 2,745 |   | — |   |
| Operating loss                                               |       | (15,606                                   | )          | (4,022 | ) | (7,319 | ) |
| Interest income                                              |       | 926                                       |       | 31 |   | 6 |   |
| Interest expense                                             |       | (370                                      | )          | (159 | ) | — |   |
| Other income  (expense)                                      |       | (340                                      | )          | 633 |   | 112 |   |
| Total other income                                           |       | 216                                       |       | 505 |   | 118 |   |
| Loss from continuing operations before income taxes          |       | (15,390                                   | )          | (3,517 | ) | (7,201 | ) |
| Income tax  (expense) benefit                                |       | 5,910                                     |       | (6 | ) | (76 | ) |
| Net loss from continuing operations                          |       | (9,480                                    | )          | (3,523 | ) | (7,277 | ) |
| Income (loss)  from discontinued operations, net of tax      |       | (4,178                                    | )          | 2,389 |   | (1,452 | ) |
| Gain on sale of  discontinued operations, net of tax         |       | 35,643                                    |       | — |   | — |   |
| Net income (loss) from discontinued operations               |       | 31,465                                    |       | 2,389 |   | (1,452 | ) |
| Net income (loss)                                            |       | $                                         | 21,985     |   | $ | (1,134 | ) | $ | (8,729 | ) |
| Net income (loss)  per common share—basic:              |       |                                      |       |   |   |   |   |
| Loss per common share from continuing operations             |       | $                                         | (0.88      | ) | $ | (0.34 | ) | $ | (0.69 | ) |
| Income (loss) per common share from discontinued  operations |       | 2.91                                      |       | 0.23 |   | (0.14 | ) |
| Net income (loss) per common share                           |       | $                                         | 2.03       |   | $ | (0.11 | ) | $ | (0.83 | ) |
| Basic weighted average common shares outstanding             |       | 10,826                                    |       | 10,523 |   | 10,498 |   |
| Net income (loss)  per common share—diluted:            |       |                                      |       |   |   |   |   |
| Loss per common share from continuing operations             |       | $                                         | (0.87      | ) | $ | (0.34 | ) | $ | (0.69 | ) |
| Income (loss) per common share from discontinued  operations |       | 2.90                                      |       | 0.23 |   | (0.14 | ) |
| Net income (loss) per common share                           |       | $                                         | 2.03       |   | $ | (0.11 | ) | $ | (0.83 | ) |
| Diluted weighted  average common shares outstanding          |       | 10,847                                    |       | 10,523 |   | 10,498 |   |

 

See notes to consolidated financial statements.

32

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**CONSOLIDATED STATEMENTS OFSTOCKHOLDERS’**

**EQUITY(DEFICIT) AND COMPREHENSIVE INCOME (LOSS)**

**(In thousands)**
|                                           | ** ** | ** ** | ** ** | ** **     | ** ** | ** **   | ** ** | ** **       | ** ** | **Retained**      | ** ** | **Accumulated**        | ** ** | ** ** | ** ** |
|-------------------------------------------|------------|------------|------------|----------------|------------|--------------|------------|------------------|------------|-------------------|------------|------------------------|------------|------------|------------|
| ** **                                | ** ** | **Common** | ** ** | **Additional** | ** ** | ** **   | ** ** | **Earnings**     | ** ** | **Other**         | ** ** | ** **             | ** ** |
| ** **                                | ** ** | **Stock**  | ** ** | **Paid-in**    | ** ** | **Treasury** | ** ** | **(Accumulated** | ** ** | **Comprehensive** | ** ** | ** **             | ** ** |
| ** **                                | ** ** | **Shares** | ** ** | **Amount**     | ** ** | **Capital**  | ** ** | **Stock**        | ** ** | **Deficit)**      | ** ** | **Income (Loss)** | ** ** | **Total**  | ** ** |
| Balance at January 1, 2004           |       | 10,836     |       |           | $          | 2,167        |       |             |       | $                 | 49,575     |                   |       |       | $          | (4,709 | ) |   |   | $ | (33,997 | ) |   |   | $ | (2,319 | ) |   | $ | 10,717 |   |
| Components of  comprehensive loss:        |       |       |       |           |       |         |       |             |       |              |       |                   |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Net loss                                  |       | —     |       |           | —     |         |       |             | —     |              |       |                   | —     |       |       |   | (8,729 | ) |   |   | — |   |   | (8,729 | ) |
| Unrealized gains on marketable securities |       | —     |       |           | —     |         |       |             | —     |              |       |                   | —     |       |       |   | — |   |   |   | 99 |   |   | 99 |   |
| Foreign currency translation              |       | —     |       |           | —     |         |       |             | —     |              |       |                   | —     |       |       |   | — |   |   |   | 244 |   |   | 244 |   |
| Additional minimum pension liability      |       | —     |       |           | —     |         |       |             | —     |              |       |                   | —     |       |       |   | — |   |   |   | (3,417 | ) |   | (3,417 | ) |
| Total comprehensive loss                  |       |       |       |           |       |         |       |             |       |              |       |                   |       |       |       |   |   |   |   |   |   |   |   | (11,803 | ) |
| Issuance of common stock                  |       | 28         |       |           | 6          |         |       |             | 132        |              |       |                   | —     |       |       |   | — |   |   |   | — |   |   | 138 |   |
| Balance at December 31, 2004         |       | 10,864     |       |           | 2,173      |         |       |             | 49,707     |              |       |                   | (4,709     | )          |       |   | (42,726 | ) |   |   | (5,393 | ) |   | (948 | ) |
| Components of  comprehensive loss:        |       |       |       |           |       |         |       |             |       |              |       |                   |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Net loss                                  |       | —     |       |           | —     |         |       |             | —     |              |       |                   | —     |       |       |   | (1,134 | ) |   |   | — |   |   | (1,134 | ) |
| Unrealized gains on marketable securities |       | —     |       |           | —     |         |       |             | —     |              |       |                   | —     |       |       |   | — |   |   |   | (568 | ) |   | (568 | ) |
| Foreign currency translation              |       | —     |       |           | —     |         |       |             | —     |              |       |                   | —     |       |       |   | — |   |   |   | (96 | ) |   | (96 | ) |
| Additional minimum pension liability      |       | —     |       |           | —     |         |       |             | —     |              |       |                   | —     |       |       |   | — |   |   |   | (3,820 | ) |   | (3,820 | ) |
| Total comprehensive loss                  |       |       |       |           |       |         |       |             |       |              |       |                   |       |       |       |   |   |   |   |   |   |   |   | (5,618 | ) |
| Issuance of common stock                  |       | 21         |       |           | 4          |         |       |             | 107        |              |       |                   | —     |       |       |   | — |   |   |   | — |   |   | 111 |   |
| Balance at December 31, 2005         |       | 10,885     |       |           | 2,177      |         |       |             | 49,814     |              |       |                   | (4,709     | )          |       |   | (43,860 | ) |   |   | (9,877 | ) |   | (6,455 | ) |
| Components of  comprehensive loss:        |       |       |       |           |       |         |       |             |       |              |       |                   |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Net income                                |       | —     |       |           | —     |         |       |             | —     |              |       |                   | —     |       |       |   | 21,985 |   |   |   | — |   |   | 21,985 |   |
| Unrealized gains on marketable securities |       | —     |       |           | —     |         |       |             | —     |              |       |                   | —     |       |       |   | — |   |   |   | 271 |   |   | 271 |   |
| Foreign currency translation              |       | —     |       |           | —     |         |       |             | —     |              |       |                   | —     |       |       |   | — |   |   |   | 220 |   |   | 220 |   |
| Decrease in minimum pension liability     |       | —     |       |           | —     |         |       |             | —     |              |       |                   | —     |       |       |   | — |   |   |   | 2,305 |   |   | 2,305 |   |
| Total comprehensive income           |       |       |       |           |       |         |       |             |       |              |       |                   |       |       |       |   |   |   |   |   |   |   |   | 24,781 |   |
| Issuance of common stock                  |       | 60         |       |           | 12         |         |       |             | 241        |              |       |                   | —     |       |       |   | — |   |   |   | — |   |   | 253 |   |
| Issuance of shares to acquire Spitz  |       | 497        |       |           | 99         |         |       |             | 2,684      |              |       |                   | —     |       |       |   | — |   |   |   | — |   |   | 2,783 |   |
| Stock-based compensation                  |       | —     |       |           | —     |         |       |             | 1,020      |              |       |                   | —     |       |       |   | — |   |   |   | — |   |   | 1,020 |   |
| Balance at  December 31, 2006        |       | 11,442     |       |           | $          | 2,288        |       |             |       | $                 | 53,759     |                   |       |       | $          | (4,709 | ) |   |   | $ | (21,875 | ) |   |   | $ | (7,081 | ) |   | $ | 22,382 |   |

 

See notes to consolidated financial statements.

33

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**CONSOLIDATED STATEMENTS OF CASH FLOWS(In thousands)**
|                                                                                                                                              | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                                   | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| Cash flows from operating  activities:                                                                                                       |       |                                        |       |   |   |   |   |
| Net loss from continuing operations                                                                                                          |       | $                                           | (9,480     | ) | $ | (3,523 | ) | $ | (7,277 | ) |
| Adjustments to reconcile  net loss to net cash used in operating activities:                                                                 |       |                                        |       |   |   |   |   |
| Depreciation and amortization                                                                                                                |       | 1,486                                       |       | 952 |   | 1,018 |   |
| Stock compensation                                                                                                                           |       | 1,020                                       |       | 15 |   | 15 |   |
| (Gain) loss on disposal of property, plant and  equipment                                                                                    |       | 551                                         |       | 132 |   | (55 | ) |
| Provision for (recovery of) losses on accounts  receivable                                                                                   |       | 142                                         |       | (424 | ) | 167 |   |
| Provision for excess and obsolete inventory                                                                                                  |       | 6                                           |       | 376 |   | 27 |   |
| Gain on sale of investments                                                                                                                  |       | —                                      |       | (654 | ) | (133 | ) |
| Gain on sale of assets                                                                                                                       |       | —                                      |       | — |   | (155 | ) |
| Gain on sale of assets held for sale                                                                                                         |       | 12                                          |       | (2,745 | ) | — |   |
| Other                                                                                                                                        |       | 34                                          |       | 105 |   | 141 |   |
| Changes in assets and  liabilities:                                                                                                          |       |                                        |       |   |   |   |   |
| Decrease (increase) in restricted cash                                                                                                       |       | 1,204                                       |       | 2,315 |   | (3,057 | ) |
| Decrease (increase) in accounts receivable                                                                                                   |       | (2,752                                      | )          | 2,384 |   | (1,378 | ) |
| Decrease (increase) in inventories                                                                                                           |       | (3,731                                      | )          | (761 | ) | 3,003 |   |
| Decrease (increase) in costs and estimated earnings  in excess of billings on uncompleted contracts, net       |       | 527                                         |       | (1,902 | ) | 674 |   |
| Decrease (increase) in prepaid expenses and deposits                                                                                         |       | (5                                          | )          | 738 |   | 1,589 |   |
| Decrease (increase) in prepaid pension and retirement                                                                                        |       | (9,178                                      | )          | — |   | — |   |
| (Decrease) increase in accounts payable                                                                                                      |       | (1,530                                      | )          | (164 | ) | 1,469 |   |
| (Decrease) increase in accrued liabilities                                                                                                   |       | 1,669                                       |       | 203 |   | (2,578 | ) |
| (Decrease) increase in accrued pension and retirement  liabilities                                                                           |       | (9,230                                      | )          | 940 |   | 702 |   |
| (Decrease) increase in customer deposits                                                                                                     |       | 1,881                                       |       | 878 |   | 547 |   |
| Net cash used in continuing operating activities                                                                                             |       | (27,374                                     | )          | (1,135 | ) | (5,281 | ) |
| Net cash provided by discontinued operating  activities                                                                                      |       | 48,719                                      |       | 668 |   | 1,740 |   |
| Net cash provided by (used in) operating activities                                                                                          |       | 21,345                                      |       | (467 | ) | (3,541 | ) |
| Cash flows from  investing activities:                                                                                                       |       |                                        |       |   |   |   |   |
| Purchases of property, plant and equipment                                                                                                   |       | (2,024                                      | )          | (1,417 | ) | (620 | ) |
| Proceeds from sale of property, plant and equipment                                                                                          |       | 30                                          |       | 85 |   | 63 |   |
| Proceeds from sale of assets held for sale                                                                                                   |       | —                                      |       | 6,277 |   | 633 |   |
| Proceeds from sale of investments                                                                                                            |       | —                                      |       | 778 |   | — |   |
| Purchase of available for sale investment                                                                                                    |       | —                                      |       | (37 | ) | — |   |
| Cash acquired in Spitz acquisition                                                                                                           |       | 149                                         |       | — |   | — |   |
| Purchase of intangible assets                                                                                                                |       | (350                                        | )          | — |   | — |   |
| Increase in other assets                                                                                                                     |       | 122                                         |       | (206 | ) | — |   |
| Net cash provided by (used in) continuing investing  activities                                                                              |       | (2,073                                      | )          | 5,480 |   | 76 |   |
| Net cash provided by (used in) discontinued investing  activities                                                                            |       | 1,056                                       |       | (650 | ) | 11,459 |   |
| Net cash provided by (used in) investing activities                                                                                          |       | (1,017                                      | )          | 4,830 |   | 11,535 |   |
| Cash flows from  financing activities:                                                                                                       |       |                                        |       |   |   |   |   |
| Net repayments on line of credit agreement                                                                                                   |       | (1,526                                      | )          | — |   | (7,685 | ) |
| Principal payments on long-term debt and capital  leases                                                                                     |       | (97                                         | )          | — |   | — |   |
| Proceeds from issuance of common stock                                                                                                       |       | 253                                         |       | 96 |   | 123 |   |
| Net cash provided by (used in) continuing financing  activities                                                                              |       | (1,370                                      | )          | 96 |   | (7,562 | ) |
| Net cash used in discontinued financing activities                                                                                           |       | (18,015                                     | )          | — |   | — |   |
| Net cash provided by (used in) financing activities                                                                                          |       | (19,385                                     | )          | 96 |   | (7,562 | ) |
| Net change in cash and cash equivalents                                                                                                      |       | 943                                         |       | 4,459 |   | 432 |   |
| Cash and cash equivalents at beginning of year                                                                                               |       | 14,606                                      |       | 10,147 |   | 9,715 |   |
| Cash and cash equivalents at end of year                                                                                                     |       | $                                           | 15,549     |   | 14,606 |   | 10,147 |   |
| *Supplemental  Disclosure of Cash Flow Information*                                                                                          |       |                                        |       |   |   |   |   |
| Cash paid during the year  for:                                                                                                              |       |                                        |       |   |   |   |   |
| Interest                                                                                                                                     |       | $                                           | 950        |   | $ | 141 |   | $ | 120 |   |
| Income taxes                                                                                                                                 |       | 72                                          |       | 19 |   | 4 |   |

 

See notes to consolidated financial statements.

34

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

*All dollar amountsare in thousands unless otherwise indicated.*

**Note 1—Nature ofOperations and Summary of Significant Accounting Policies**

***Nature ofOperations***

Evans &Sutherland Computer Corporation, referred to in these notes as “Evans &Sutherland,” “E&S,” “we,” “us,” “our” or the “Company,” produces visualsystems used to rapidly and accurately display images. We design, manufacture,market and support our visual systems for various applications, includingplanetariums, science centers and entertainment venues. Our products andsolutions range from the visual systems generated by a desktop PC to what webelieve are the most advanced visual systems in the world. The Company operatesas one segment, which is the visual simulation market.

***Basis ofPresentation***

Evans &Sutherland’s fiscal year ends on December 31. The consolidated financialstatements include the accounts of Evans & Sutherland and its whollyowned subsidiaries. All inter-company accounts and transactions have beeneliminated in consolidation.

***Use ofEstimates***

The preparation offinancial statements in conformity with U.S. generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe amounts reported in the consolidated financial statements and accompanyingnotes. The accounting estimates that require management’s most difficult andsubjective judgments include revenue recognition based on the percentage-ofcompletion method, inventory reserves, accruals for liquidated damages and latepenalties, allowance for doubtful accounts, income tax valuation allowance,restructuring charges, impairment of long-lived assets, pension and retirementobligations and useful lives of depreciable assets. Actual results could differfrom those estimates.

***Cash andCash Equivalents***

The Company considers allhighly liquid investments with original maturities of three or fewer months tobe cash equivalents. The Company maintains cash balances in bank accounts that,at times, may exceed federally insured limits. The Company has not experiencedany losses in these accounts and believes it is not exposed to any significantrisk with respect to cash. As of December 31, 2006, cash deposits exceededthe federally insured limits by approximately $15,874.

***RestrictedCash***

Restricted cash thatguarantees issued letters of credit that mature or expire within one year isreported as a current asset. Restricted cash that guarantees issued letters ofcredit that mature or expire in more than one year are reported as long-termother assets. Long-term restricted cash at December 31, 2006 and 2005 was$0 and $396, respectively.

***TradeAccounts Receivable***

In the normal course of business, we provide unsecuredcredit terms to our customers. Accordingly, we maintain an allowance fordoubtful accounts for possible losses on uncollectible accounts receivable. We routinely analyze accounts receivable andcosts and estimated earnings in excess of billings, and consider history,customer creditworthiness, facts and circumstances specific to outstandingbalances, 

35

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

currenteconomic trends, and payment term changes when evaluating adequacy of theallowance for doubtful accounts. Changes in these factors could result inmaterial differences to bad debt expense. Past due balances are reviewedindividually for collectibility.

Uncollectible accounts receivable are charged againstthe allowance for doubtful accounts only after exhaustive efforts have beenmade to collect and with management’s approval.

Thetable below represents changes in our allowance for doubtful receivables duringfiscal year:

| ** **                                                  | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Beginning balance                                           |       | $        | 62         |     | $          | 365      |       | $ | 93 |   |
| Acquisition of  Spitz                                       |       | 138      |       | —   |       | —   |       |
| Provision for  (reduction in) losses on accounts receivable |       | 142      |       | (424     | )          | 167      |       |
| Charges against  the reserve                                |       | (14      | )          | 121      |       | 105      |       |
| Ending balance                                              |       | $        | 328        |     | $          | 62       |       | $ | 365 |   |

 

***Inventories***

Inventory includes materials at standard costs, whichapproximate average costs, as well as inventoried costs on programs andlong-term contracts. Inventoried costs include material, direct engineering andproduction costs, and applicable overhead, not in excess of estimatedrealizable value. Spare parts and general stock materials are stated at costnot in excess of realizable value. We periodically review inventories forexcess supply, obsolescence, and valuations above estimated realizable amounts,and provide a reserve we consider sufficient to cover these items. Revisions ofthese estimates could result in the need for adjustments.

Inventoriesnet of reserves at fiscal year-end were as follows:

| ** **              | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------|------------|----------|------------|----------|------------|
| Raw materials           |       | $3,990   |       | $864     |       |
| Work-in-process         |       | 2,723    |       | 1,022    |       |
| Total  inventories, net |       | $6,713   |       | $1,886   |       |

 

36

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

***Property,Plant and Equipment***

Property,plant and equipment are stated at cost. Depreciation is computed using thestraight-line method based on the estimated useful lives of the related assets.Expenditures that materially increase values or capacities or extend usefullives of property and equipment are capitalized. Routine maintenance, repairsand renewal costs are expensed as incurred. When property is retired orotherwise disposed of, the book value of the property is removed from the fixedassets and the related accumulated depreciation accounts. Depreciation isincluded in cost of sales, research and development or selling, general andadministrative expenses depending on the nature of the asset. The cost andestimated useful lives of property, plant and equipment and the totalaccumulated depreciation and amortization were as follows at December 31:

| ** **                                      | ** ** | **Estimated  useful lives** | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|----------|------------|----------|------------|
| Land                                            |       | n/a                              |       | $        | 2,250      |     | $          | — |   |
| Buildings and  improvements                     |       | 35-40  years                     |       | 10,945   |       | 9,362    |       |
| Manufacturing  machinery and equipment          |       | 3 to  8 years                    |       | 5,726    |       | 5,255    |       |
| Office furniture  and equipment                 |       | 8  years                         |       | 812      |       | 937      |       |
| Total                                           |       |                             |       | 19,733   |       | 15,554   |       |
| Less accumulated  depreciation and amortization |       |                             |       | (7,044   | )          | (8,917   | )          |
| Total property,  plant and equipment, net       |       |                             |       | $        | 12,689     |     | $          | 6,637 |   |

 

***SoftwareDevelopment Costs***

Software developmentcosts, if material, are capitalized from the date technological feasibility isachieved until the product is available for general release to customers. Suchcosts have not been material during the periods presented.

***Investments***

We classify our marketable debt and equity securitiesas available-for-sale. Available-for-sale securities are recorded at fairvalue. Unrealized holding gains and losses, net of the related tax effect, areexcluded from earnings and are reported as a component of accumulated othercomprehensive income (loss) until realized. Dividend and interest income arerecognized when earned. Realized gains and losses from the sale of securities areincluded in results of operations and are determined on the specificidentification basis. A decline in the market value that is deemed other thantemporary results in a charge to other income (expense) and the establishmentof a new cost basis for the investment.

We account for investmentsin nonmarketable securities using the cost and equity methods. In assessing thefair value cost method of such investments, we consider recent equitytransactions that investees have entered into, the status of each investee’stechnology and strategies in place to achieve their objectives, as well as theinvestee’s financial condition and results of operations. To the extent thereare changes in these assessments, adjustments may need to be recorded. Forinvestments accounted for using the equity method, adjustments are made to thecarrying amount of the investment to account for our equity in undistributedearnings (losses) of the investee. Investments are periodically evaluated for adecline in value considered other-than-temporary. Any such decline isrecognized as a loss in the statement of operations.

37

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

***Impairmentof Long- Lived Assets***

Long-lived assets arereviewed for impairment when events or changes in circumstances indicate thebook value of an asset may not be fully recoverable. When this occurs, wereview the value assigned to long-lived assets by analyzing the anticipated,undiscounted cash flows they generate. When the expected future undiscountedcash flows from these assets do not exceed their carrying balances, the Companydetermines the estimated fair value of such assets. An impairment is recognizedto the extent the carrying amount of the assets exceeds their estimated fairvalue. Assets held for sale are reported at the lower of their carrying amountor fair value less costs to sell.

***WarrantyReserve***

We provide a warrantyreserve for estimated future costs of servicing products under warrantyagreements extending for periods from 90 days to one year. Anticipated costsfor product warranties are based upon estimates derived from experience factorsand are recorded at the time of sale or over the period revenues are recognizedfor long-term contracts. Warranty reserves are classified as accruedliabilities in the accompanying consolidated balance sheets.

***RevenueRecognition***

Oursales include revenue from system hardware, software, database products andservice contracts. The following table provides information on revenue byrecognition method applied during fiscal years:

| ** **               | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|----------|------------|
| Percentage-of-completion |       | $        | 6,883      |     | $          | 10,053   |       | $ | 3,262 |   |
| Completed  contract      |       | 6,706    |       | 4,759    |       | 5,824    |       |
| Other                    |       | 1,459    |       | 299      |       | 393      |       |
| Total sales              |       | $        | 15,048     |     | $          | 15,111   |       | $ | 9,479 |   |

 

*Percentage-of-Completion.**  *In arrangements that are longer in term and requiresignificant production, modification or customization, revenue is recognized inaccordance with the provisions of Statement of Position 81-1, “Accountingfor Performance of Construction-Type and Certain Production-Type Contracts” (“SOP81-1”), using the percentage-of-completion method. In applying theprovisions of SOP 81-1, we utilize cost-to-cost methodology whereby weestimate the percent complete by calculating the ratio of costs incurred(consisting of material, labor and subcontracting costs, as well as anallocation of indirect costs) to management’s estimate of total anticipatedcosts.  This ratio is then utilized todetermine the amount of gross profit earned based on management’s estimate oftotal estimated gross profit at completion. We routinely review estimatesrelated to percentage-of-completion contracts and adjust for changes in theperiod revisions are made. Billings on uncompleted percentage-of-completioncontracts may be greater than or less than incurred costs and estimatedearnings and are recorded as an asset or liability in the accompanyingconsolidated balance sheets.

In those arrangements where software is a significantcomponent of the contract, the Company applies the guidance of Statement ofPosition 97-2 “Software Revenue Recognition,” which allows for use of thepercentage-of-completion method as described above.

*CompletedContract.**  *Contractarrangements which typically require a relatively short period of time tocomplete the production, modification, and customization of our products areaccounted for using the completed contract method. Accordingly, revenue isrecognized upon delivery of the completed product, 

38

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

provided persuasiveevidence of an arrangement exists, title and risk of loss has transferred, thefee is fixed and determinable, and collection is reasonably assured.

*Other.**  *Other revenue consists primarily of amounts earnedunder maintenance contracts that are generally sold as a single element to ourcustomers. Revenue from product maintenance contracts, including separatelypriced extended warranty contracts, is deferred and recognized over the periodof performance under the contract.

*AnticipatedLosses.**  *Forcontracts with anticipated losses at completion, a provision is recorded whenthe loss becomes known. After an anticipated loss is recorded, subsequentrevenue and cost of sales are recognized in equal, offsetting amounts ascontract costs are incurred and do not generate further gross profits (losses).

*Multiple ElementArrangements.*   Some of our contracts includemultiple elements. Revenue earned on elements such as products, services andmaintenance contracts are allocated to each element based on the relative fairvalues of the elements.

***Stock-BasedCompensation***

Prior to December 31, 2005, as permitted underStatement of Financial Accounting Standards (“SFAS”) No. 123, the Companyaccounted for its stock option plans following the recognition and measurementprinciples of Accounting Principles Board (“APB”) Opinion No. 25, “Accountingfor Stock Issued to Employees,” and related interpretations. Accordingly, nostock-based compensation expense from the issuance of stock options wasreflected in the Company’s statements of operations as all options granted hadan exercise price equal to the market value of the underlying common stock onthe date of grant and the related number of shares granted was fixed at thatpoint in time.

In December 2004, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 123(R), “Share Based Payment.” ThisStatement revised SFAS No. 123 by eliminating the option to account foremployee stock options under APB No. 25 and required companies torecognize the cost of employee services received in exchange for awards ofequity instruments based on the grant-date fair value of those awards.

On January 1, 2006 theCompany adopted the provisions of SFAS No. 123(R) using the modifiedprospective application method. Using this modified prospectiveapplication method, compensation cost is recognized on a straight-line basisfor (1) all awards granted, modified, cancelled, or repurchased after thedate of adoption and (2) the unvested portion of previously granted awardsfor which the requisite service has not yet been rendered as of the date ofadoption, based on the fair value of those awards on the grant-date. Inaccordance with the modified prospective application method, operating resultsfor the years ended December 31, 2005 and 2004 have not been restated.

Share-based compensation expense included in thestatement of operations for the year ended December 31, 2006 wasapproximately $1,020. Option grants accounted for $317 of the 2006 share-basedcompensation expense while $228 was due to modifications to our former chiefexecutive officer’s option grants as a result of his separation agreementdiscussed in Note 10, and $474 was due to the accelerated vesting of options onFebruary 7, 2006 as a result of the Asset Purchase Agreement executed on February 7,2006 as discussed in Note 2.

Thefollowing table illustrates the effect on net loss and loss per common share ifthe Company had applied the fair value recognition provisions of SFAS No. 123,Accounting for Stock-Based Compensation, 

39

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

to stock-based employee compensation for periodspresented prior to the Company’s adoption of SFAS No. 123(R):

| ** **                                        | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------------------|------------|----------|------------|----------|------------|
| Net loss:                                         |       | $        | (1,134     | )        | $          | (8,729 | ) |
| Stock-based  compensation under fair value method |       | (550     | )          | (397     | )          |
| Pro forma net  loss                               |       | $        | (1,684     | )        | $          | (9,126 | ) |
| Net loss per basic and diluted common share:      |       |     |       |     |       |
| As reported                                       |       | $        | (0.11      | )        | $          | (0.83 | ) |
| Pro forma                                         |       | (0.16    | )          | (0.87    | )          |

 

***Income Taxes***

We use the asset and liabilitymethod of accounting for income taxes. Under the asset and liability method,deferred income tax assets and liabilities are recognized for the future incometax consequences attributable to differences between the financial statementcarrying amounts of existing assets and liabilities and their respective incometax bases and operating loss and income tax credit carry-forwards. Deferredincome tax assets and liabilities are measured using enacted tax rates expectedto apply to taxable income in the years in which those temporary differencesare expected to be recovered or settled. The effect on deferred income taxassets and liabilities of a change in income tax rates is recognized in theperiod that includes the enactment date.

***OtherComprehensive Loss***

We have applied the provisions of SFAS No. 109, “Accountingfor Income Taxes,” to our gains and losses included in other comprehensive lossbut excluded them from our net income or loss. On a net basis for 2006, 2005and 2004, there was a deferred income tax asset as a result of the itemsreflected in comprehensive loss. However, in applying SFAS No. 109 wedetermined that it is more likely than not that we will not realize such netdeferred income tax assets and have therefore established a valuation allowanceagainst the full amount of the net deferred income tax asset. Accordingly, thenet income tax effect of the items included in other comprehensive loss is zero.Therefore, we have included no income tax expense or benefit in relation toitems reflected in other comprehensive loss.

Thecomponents of accumulated other comprehensive loss was as follows as of December 31:

| ** **                                   | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------------------|------------|----------|------------|----------|------------|
| Additional minimum  pension liability        |       | $        | (7,352     | )        | $          | (9,657 | ) |
| Net unrealized holding  gains on investments |       | 271      |       | (220     | )          |
| Total accumulated other  comprehensive loss  |       | $        | (7,081     | )        | $          | (9,877 | ) |

 

***Leases***

We recognize scheduledrent increases on a straight-line basis over the lease term, which may includeoptional lease renewal terms, and deferred rent income and expense arerecognized to reflect the difference between the rent paid or received in thecurrent period and the calculated straight-line amount.

40

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

***Goodwill***

In accordance with theprovisions of SFAS No. 142, “Goodwill and Other Intangible Assets,” theCompany tests its recorded goodwill for impairment on an annual basis, or moreoften if indicators of potential impairment exist, by determining if thecarrying value of each reporting unit exceeds its estimated fair value. Factorsthat could trigger an impairment include, but are not limited to,underperformance relative to historical or projected future operating results,significant changes in the manner of use of the acquired assets or the Company’soverall business and significant negative industry or economic trends. Futureimpairment reviews may require write-downs in the Company’s goodwill and couldhave a material adverse impact on the Company’s operating results for theperiods in which such write-downs occur.

***Fair Value of Financial Instruments***

The carrying amount ofcash and cash equivalents, receivables, accounts payable and accrued expensesapproximates fair value because of their short maturity. The fair values ofmarketable securities available for sale are based on quoted market prices. Fornon-marketable securities classified as long-term assets related todiscontinued operations as of December 31, 2005, a reasonable estimate offair value was impractical. The fair value of the 6% Debentures classified asLong-term liabilities related to discontinued operations was $11,530 as of December 31,2005, based on quoted market prices. The carrying value of the long-term debtdiscussed in Note 8 equates to its carrying value because the interest rates ofthe debt approximate market interest rates at the reporting periods.

***RecentAccounting Pronouncements***

In June 2006, the FASB issued InterpretationNumber 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes—aninterpretation of FASB Statement No. 109.” The interpretation contains atwo step approach to recognizing and measuring uncertain tax positionsaccounted for in accordance with SFAS No. 109. The first step is toevaluate the tax position for recognition by determining if the weight ofavailable evidence indicates it is more likely than not that the position willbe sustained on audit, including resolution of related appeals or litigationprocesses, if any. The second step is to measure the tax benefit as the largestamount which is more than 50% likely of being realized upon ultimatesettlement. The provisions are effective for the Company beginning in the firstquarter of 2007. The Company is evaluating the impact of FIN 48 on itsconsolidated financial statements.

In September 2006, the FASB issued SFAS No. 157,“Fair Value Measurements.” SFAS No. 157 defines fair value, establishes aframework for measuring fair value in accordance with generally acceptedaccounting principles (“GAAP”) and expands disclosures about fair valuemeasurements. This statement will be adopted by the Company for its fiscalyears beginning after November 15, 2007 and interim periods within thosefiscal years. The Company is currently evaluating the impact of SFAS No. 157on its consolidated financial statements.

In September 2006,the FASB issued SFAS No. 158, “Employers’ Accounting for Defined BenefitPension and Other Postretirement Plans, an amendment of FASB Statements No. 87,88, 106 and 132-R.” SFAS No. 158 requires employers to recognize ontheir balance sheets the funded status of pension and other postretirementbenefit plans as of the end of the fiscal year ending after December 15,2006, for public companies. SFAS No. 158 requires that companies recognizeactuarial gains and losses, prior service costs, and any remaining transitionamounts from the initial application of Statements 87 and 106 when recognizinga plan’s funded status, with the offset to accumulated other comprehensiveincome. SFAS No. 158 will also require fiscal-year-end measurements ofplan assets and benefit obligations, eliminating 

41

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

the useof earlier measurement dates currently permissible. The new measurement-daterequirement will not be effective until fiscal years ending after December 15,2008. The Company has adopted the provisions of this statement as of December 31,2006. The adoption did not have a material impact on the Company’s consolidatedfinancial statements.

**Note 2—DiscontinuedOperations**

On May 26, 2006, we sold substantially all of theassets and certain liabilities primarily related to our commercial and militarysimulation businesses and related service operations (the “Simulation Business”)to certain subsidiaries of Rockwell Collins, Inc., a Delaware corporation(“Rockwell Collins”), pursuant to an asset purchase agreement (the “AssetPurchase Agreement”), dated as of February 7, 2006, by and between theCompany and Rockwell Collins. In connection with the completion of the sale ofthe Simulation Business, on May 26, 2006 the Company entered into a laserprojection systems agreement (the “Laser Agreement”) with Rockwell Collins andRockwell Collins Simulation & Training Solutions LLC, pursuant towhich the Company has agreed to provide, and grant exclusive and non-exclusiveintellectual property licenses to use and sell, laser projection systems inconnection with the Simulation Business and certain related businesses ofRockwell Collins. The transaction contemplated by the Asset Purchase Agreementand the Laser Agreement (the “Transaction”) was approved by the Company’sshareholders at a combined annual and special meeting of shareholders held on May 25,2006.

The aggregate consideration contemplated in theTransaction was $71,500 in cash, consisting of the $66,500 purchase price underthe Asset Purchase Agreement (the “Asset Purchase Price”) for the assetsprimarily related to the Simulation Business and $5,000 under the LaserAgreement. On May 26, 2006, the closing of the sale of the SimulationBusiness, Rockwell Collins paid the Company $59,500 under the terms of theAsset Purchase Agreement, and deposited $10,000 (consisting of the remaining$7,000 of the Asset Purchase Price and $3,000 under the Laser Agreement) inescrow pursuant to an escrow agreement (the “Escrow Agreement”), dated as of May 26,2006, by and between the Company, Rockwell Collins and U.S. Bank NationalAssociation, as escrow agent. The Laser Agreement requires Rockwell Collins topay the remaining $2,000 of consideration in the Transaction directly to theCompany upon the completion of certain performance milestones by the Company. Underthe terms of the Escrow Agreement, the deposited amount will be held in escrowto secure (i) any post-closing reduction in the Asset Purchase Price underthe Asset Purchase Agreement, (ii) the Company’s indemnificationobligations under the Asset Purchase Agreement and (iii) the Company’sobligations (not to exceed $3,000 of the escrowed funds) to meet specifiedmilestones under the Laser Agreement. The escrowed funds will be released ininstallments as set forth in the Escrow Agreement, subject to the passage oftime and the Company fulfilling requirements of the Escrow Agreement. Inconnection with the sale of our Simulation Business, we agreed to indemnifyRockwell Collins for any losses from breaches of the representations,warranties or covenants we made in the Asset Purchase Agreement that occurwithin certain periods after the closing.

The Asset Purchase Agreement provides for anadjustment to the Asset Purchase Price based on the value, calculated inaccordance with the terms of the Asset Purchase Agreement, of the net assetsdelivered at the closing date (the “Closing Net Assets”). Based on the value ofthe Closing Net Assets calculated by the Company and Rockwell Collins under theprocedures set forth in the Asset Purchase Agreement, the Asset Purchase Pricehas been adjusted by $4,800 resulting in an adjusted Asset Purchase Price of$61,700. In accordance with the terms of the Escrow Agreement, inMarch 2007, $200 of the $7,000 held for the Asset Purchase Price wasreleased to the Company and $4,800 was released to Rockwell Collins. Theremaining $2,000 held for the Asset Purchase Price is scheduled to be releasedunder the Escrow Agreement on July 1, 2007.

42

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

As of December 31, 2006, the Company has recordedproceeds of $59,700 from the Transaction, representing the funds it receivedthrough March 2007. We will record additional gain on the Transaction whenand to the extent that the remaining amounts to be paid by Rockwell Collins andthe remaining amounts held in escrow are released to the Company.

Thesale of assets by the Company pursuant to the Asset Purchase Agreement was ataxable transaction for income tax purposes. Accordingly, we recognized a gainwith respect to the sale of assets pursuant to the Asset Purchase Agreement inan amount equal to the difference between the amount of the considerationreceived for each asset over the adjusted tax basis in the asset sold. As alltax information is not yet available we have made estimates for certain itemsin computing the tax gain until final information becomes available. Althoughthe asset sale resulted in taxable gain to the Company, a substantial portionof the taxable gain will be offset by current year losses from operations, andavailable net operating loss and tax credit carryforwards. The gain on the saleof the Simulation Business is comprised of:

| Cash  consideration under Asset Purchase Agreement                       |   |   |   | $       | 66,500 |   |
|--------------------------------------------------------------------------|--------|--------|--------|---------|--------|--------|
| Adjustment to Asset Purchase Price due to Closing  Net Asset computation |   | (4,800 | )      |    |   |
| Amount in escrow under Asset Purchase Agreement                          |   | (2,000 | )      |    |   |
| Transaction costs                                                        |   | (607   | )      |    |   |
| Net proceeds                                                             |   |   |   | 59,093  |   |
| Book value of  assets acquired by Rockwell Collins                       |   |   |   | (33,115 | )      |
| Book value of  liabilities assumed by Rockwell Collins                   |   |   |   | 18,722  |   |
| Gain before  income taxes                                                |   |   |   | 44,700  |   |
| Income taxes                                                             |   |   |   | (9,057  | )      |
| Net gain                                                                 |   |   |   | $       | 35,643 |   |

 

43

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

As aresult of the sale of the Simulation Business, the consolidated balance sheetas of December 31, 2005 and the consolidated statements of operations forthe years ended December 31, 2005 and 2004 have been restated to recordthe necessary adjustments required to reflect the assets, liabilities, andoperations of the Simulation Business as discontinued operations. Assets and liabilitiesof the Simulation Business included as assets or liabilities related todiscontinued operations in the accompanying condensed consolidated balancesheet as of December 31, 2005 consisted of the following:

| ** **                                                                   | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                   | ** ** | **2005**              | ** ** |
| Current assets:                                                              |       |                  |       |   |   |
| Accounts receivable                                                          |       |                  | $          | 9,600 |   |   |
| Costs and estimated earnings in excess of billings  on uncompleted contracts |       |                  | 6,659      |   |   |
| Inventories                                                                  |       |                  | 9,300      |   |   |
| Prepaid expenses and deposits                                                |       |                  | 2,360      |   |   |
| Current assets related to discontinued operations                            |       |                  | 27,919     |   |   |
| Long-term assets:                                                            |       |                  |       |   |   |
| Investments                                                                  |       |                  | 1,223      |   |   |
| Property, plant and equipment, net                                           |       |                  | 8,257      |   |   |
| Other assets                                                                 |       |                  | 366        |   |   |
| Long-term assets related to discontinued operations                          |       |                  | $          | 9,846 |   |   |
| Current  liabilities:                                                        |       |                  |       |   |   |
| Accounts payable                                                             |       |                  | $          | 4,677 |   |   |
| Accrued liabilities                                                          |       |                  | 5,730      |   |   |
| Billings in excess of costs and estimated earnings  on uncompleted contracts |       |                  | 3,906      |   |   |
| Customer deposits                                                            |       |                  | 3,354      |   |   |
| Current liabilities related to discontinued  operations                      |       |                  | 17,667     |   |   |
| Long-term  liabilities:                                                      |       |                  |       |   |   |
| Convertible subordinated notes                                               |       |                  | 18,015     |   |   |
| Deferred rent obligation                                                     |       |                  | 2,010      |   |   |
| Long-term liabilities related to discontinued  operations                    |       |                  | $          | 20,025 |   |   |

 

44

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Summarizedresults of operations for the Simulation Business included as income (loss)from discontinued operations, net of tax, in the accompanying condensedconsolidated statements of operations for the years ended December 31 wereas follows:

| ** **                                      | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Sales                                           |       | $        | 18,661     |     | $          | 58,456   |       | $ | 58,380 |   |
| Cost of sales                                   |       | 13,515   |       | 37,771   |       | 36,871   |       |
| Gross profit                                    |       | 5,146    |       | 20,685   |       | 21,509   |       |
| Operating  expenses                             |       | 12,023   |       | 17,447   |       | 29,656   |       |
| Gain on assets  held for sale                   |       | 407      |       | —   |       | 4,298    |       |
| Gain on sale of  assets                         |       | —   |       | —   |       | 3,662    |       |
| Operating income (loss)                         |       | (6,470   | )          | 3,238    |       | (187     | )          |
| Other income  (expense), net                    |       | (483     | )          | (1,285   | )          | (1,229   | )          |
| Income (loss) before income taxes               |       | (6,953   | )          | 1,953    |       | (1,416   | )          |
| Income tax  (expense) benefit                   |       | 2,775    |       | 436      |       | (36      | )          |
| Net income (loss)  from discontinued operations |       | $        | (4,178     | )        | $          | 2,389    |       | $ | (1,452 | ) |

 

**Note 3—Acquisition**

On April 28, 2006, the Company completed theacquisition of Spitz, Inc. (“Spitz”) by acquiring all outstanding sharesof Spitz common stock from Transnational Industries, Inc. (“Transnational”)pursuant to a stock purchase agreement (the “Stock Purchase Agreement”), datedas of February 7, 2006, by and between the Company and Transnational.Consideration under the Stock Purchase Agreement consisted of 412,500unregistered shares of the Company’s Common Stock, $0.20 par value, subject toa post-closing share adjustment depending on the average trading price of theCompany’s common stock for the 60-day period prior to registration of theshares issued at closing. Pursuant to a Registration Rights Agreement betweenthe Company, Spitz, and Transnational, the Company was required to use its bestefforts to register those shares of stock issued as consideration for theoutstanding stock of Spitz. Registration of the shares issued to Transnationalbecame effective on November 9, 2006 and the Company issued an additional84,948 shares in accordance with the post-closing adjustment. Based on theaverage closing price of the Company’s Common Stock for the period two daysprior and two days after the day the agreement was announced, the value of thetotal shares issued is $2,814. Transaction costs were $70 and stock registrationcosts were $30. The purchase price was determined in arms-length negotiationsbetween the Company and Transnational and we believe it is a nontaxabletransaction. The Company plans to continue to operate Spitz as a wholly ownedsubsidiary. Spitz designs, manufactures and supports visual systems forplanetariums, science centers and entertainment venues and provides uniquedomes and similarly shaped structures for specialized architecturalapplications.

45

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Thetransaction has been accounted for as a purchase and the operations of Spitzhave been consolidated with the operations of the Company effective May 1,2006 in the accompanying consolidated financial statements. The following proforma information gives effect to this acquisition as if it had been completedas of the beginning of the Company’s fiscal periods presented. The Company’sfiscal year end is December 31 and Spitz’ fiscal year end was January 31.Because historical results of operations for Spitz are not available for thefiscal periods presented, results from Spitz fiscal periods are presented as ifthey covered the same periods as the Company’s fiscal periods. The pro formainformation is presented for illustrative purposes only. Such information isnot necessarily indicative of the operating results had the acquisition takenplace as of the beginning of the Company’s fiscal periods presented, nor is itindicative of the results that may be expected for future periods.

| ** **                                                              | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Sales                                                                   |       | $        | 17,910     |     | $          | 26,548   |       | $ | 20,241 |   |
| Net loss from  continuing operations                                    |       | $        | (10,594    | )        | $          | (4,935   | )          | $ | (8,189 | ) |
| Net income (loss)                                                       |       | $        | 20,872     |     | $          | (2,546   | )          | $ | (9,855 | ) |
| Basic and diluted net loss per common share from  continuing operations |       | $        | (0.98      | )        | $          | (0.47    | )          | $ | (0.78 | ) |
| Basic net income  (loss) per common share                               |       | $        | 1.93       |     | $          | (0.24    | )          | $ | (0.94 | ) |
| Diluted net income  (loss) per common share                             |       | $        | 1.92       |     | $          | (0.24    | )          | $ | (0.94 | ) |

 

Thepurchase consideration has been allocated based on an assessment of the fairmarket values of the acquired assets and liabilities assumed. The considerationpaid by the Company was $2,884, including transaction costs of $70. The excessof the purchase price over the fair value of the net assets of Spitz gives riseto goodwill which reflects value resulting from the marketing advantages andoperating efficiencies created by the business combination. The following tablesets forth the allocation of the purchase consideration to the tangible andintangible assets acquired and liabilities assumed as of April 28, 2006based upon an independent valuation.

| Cash and  restricted cash                                                    |   | $      | 491    |   |
|------------------------------------------------------------------------------|--------|--------|--------|--------|
| Accounts  receivable                                                         |   | 1,919  |   |
| Costs and estimated earnings in excess of billings  on uncompleted contracts |   | 388    |   |
| Inventories                                                                  |   | 1,015  |   |
| Prepaid expenses  and deposits                                               |   | 192    |   |
| Property, plant  and equipment                                               |   | 5,745  |   |
| Other assets                                                                 |   | 87     |   |
| Accounts payable                                                             |   | (722   | )      |
| Accrued  liabilities                                                         |   | (917   | )      |
| Deferred revenue                                                             |   | (435   | )      |
| Billings in excess of costs and estimated earnings  on uncompleted projects  |   | (1,205 | )      |
| Loans and other  long-term debt, less current portion                        |   | (5,259 | )      |
| Definite-lived  intangibles (see Note 4)                                     |   | 950    |   |
| Goodwill                                                                     |   | 635    |   |
| Total consideration  including estimated acquisition costs                   |   | $      | 2,884  |   |

 

46

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**Note 4—IntangibleAssets and Goodwill**

Intangibleassets and goodwill consisted of the following as of December 31, 2006:

| **Class**                                      | ** ** | ** ** | ** ** | **Amortization  Period in  Years** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Value** | ** ** | **Amortization for  the 12 months  ended  December 31,  2006** | ** ** |
|------------------------------------------------|------------|------------|------------|-----------------------------------------|------------|-----------------------------|------------|-------------------------------|------------|--------------------------|------------|------------------------------------------------------------------------------------|------------|
| Customer backlog                               |       |       | 1          |                                    |       |                        | $          | 320                           |       |                     |       | $                                                                                  | (285       | ) |   |   | $ | 35 |   |   |   | $ | 285 |   |   |
| Maintenance and  legacy customers              |       |       | 10         |                                    |       |                        | 350        |                          |       |                     | (29        | )                                                                                  |       |   | 321 |   |   |   | 29 |   |   |
| Planetarium shows                              |       |       | 10         |                                    |       |                        | 280        |                          |       |                     | (24        | )                                                                                  |       |   | 256 |   |   |   | 24 |   |   |
| Intellectual  property rights                  |       |       | 5          |                                    |       |                        | 350        |                          |       |                     | (12        | )                                                                                  |       |   | 338 |   |   |   | 12 |   |   |
| Total                                          |       |       |       |                                    |       |                        | $          | 1,300                         |       |                     |       | $                                                                                  | (350       | ) |   |   | $ | 950 |   |   |   | $ | 350 |   |   |
| Goodwill                                       |       |       |       |                                    |       |                        |       |                          |       |                     |       |                                                                               |       |   | 635 |   |   |   |   |   |   |
| Total                                          |       |       |       |                                    |       |                        |       |                          |       |                     |       |                                                                               |       |   | $ | 1,585 |   |   |   |   |   |   |
| Weighted average  amortization period in years |       |       | 7.9        |                                    |       |                        |       |                          |       |                     |       |                                                                               |       |   |   |   |   |   |   |   |   |

 

Goodwill of $635 consists of the excess of thepurchase consideration paid in the acquisition of Spitz (see Note 3) over thefair value of the net assets acquired. We have determined that the assumptionsused in computing the valuation of goodwill as of April 28, 2006, the dateof the acquisition of Spitz, have not materially changed and therefore there isno impairment of goodwill as of December 31, 2006.

Customer backlog, maintenance and legacy customers andplanetarium shows represent the value of definite-lived intangibles that wereidentified in the acquisition of Spitz.

In November 2006, the Company acquired certainintellectual property rights to protect the application of certain processes inthe use of its products for cash payments totaling $350.

Estimatedfuture amortization expense is as follows:

| ** **                        | ** ** | **December 31,** | ** ** |
|-----------------------------------|------------|-----------------------|------------|
| **Class**                         | ** ** | ** **            | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **Thereafter** | ** ** |
| Customer backlog                  |       | $                     | 35         |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |   | $ | — |   |   |
| Maintenance and  legacy customers |       | 43                    |       | 39 |   | 39 |   | 35 |   | 35 |   |   | 130 |   |   |
| Planetarium shows                 |       | 36                    |       | 36 |   | 34 |   | 31 |   | 25 |   |   | 94 |   |   |
| Intellectual  property rights     |       | 70                    |       | 70 |   | 70 |   | 70 |   | 58 |   |   | — |   |   |
| Total                             |       | $                     | 184        |   | $ | 145 |   | $ | 143 |   | $ | 136 |   | $ | 118 |   |   | $ | 224 |   |   |
|                                   |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Note 5—Costs andEstimated Earnings on Uncompleted Contracts**

Comparativeinformation with respect to uncompleted contracts at fiscal year-end:

| ** **                                                               | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Total accumulated  costs and estimated earnings on uncompleted contracts |       | $        | 20,833     |     | $          | 16,426 |   |
| Less total billings  on completed contracts                              |       | (21,443  | )          | (15,692  | )          |
|                                                                     |       | $        | (610       | )        | $          | 734 |   |

 

47

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Theabove amounts are reported in the consolidated balance sheets as follows:

| ** **                                                                   | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Costs and  estimated earnings in excess of billings on uncompleted contracts |       | $        | 1,366      |     | $          | 2,850 |   |
| Billings in  excess of costs and estimated earnings on uncompleted contracts |       | (1,976   | )          | (2,116   | )          |
|                                                                         |       | $        | (610       | )        | $          | 734 |   |

 

**Note 6—Leases**

We occupy real property and use certain equipmentunder lease arrangements that are accounted for as operating leases. Our realproperty leases contain escalation clauses. Rental expenses for all operatingleases for 2006, 2005, and 2004 were $265, $228 and $228, respectively.

Futureminimum lease payments under operating leases that have initial or remainingnon-cancelable lease terms in excess of one year are as follows:

| **Fiscal year** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------|------------|------------|------------|------------|------------|
| 2007                 |       | $          | 680        |       |
| 2008                 |       | 215        |       |
| 2009                 |       | 186        |       |
| 2010                 |       | 186        |       |
| 2011                 |       | 197        |       |
| Thereafter           |       | 5,087      |       |
| Total                |       | $          | 6,551      |       |

 

Sub-lease rental incomefor all operating leases for 2006, 2005 and 2004 was $7, $117 and $357,respectively. At December 31, 2006, we had no future lease rental incomefrom operating leases that have initial or remaining noncancelable lease terms.

**Note 7—EmployeeRetirement Benefit Plans**

***PensionPlan***

The Pension Plan is aqualified defined benefit pension plan funded by Company contributions. Ourfunding policy is to contribute amounts sufficient to satisfy regulatoryfunding standards, based upon independent actuarial valuations. The PensionPlan was frozen in 2002. Benefits at normal retirement age (65) are based uponthe employee’s years of service, as of the date of the curtailment foremployees not yet retired, and the employee’s compensation prior to thecurtailment.

***SupplementalExecutive Retirement Plan***

We maintain an unfundedSupplemental Executive Retirement Plan (“SERP”). The SERP provides eligibleexecutives defined pension benefits, outside our pension plan, based on averagesalary, years of service and age at retirement. The SERP was amended in 2002 todiscontinue further SERP gains from future salary increases and close the SERPto new participants.

***401(k) DeferredSavings Plan***

We have a deferred savingsplan that qualifies under Section 401(k) of the Internal Revenue Code.The 401(k) plan covers all employees of the Company who have at least oneyear of service and who are 

48

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

age 18or older. We make matching contributions on employee contributions after theemployee has achieved one year of service. We may also make extra matchingcontributions based on our profitability and other financial and operationalconsiderations. No extra matching contributions have been made to date. Ourcontributions to the 401(k) plan for 2006, 2005 and 2004 were $240, $591and $625, respectively.

***ExecutiveSavings Plan***

The Executive Savings Plan (“ESP”) is an unfundeddeferred compensation plan that allows tax-deferred retirement savings beyondthe amount that can be contributed to the 401(k) plan. The ESP, anonqualified plan that does not have the same protections as a qualified 401(k) plan,covers a portion of the management employees. Participants earn matchingamounts on their contributions with the same percentage limit as the qualified401(k) plan. Consistent with the curtailment of the SERP, the ESP wasamended in 2002 to permit the Board of Directors to grant additionaldiscretionary contributions.

We purchase Company-ownedlife insurance policies insuring the lives of participants in the ESP. Thepolicies accumulate asset values and exist to cover the cost of employeesupplemental retirement benefit liabilities. At December 31, 2006 and2005, prepaid expenses and deposits included our investments in the policies of$955 and $957, respectively. At December 31, 2005, an additional $1,224 ofinvestment in the policies was classified as long-term assets related todiscontinued operations. Net insurance expense from these policies was $50, $96and $160 for the years ended December 31, 2006, 2005 and 2004,respectively.

***Obligationsand Funded Status***

E&S uses a December 31 measurement date for boththe Pension Plan and SERP.

49

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

As of December 31,2006 and 2005, the projected benefit obligations related to our defined benefitplans were equal to the accumulated benefit obligations, and therefore therewere no adjustments to the recorded pension liabilities and accumulated othercomprehensive income balances upon adoption of SFAS No. 158. Informationconcerning the obligations, plan assets and funded status of employeeretirement defined benefit plans are provided below:

| ** **                                         | ** ** | **Pension Plan** | ** ** | **SERP**   | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|------------|------------|
| ** **                                         | ** ** | **2006**              | ** ** | **2005**   | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Changes  in benefit obligation**                 | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Projected benefit  obligation at beginning of year |       | $                     | 43,290     |       | $          | 41,327 |   | $ | 8,919 |   | $ | 8,303 |   |
| Service cost                                       |       | —                |       | —     |       | 63 |   | 146 |   |
| Interest cost                                      |       | 2,400                 |       | 2,401      |       | 475 |   | 486 |   |
| Actuarial (gain)  loss                             |       | (213                  | )          | 2,711      |       | 239 |   | 465 |   |
| Benefits paid                                      |       | (242                  | )          | (236       | )          | (560 | ) | (481 | ) |
| Settlement  payments                               |       | (5,287                | )          | (2,913     | )          | (3,052 | ) | — |   |
| Projected benefit  obligation at end of year       |       | $                     | 39,948     |       | $          | 43,290 |   | $ | 6,084 |   | $ | 8,919 |   |
| **Changes in plan assets**                         | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fair value of  plan assets at beginning of year    |       | $                     | 27,613     |       | $          | 29,916 |   | $ | — |   | $ | — |   |
| Actual return on  plan assets                      |       | 3,157                 |       | 846        |       | — |   | — |   |
| Contributions                                      |       | 11,348                |       | —     |       | 3,612 |   | 481 |   |
| Benefits paid                                      |       | (5,529                | )          | (3,149     | )          | (3,612 | ) | (481 | ) |
| Fair value of  plan assets at end of year          |       | $                     | 36,589     |       | $          | 27,613 |   | $ | — |   | $ | — |   |
| **Net Amount Recognized**                          | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Unfunded status                                    |       | $                     | (3,359     | )          | $          | (15,677 | ) | $ | (6,084 | ) | $ | (8,919 | ) |
| Unrecognized net  actuarial loss                   |       | 6,976                 |       | 9,255      |       | 824 |   | 1,158 |   |
| Unrecognized  prior service cost                   |       | —                |       | —     |       | (448 | ) | (756 | ) |
| Net amount recognized                              |       | $                     | 3,617      |       | $          | (6,422 | ) | $ | (5,708 | ) | $ | (8,517 | ) |

 

Amountsrecognized in the consolidated balance sheets consist of:

| ** **                              | ** ** | **Pension Plan** | ** ** | **SERP** | ** ** |
|-----------------------------------------|------------|-----------------------|------------|----------|------------|
| ** **                              | ** ** | **2006**              | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Accrued liability                       |       | $                     | (3,359     | )        | $          | (15,677 | ) | $ | (6,084 | ) | $ | (8,919 | ) |
| Accumulated other  comprehensive income |       | 6,976                 |       | 9,255    |       | 376 |   | 402 |   |
| Net amount recognized                   |       | $                     | 3,617      |     | $          | (6,422 | ) | $ | (5,708 | ) | $ | (8,517 | ) |

 

**Components of net periodic benefit cost**

| ** **                               | ** ** | **Pension Plan** | ** ** | **SERP** | ** ** |
|------------------------------------------|------------|-----------------------|------------|----------|------------|
| ** **                               | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Service cost                             |       | $                     | —     |     | $          | — |   | $ | — |   | $ | 63 |   | $ | 146 |   | $ | 519 |   |
| Interest cost                            |       | 2,400                 |       | 2,401    |       | 2,498 |   | 475 |   | 485 |   | 508 |   |
| Expected return  on assets               |       | (2,350                | )          | (2,288   | )          | (2,362 | ) | — |   | — |   | — |   |
| Amortization of  actuarial loss          |       | 335                   |       | 112      |       | 67 |   | 58 |   | — |   | — |   |
| Amortization of  prior year service cost |       | —                |       | —   |       | — |   | (53 | ) | (59 | ) | (59 | ) |
| Settlement charge                        |       | 923                   |       | 623      |       | — |   | 5 |   | — |   | — |   |
| Net periodic benefit  cost (benefit)     |       | $                     | 1,308      |     | $          | 848 |   | $ | 203 |   | $ | 548 |   | $ | 572 |   | $ | 968 |   |

 

50

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**Additionalinformation**

The increase (decrease) to our unrecognized netactuarial loss recorded in other comprehensive income for the Pension Plan of$(2,279) and $3,418 during 2006 and 2005, respectively, arose from thedifference between the accumulated benefit obligation and the accrued pensionexpense at the end of each year.

The increase (decrease) toour minimum liability recorded in other comprehensive income for the SERP of$(26) and $402 during 2006 and 2005, respectively, arose from the difference betweenthe accumulated benefit obligation and the accrued pension expense at the endof each year.

**Assumptions**

The weighted average assumptions used to determinebenefit obligations at December 31, 2006 and 2005, included discount ratesof 6.00% and 5.75%, respectively, for the Pension Plan and SERP. The weightedaverage assumptions used to determine net periodic cost for years ended December 31,2006 and 2005 included a discount rate of 5.75% and 6.00%, respectively, forthe Pension and SERP. The weighted average assumption used to determine anexpected long-term rate of return on Pension Plan assets was 8.00%.

The long-term rate ofreturn on plan assets was estimated as the weighted average of expected returnof each of the asset classes in the target allocation of plan assets. Theexpected return of each asset class is based on historical market returns.

***PensionPlan Assets***

ThePension Plan’s weighted-average asset allocations at fiscal year-end,weighted-average planned targeted asset allocations going forward, and expectedlong-term returns on plan assets are as follows:

| **Asset allocation category of plan assets** | ** ** | ** ** | ** ** | **Target %** | ** ** | **2006   Actual %** | ** ** | **2005   Actual %** | ** ** | **Expected  Return %** | ** ** |
|-----------------------------------------------------------------------|------------|------------|------------|-------------------|------------|-------------------------------|------------|-------------------------------|------------|-----------------------------|------------|
| Cash and cash  equivalents                                            |       |       | 0          |              |       |                          | 0.7        |                          |       |                        | 57         |   |   |   | — |   |   |
| Fixed income                                                          |       |       | 40         |              |       |                          | 39.6       |                          |       |                        | —     |   |   |   | 2 |   |   |
| Domestic equities                                                     |       |       | 50         |              |       |                          | 49.4       |                          |       |                        | 35         |   |   |   | 5 |   |   |
| International equities                                                |       |       | 10         |              |       |                          | 10.3       |                          |       |                        | 8          |   |   |   | 1 |   |   |
|                                                                  |       |       |       |              |       |                          |       |                          |       |                        |       |   |   |   | 8 |   |   |

 

The asset allocation policy, consistent with thelong-term growth objectives of the Pension Plan, is to invest on a diversifiedbasis among various asset classes as determined by the Pension PlanAdministrative Committee. Assets will be invested in a manner that will providefor long-term growth with a goal to achieve returns equal to or greater thanapplicable benchmarks. Investments will be managed by registered investmentadvisors. When investing Pension Plan assets, the investment managers ofseparately managed accounts shall not utilize derivative instruments forspeculative purposes or to create leveraged positions.

No equity securities ofthe Company were part of the Pension Plan assets as of December 31, 2006or 2005.

51

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

***Cash Flow***

**Employercontributions**

Our funding policy is to contribute amounts sufficientto satisfy regulatory funding standards, based upon independent actuarialvaluations. We are not required to fundthe SERP. All benefit payments are made by us directly to those who receivebenefits from the SERP. As such, these payments are treated as bothcontributions and benefits paid for reporting purposes.

No contributions are expected to be made to thePension Plan in 2007. On May 26, 2006, the Company entered an assetpurchase agreement with Rockwell Collins, Inc. (see Note 2). Usingproceeds from the sale, the Company contributed $11,348 to pension assetsduring September 2006 in order to meet a funding obligation for plan years2005 and 2006.

Also using proceeds fromthe sale, the Company contributed $5,550 to the SERP plan to meet its change ofcontrol provision. The Company invested these funds in debt and equity securitiesthat have been classified and accounted for as available-for-sale securities. AtDecember 31, 2006, the investment was reported at its fair market value of$5,832 and was classified as prepaid pension and retirement. There was $271 ofunrealized gain recorded in accumulated other comprehensive income as of December 31,2006. The Company expects to contribute and pay benefits of approximately $560related to the SERP in 2007. This contribution is expected to be made byliquidating the prepaid pension and retirement investments. As a result of thechange in control and termination of certain employees, the Company recorded atermination charge of $255.

**Estimated futurebenefit payments**

Thefollowing benefit payments are expected to be paid based on actuarial estimatesand prior experience:

| **Fiscal years** | ** ** | ** ** | ** ** | **Pension  Plan** | ** ** | **SERP** | ** ** |
|-----------------------|------------|------------|------------|-------------------|------------|----------|------------|
| 2007                  |       | $          | 2,137      |              | $          | 560      |       |
| 2008                  |       | 1,448      |       | 574               |       |
| 2009                  |       | 2,269      |       | 589               |       |
| 2010                  |       | 2,161      |       | 568               |       |
| 2011                  |       | 2,574      |       | 535               |       |
| 2012-2016             |       | 15,081     |       | 2,514             |       |
|                       |            |            |            |                   |            |          |            |  |  |

 

52

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**Note 8—Long-termDebt**

Long-termdebt consists of the following as of December 31:

| ** **                                                                                                                                                                                                 | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Mortgage note  payable due in monthly installments of $23 including interest at 5.75%  through January 1, 2024; payment and rate subject to adjustment every 3  years, starting January 17, 2007 |       | $        | 2,930      |     |       | $ | — |   |   |
| Revolving credit  note payable, due June 30, 2007 with monthly interest at prime plus 0.5%  (8.75% at December 31, 2006)                                                                         |       | 700      |       |     | —     |   |   |
| Capitalized lease  obligations                                                                                                                                                                             |       | 8        |       |     | —     |   |   |
| Total debt                                                                                                                                                                                                 |       | 3,638    |       |     | —     |   |   |
| Less current  portion                                                                                                                                                                                      |       | (793     | )          |     | —     |   |   |
| Long term debt, less  current portion                                                                                                                                                                      |       | $        | 2,845      |     |       | — |   |   |

 

Principalmaturities on total debt are scheduled to occur in the following years:

| 2007       |   | $     | 793    |   |
|------------|--------|-------|--------|--------|
| 2008       |   | 88    |   |
| 2009       |   | 96    |   |
| 2010       |   | 104   |   |
| 2011       |   | 113   |   |
| Thereafter |   | 2,444 |   |
| Total debt |   | $     | 3,638  |   |

 

***Line of Credit***

On April 28, 2006, Spitz entered into a Line ofCredit Agreement (the “Credit Agreement”) and a Line of Credit Note (the “Note”)with a commercial bank, continuing a $3,000 line of credit for working capitalpurposes. Under the Note, the outstanding balance will bear a per annuminterest rate of one-half percent (0.5%) above the Wall Street Prime rate. TheNote matures June 30, 2007. The Note is secured by Spitz real and personalproperty, a guaranty agreement (the “Guaranty Agreement”) entered into by theCompany, and a pledge agreement (the “Pledge Agreement”) entered into by theCompany and the commercial bank. Three days after entering into the CreditAgreement, the maximum line of credit decreased to $2,500 per the CreditAgreement. Under the Credit Agreement, Spitz is required to, among other termsand conditions: maintain a minimum tangible net worth of $1,700, determinedquarterly; maintain a $200 average daily balance, measured quarterly, in itsdeposit accounts; and maintain an aggregate daily balance of Spitz depositaccounts with a commercial bank of not less than $100 for any consecutive fiveday period. Under the Guaranty Agreement, the Company has guaranteed thepayment and performance of the conditions of the Note. Under the PledgeAgreement the Company has granted to the commercial bank a first prioritysecurity interest and lien in and to all of the outstanding shares of Spitzcommon stock to secure the Note.

On July 28, 2006, theCompany and Spitz entered into an agreement to modify and amend the Creditagreement (“Modification Agreement”). The Modification Agreement reduced theborrowing limit to $1,100 and made certain changes to the terms of the CreditAgreement regarding the reporting for compliance of the tangible net worthcovenant. As of December 31, 2006, the Company was in compliance with thetangible net worth covenant and other covenants of the line of credit.

53

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

***Mortgage Note***

The mortgage note payablerepresents the balance on a $3,200 note (“Mortgage Note”) issued on January 14,2004 by Spitz. The Mortgage Note requires repayment in monthly installments ofprincipal and interest over twenty years. The monthly installment for the firstthree years is $23 and includes interest at 5.75% per annum. On January 14,2007 and each third year thereafter, the interest rate will be adjusted to thegreater of 5.75% or 3% over the Three-Year Constant Maturity Treasury Ratepublished by the United States Federal Reserve (“3YCMT”). The 3YCMT as of January 14,2007 was 4.83%. The monthly installment will be recalculated on the first monthfollowing a change in the interest rate. The recalculated monthly installmentwill be equal to the monthly installment sufficient to repay the principalbalance, as of the date of the change in the interest rate, over the remainingportion of the original twenty-year term. As of February 2007, the newmonthly installment amount is $26.The Mortgage Note is secured by the realproperty acquired with the proceeds of the note pursuant to a Mortgage andSecurity Agreement. The Mortgage Note and Credit Agreement contain crossdefault provisions whereby the default of either agreement will result in thedefault of both agreements. On March 30, 2007, the Company executed aGuarantee of Spitz’ obligation under the Mortgage Note in consideration for thereplacement of the requirement of annual audited financial statements of Spitzunder the Mortgage Note and Credit Agreement with the annual audited financialstatements of the Company.

***Lease Obligations***

With the acquisition ofSpitz, the Company acquired certain capital leases for equipment. Future annualrentals reflect interest rates ranging from 8.1% to 9.6%. Equipment related tosuch leases has been capitalized at its estimated fair value in connection withthe purchase price allocation and is reflected in property, plant and equipmentin the amount of $187 net of accumulated amortization of $18 as December 31,2006.

***6%Convertible Subordinated Debentures***

As of December 31,2005, there was $18,015 of 6% Convertible Subordinated Debentures outstanding(the “6% Debentures”) that were classified as long-term liabilities related todiscontinued operations. The 6% Debentures, due in 2012, were unsecured andwere convertible at each bondholder’s option into shares of our common stock ata conversion price of $42.10 per share for an aggregate of 428,000 shares ofour common stock if all outstanding 6% Debentures were converted, subject toadjustment. Prior to the sale of the Simulation Business, the 6% Debentureswere redeemable at our option, in whole or in part, at par. The Debenturesrequired redemption upon the sale of the Simulation Business. Accordingly, allof the Debentures were redeemed on June 26, 2006.

**Note 9—Income Taxes**

The income tax expense of $372 for 2006 is primarilyattributable to estimated tax on the gain from the sale of the SimulationBusiness. The income tax benefit of $430 for 2005 is primarily attributable tofavorable resolution of certain income tax contingencies. The income taxexpense of $112 for 2004 is primarily attributable to foreign income taxes.

54

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Theactual expense (benefit) differs from the expected tax expense (benefit) ascomputed by applying the U.S. federal statutory income tax rate of 35 percent,during fiscal year:

| ** **                                                | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Tax (expense)  benefit at U.S. federal statutory rate     |       | $        | (7,798     | )        | $          | 547      |       | $ | 3,016 |   |
| Gains of foreign  subsidiaries                            |       | (450     | )          | —   |       | —   |       |
| Adjustment for  resolution of tax contingency             |       | 147      |       | 430      |       | —   |       |
| State taxes (net  of federal income tax benefit)          |       | (620     | )          | —   |       | —   |       |
| Change in  valuation allowance attributable to operations |       | 8,605    |       | (489     | )          | (2,987   | )          |
| Other, net                                                |       | (256     | )          | (58      | )          | (141     | )          |
| Tax expense (benefit)                                     |       | $        | (372       | )        | $          | 430      |       | $ | (112 | ) |

 

Incometax (expense) benefit consisted of the following:

| ** **                                                       | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Income tax  (expense) benefit from continuing operations         |       | $        | 5,910      |     | $          | (6       | )          | $ | (76 | ) |
| Income tax  (expense) benefit from discontinued operations       |       | 2,775    |       | 436      |       | (36      | )          |
| Income tax  expense from gain on sale of discontinued operations |       | (9,057   | )          | —   |       | —   |       |
| Tax expense (benefit)                                            |       | $        | (372       | )        | $          | 430      |       | $ | (112 | ) |

 

Thetax effects of temporary differences that give rise to significant portions ofthe deferred tax assets and liabilities as of fiscal year-end:

| ** **                                                                  | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|-----------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| **Deferred  income tax assets:**                                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Plant and  equipment, principally due to differences in depreciation        |       | $          | 211        |       | $          | 1,597 |   |
| Inventory  reserves and other inventory related temporary basis differences |       | 633        |       | 5,717      |       |
| Warranty,  vacation, deferred rent and other liabilities                    |       | 1,894      |       | 4,287      |       |
| Pension accrual                                                             |       | 2,373      |       | 5,948      |       |
| Net operating  loss carryforwards                                           |       | 58,996     |       | 55,938     |       |
| Credit  carryforwards                                                       |       | 6,408      |       | 6,015      |       |
| Other                                                                       |       | 1,046      |       | 739        |       |
| Total deferred income tax assets                                            |       | 71,561     |       | 80,241     |       |
| Less valuation allowance                                                    |       | (71,324    | )          | (80,220    | )          |
| Net deferred income tax assets                                              |       | 237        |       | 21         |       |
| **Deferred income tax liabilities:**                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Intangible assets                                                           |       | (237       | )          | —     |       |
| Other                                                                       |       | —     |       | (21        | )          |
| Total deferred income tax liabilities                                       |       | (237       | )          | (21        | )          |
| Net deferred income  tax assets and liabilities                             |       | $          | —     |       | $          | — |   |

 

55

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Worldwideincome (loss) before income taxes consisted of the following:

| ** **    | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------|------------|----------|------------|----------|------------|----------|------------|
| United States |       | $        | 19,856     |     | $          | (1,565   | )     | $ | (8,618 | ) |
| Foreign       |       | 2,501    |       | 1        |       | 1        |       |
| Total         |       | $        | 22,357     |     | $          | (1,564   | )     | $ | (8,617 | ) |

 

Incometax (expense) benefit consisted of the following:

| ** **                               | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| *Current*                                |       |     |       |     |       |     |       |
| U.S. federal                             |       | $        | —     |     | $          | —   |       | $ | — |   |
| State                                    |       | (20      | )          | (6       | )          | —   |       |
| Foreign                                  |       | (352     | )          | 436      |       | (112     | )          |
| Total                                    |       | $        | (372       | )        | $          | 430      |       | $ | (112 | ) |
| *Deferred*                               |       |     |       |     |       |     |       |
| U.S. federal                             |       | (7,583   | )          | 706      |       | 5,588    |       |
| State                                    |       | (1,116   | )          | 103      |       | 822      |       |
| Foreign                                  |       | (197     | )          | (32      | )          | 24       |       |
|                                     |       | (8,896   | )          | 777      |       | 6,434    |       |
| Valuation  allowance increase (decrease) |       | 8,896    |       | (777     | )          | (6,434   | )          |
| Total                                    |       | $        | —     |     | $          | —   |       | $ | — |   |

 

We have total federal net operating loss carryforwardsof approximately $154,080 of which $176 begins to expire in 2007. We havevarious federal tax credit carryforwards of approximately $3,700 that expirebetween 2007 and 2021. We also have state net operating loss carryforwards ofapproximately $130,400 and state tax credit carryforwards of approximately $2,700that expire depending on the rules of the various states to which the lossor credit is allocated.

During the year ended December 31,2006, we decreased the valuation allowance on deferred income tax assets byapproximately $8,896. During the years ended December 31, 2005 and 2004,we increased the valuation allowance on deferred income tax assets byapproximately $777 and $6,434, respectively. Valuation allowances wereestablished according to our belief that it is more likely than not that thesenet deferred income tax assets will not be realized.

**Note 10—Commitmentsand Contingencies**

***CEO Resignation***

On June 8, 2006, weannounced the resignation of James R. Oyler as the Company’s Chief ExecutiveOfficer, President, and member of the Board of Directors, effective June 7,2006. In connection with the resignation ofMr. Oyler, the Company and Mr. Oyler entered into a Separation andRelease Agreement (the “Separation Agreement”), which provided, in part, that Mr. Oylerreceive his base salary through July 7, 2006; lump sum severance in anamount equal to two times Mr. Oyler’s “Gross Income” (as defined anddetermined in accordance with Mr. Oyler’s employment agreement) on January 10,2007; payment of the Company’s obligations to Mr. Oyler under itscompensation plans; payment of Mr. Oyler’s medical, dental and visionpremiums under COBRA until July 7, 2008; acceleration of the vesting ofany stock options issued and not 

56

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

vested as of June 7, 2006; and miscellaneous otherterms. The Company has made all required payments to Mr. Oyler as of thedate of this filing.

***Research and Development Arrangement***

In December 2005, weentered into a research and development agreement with a third party to pay $60a month for 24 months in return for design and development services to beprovided by the third party, and $2 million in quarterly payments over a twoyear period in exchange for future exclusive rights to the application of theresults of the research and development efforts to be provided by the thirdparty. We also agreed to pay $400 in cash or freely tradable common stock uponthe earlier of 2 years or a public announcement of a product utilizing theresults of the research and development efforts. We had $1,810 remaining to payas of December 31, 2006. Because the agreement relates to technology thatis under development and has not reached technological feasibility, allpayments made under the agreement are expensed as research and development asincurred. As of December 31, 2006, the Company had paid $2,030 of researchand development costs under the agreement.

***Other***

In December 2005, the Company sold a buildingwith a net book value of $3,820, for proceeds of $6,277, net of closing costs. We recognized a gain on the sale of $2,745in 2005. As part of the sale, we entered into a 21 month lease agreementwith the buyer obligating us to makecertain monthly payments through September 2007 depending on the remainingspace available for lease in the building sold. The Company is requiredto pay a monthly pro rata share of operating expenses not to exceed $319 overthe twenty-one month lease term. As ofDecember 31, 2006, we had a maximum remaining guarantee related to theseobligations of $468 recorded as an accrued liability. The maximum rentalguarantee may decrease as available space is leased, based on terms of therental guarantee. To the extent the maximum rental guarantee is reduced,additional gain will be realized.

As of December 31,2006, we had outstanding letters of credit and bank guarantees of $633. Lettersof credit that expire in 2007 total $633.

**Note 11—LegalProceedings**

In December 2005, wesettled a lawsuit previously filed by the Company against an insurance companywith respect to an insurance claim made by the Company for losses incurred dueto the cancellation of a significant contract by a customer. Under the terms ofthe settlement, the Company received a payment of $8,000 and agreed to dismissthe lawsuit and to provide a release of claims against the insurance company. Theinsurance settlement proceeds of $8,000 were recorded as gain on insurancesettlement and included with the loss from discontinued operations for the yearended December 31, 2005.

In the normal course ofbusiness, we may have various legal claims and other contingent matters. Althoughthe final outcome of such matters cannot be predicted, we believe the ultimatedisposition of these matters will not have a material adverse effect on ourconsolidated financial condition, liquidity or results of operations.

**Note 12—Stock Option and Stock Purchase Plans**

***Stock Option Plans***

In 2004, shareholdersapproved the adoption of the 2004 Stock Incentive Plan of Evans &Sutherland Computer Corporation (“2004 Plan”), which expires in 2014. The 2004Plan is a stock incentive plan that 

57

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

providesfor the grant of options and restricted stock awards to employees and for thegrant of options to non-employee directors. Under the 2004 Plan non-employeedirectors receive an annual option grant for no more than 10,000 shares. Newnon-employee directors receive an option grant for no more than 10,000 sharesupon their appointment or election. In addition, with the adoption of this planno additional options can be issued under any of the prior stock-based plans. The2004 Plan establishes a minimum exercise price for options of 110% of fairmarket value on the date of grant. Restricted stock awards may be qualified asa performance-based award that conditions a participant’s award uponachievement by the Company or its subsidiaries of performance goals establishedby our Board of Directors’ Compensation Committee.

The number of shares,terms, and exercise period of option grants are determined by the Board ofDirectors on an option-by-option basis. Options generally vest ratably overthree years and expire ten years from the date of grant. As of December 31,2006, options to purchase 487,022 shares of common stock were authorized andreserved for future grant.

Upon execution of theAsset Purchase Agreement (see Note 2 ), all options outstanding under the 2004Plan on February 7, 2006 were subject to accelerated vesting and becamefully vested by their terms.

Asummary of activity follows (shares in thousands):

| ** **                                                      | ** ** | **2006**                   | ** ** | **2005**                                | ** ** | **2004**                   | ** ** |
|-----------------------------------------------------------------|------------|----------------------------|------------|-----------------------------------------|------------|----------------------------|------------|
| ** **                                                      | ** ** | **Number  of shares** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Number  of shares** | ** ** | **Weighted-  average  exercise  price** | ** ** | **Number  of shares** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
| Outstanding at  beginning of year                               |       |                       | 2,226      |                                    |       |                       | $          | 10.38 |   |   |   | 2,183 |   |   |   | $ | 10.68 |   |   |   | 2,344 |   |   |   | $ | 11.33 |   |   |
| Granted                                                         |       |                       | 315        |                                    |       |                       | 6.59       |   |   |   | 257 |   |   |   | 7.30 |   |   |   | 288 |   |   |   | 4.79 |   |   |
| Exercised                                                       |       |                       | (57        | )                                       |       |                       | 4.27       |   |   |   | (3 | ) |   |   | 3.52 |   |   |   | (2 | ) |   |   | 4.56 |   |   |
| Cancelled                                                       |       |                       | (567       | )                                       |       |                       | 11.61      |   |   |   | (211 | ) |   |   | 9.81 |   |   |   | (447 | ) |   |   | 10.24 |   |   |
| Outstanding at  end of year                                     |       |                       | 1,917      |                                    |       |                       | 9.59       |   |   |   | 2,226 |   |   |   | 10.38 |   |   |   | 2,183 |   |   |   | 10.68 |   |   |
| Exercisable at year end                                         |       |                       | 1,609      |                                    |       |                       | 10.17      |   |   |   | 1,775 |   |   |   | 11.43 |   |   |   | 1,758 |   |   |   | 12.00 |   |   |
| Weighted average  fair value of options granted during the year |       |                       | $     | 2.39                                    |       |                       |       |   |   |   |   | $  | 2.79 |   |   |   |   |   |   |   | $  | 1.99 |   |   |   |   |   |   |
|                                                                 |            |                            |            |                                         |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

58

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

As of December 31, 2006, options exercisable andoptions outstanding had a weighted average remaining contractual term of 4.0and 4.8 years, respectively, and an aggregate intrinsic value of $6 and $6,respectively.

Thefair value of each option grant is estimated on the date of the grant using theBlack-Scholes option-pricing model with the following weighted-averageassumptions used for grants:

| ** **                | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|----------|------------|
| Expected life (in  years) |       |     | 2.6        |     |       |     | 2.6        |   |   |   | 2.6 |   |   |
| Risk free interest  rate  |       |     | 4.8        | %        |       |     | 3.8        | % |   |   | 1.8 | % |   |
| Expected  volatility      |       |     | 65         | %        |       |     | 71         | % |   |   | 69 | % |   |
| Dividend yield            |       |     | —     |     |       |     | —     |   |   |   | — |   |   |

 

Expected option lives and volatilities are based onhistorical data of the Company. Our risk free interest rate is calculated asthe average US Treasury bill rate that corresponds with the option life. Historically,the Company has not declared dividends and there are no future plans to do so.

During the years ended December 31,2006, 2005, and 2004, the total intrinsic value of options exercised was $72,$7, and $4 , respectively. As of December 31,2006, there was approximately $394 of total unrecognized share-basedcompensation cost related grants under our plans that will be recognized over aweighted-average period of 1.2 years.

***StockPurchase Plan***

The Company also had anemployee stock purchase plan under which a maximum of 800,000 shares of commonstock could be purchased by eligible employees. This plan allowed employees tohave up to 10% of their gross pay withheld each pay period to purchase theCompany’s common stock at 85% of the market value of the stock at the time ofthe sale. Under this plan, 2,253 shares in 2006, 17,702 shares in 2005, and26,132 shares in 2004 were purchased. The employee stock purchase plan expiredon February 20, 2006.

**Note 13—PreferredStock**

***Class APreferred Stock***

We have 5,000,000 authorized shares of Class APreferred Stock. As of December 31, 2006 and 2005, there were no Class APreferred shares of stock outstanding. Prior to 1998, we had reserved 300,000shares of Class A Preferred Stock as Series A Junior Preferred Stockunder a shareholder rights plan which expired in November 1998. In November 1998,the Board of Directors declared a dividend of one preferred stock purchaseright (“Right”) for each outstanding share of common stock of E&S forshareholders of record on November 19, 1998, and for all future issuancesof common stock. The Rights are not currently exercisable or transferable apartfrom the common stock and do not have voting rights or rights to receivedividends. Each Right entitles the registered holder to purchase from E&Sone thousandth of a share of Preferred Stock at a price per share of $60.00,subject to adjustment. The Rights will be exercisable ten business daysfollowing a public announcement of a person or group of affiliated personsacquiring beneficial ownership of 15% or more of our outstanding common sharesor following the announcement of a tender offer or exchange offer upon theconsummation of which would result in the beneficial ownership by a person orgroup of affiliated persons of 15% or more of the outstanding E&S stock. TheRights may be redeemed by E&S at a price of $0.01 per Right before November 30,2008.

59

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

In the event that we are acquired in a merger or otherbusiness combination transaction, provision shall be made so that each holderof a Right, excluding the Rights beneficially owned by the acquiring persons,will have the right to receive, upon exercise thereof at the then currentexercise price, that number of common shares of the surviving company which atthe time of such transaction will have a market value of two times the exerciseprice of the Right. In the event that a person or group of affiliated personsacquires beneficial ownership of 15% or more of our outstanding common shares,provision shall be made so that each holder of a Right, excluding the Rightsbeneficially owned by the acquiring persons, shall have the right to receive,upon exercise thereof, a share of common stock at a purchase price equal to 50%of the then current exercise price.

On August 13, 2004,E&S and American Stock Transfer & Trust Company amended the Rightsto allow Peter R. Kellog to acquire beneficial ownership up to 19.9% of ouroutstanding common shares without triggering the exercisability of the Rights. OnJune 7, 2000, E&S and American Stock Transfer & Trust Companyamended the Rights to allow the State of Wisconsin Investment Board to acquirebeneficial ownership up to 19.9% of our outstanding common shares withouttriggering the exercisability of the Rights.

***Class BPreferred Stock***

We have 5,000,000authorized shares of Class B Preferred Stock. As of December 31, 2006and 2005, no shares were outstanding.

**Note 14—Net Income(Loss) per Common Share**

Net income (loss) per common share is computed basedon the weighted-average number of common shares and, as appropriate, dilutivecommon stock equivalents outstanding during the period. Stock options arepotentially common stock equivalents.

Basic income or loss percommon share is based upon the average number of shares of common stockoutstanding during the period. Diluted net income per common share in 2006includes the effect of 21 dilutive shares from stock options deemed to becommon stock equivalents under SFAS No. 123(R). The effect of 26 and 11shares from stock options were excluded from the computation in 2005 and 2004,respectively, because the net loss in each year made the inclusion of suchshares anti-dilutive. Other potentially dilutive securities from stock optionsare discussed in Note 12.

**Note 15—GeographicInformation**

Thetable below presents sales by geographic location of our customers during thefiscal year. Sales within individual countries greater than 10% of consolidatedsales are shown separately:

| **Region or Country** | ** ** | ** ** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| United States                   |       | $          | 7,064      |     | $          | 9,297    |       | $        | 3,256      |   |
| Europe                          |       | 3,719      |       | 1,466    |       | 3,041    |       |
| Asia                            |       | 2,624      |       | 3,375    |       | 3,178    |       |
| North America  (excluding U.S.) |       | 1,291      |       | 146      |       | 4        |       |
| Other                           |       | 350        |       | 827      |       | —   |       |
| Total sales                     |       | $          | 15,048     |     | $          | 15,111   |       | $        | 9,479      |   |

 

60

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**Note 16—SignificantCustomers**

For the year ended December 31, 2006, noindividual customer provided 10% or more of total revenue. For the year ended December 31,2005, revenue from Customers A and B were 12% and 11% of total revenue,respectively. For the year ended December 31, 2004, revenue from CustomersB and C were 13% and 11% of total revenue, respectively.

At December 31, 2006, accounts receivable fromCustomers A, B and G were 19%, 14% and 14%, of total accounts receivable,respectively. At December 31, 2005, accounts receivable from Customers Aand D were 41% and 12% of total accounts receivable, respectively.

At December 31, 2006,Customers A and E had costs and estimated earnings in excess of billings thatrepresented 21% and 14% of total costs and estimated earnings in excess ofbillings, respectively. At December 31, 2005, Customers A and F had costsand estimated earnings in excess of billings that represented 49% and 26% oftotal costs and estimated earnings in excess of billings, respectively.

**Note 17—Restatementof Quarterly Financial Statements**

Duringthe fiscal 2006 year-end closing process, we reviewed our  classifications of the assets and liabilitiesof our discontinued Simulation Business that was sold to Rockwell Collinsduring the second quarter of 2006 and determined that certain items previouslyreported related to the reclassification of discontinued operations had beenclassified incorrectly between assets and liabilities from continuingoperations and assets and liabilities of discontinued operations for thebalance sheet at December 31, 2005, as previously filed on Form 10-Qas of June 30, 2006 and September 29, 2006. In addition, we foundthat the statement of operations for the nine months ended September 30,2005 required a reclassification of selling and marketing expenses betweencontinuing and discontinued operations. The amounts as filed and as restatedare presented below:

**Selected BalanceSheet Data (Unaudited)**

| **December 31, 2005**                           | ** ** | ** **   | ** ** | **As Previously  Reported** | ** ** | **Adjustment** | ** ** | **As Restated** | ** ** |
|-----------------------------------------------------------|------------|--------------|------------|----------------------------------|------------|----------------|------------|----------------------|------------|
| ***Assets***                                              | ** ** |         | ** ** | ** **                       |       |           | ** ** | ** **           |       |   | ** ** | ** ** |   |
| Accounts  receivable, net                                 |       |         | $          | 1,216                            | ** ** |           |       | $                    | (46        | ) |   |   | $ | 1,170 | ** ** |   |
| Prepaid expenses  and deposits                            |       |         | 3,285      | ** **                       |       |           | (1,877     | )                    |       |   | 1,408 | ** ** |   |
| Current assets  related to discontinued operations        |       |         | 25,995     | ** **                       |       |           | 1,924      |                 |       |   | 27,919 | ** ** |   |
| Property, plant  and equipment                            |       |         | 6,631      | ** **                       |       |           | 6          |                 |       |   | 6,637 | ** ** |   |
| Intangible assets                                         |       |    | —     | ** **                       |       |           | 10         | ** **           |       |   | 10 | ** ** |   |
| Other assets                                              |       |         | 959        | ** **                       |       |           | (340       | )                    |       |   | 619 | ** ** |   |
| Long-term assets  related to discontinued operations      |       |         | 9,523      | ** **                       |       |           | 323        | ** **           |       |   | 9,846 | ** ** |   |
| ***Liabilities***                                         | ** ** |         | ** ** | ** **                       |       |           | ** ** | ** **           |       |   | ** ** | ** ** |   |
| Accounts payable                                          |       |         | 3,095      | ** **                       |       |           | (184       | )                    |       |   | 2,911 | ** ** |   |
| Accrued  liabilities                                      |       |         | 7,288      | ** **                       |       |           | (3,685     | )                    |       |   | 3,603 | ** ** |   |
| Current  liabilities related to discontinued operations   |       |         | 13,798     | ** **                       |       |           | 3,869      |                 |       |   | 17,667 | ** ** |   |
| Convertible  subordinated notes                           |       |         | 18,015     | ** **                       |       |           | (18,015    | )                    |       |   | — | ** ** |   |
| Long-term liabilities  related to discontinued operations |       |         | 2,011      | ** **                       |       |           | 18,015     |                 |       |   | 20,025 | ** ** |   |
|                                                           |            |              |            |                                  |            |                |            |                      |            |  |  |  |  |  |  |  |  |  |

 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**Selected Statement of Operations Data (Unaudited)**

| **For the nine months ended September 30, 2005** | ** ** | ** ** | ** ** | **As Previously  Reported** | ** ** | **Adjustment** | ** ** | **As Restated** | ** ** |
|-------------------------------------------------------------------------------------|------------|------------|------------|----------------------------------|------------|----------------|------------|----------------------|------------|
| Selling, general  and administrative expense                                        |       |       | $          | 3,525                            |       |           |       | $                    | 801        |   |   |   | $ | 4,326 |   |   |
| Operating loss                                                                      |       |       | (3,054     | )                                |       |           | (801       | )                    |       |   | (3,855 | ) |   |
| Net loss from  continuing operations                                                |       |       | (2,675     | )                                |       |           | (801       | )                    |       |   | (3,476 | ) |   |
| Loss from  discontinued operations                                                  |       |       | (6,035     | )                                |       |           | 801        |                 |       |   | (5,234 | ) |   |
| Basic and diluted:                                                                  |       |       |       |                             |       |           |       |                 |       |   |   |   |   |
| Loss from continuing operations                                                     |       |       | $          | (0.25                            | )          |           |       | $                    | (0.08      | ) |   |   | $ | (0.33 | ) |   |
| Loss from  discontinued operations                                                  |       |       | $          | (0.57                            | )          |           |       | $                    | 0.08       |   |   |   | $ | (0.49 | ) |   |

 

| **For the nine months ended September 30, 2006** | ** ** | ** ** | ** ** | **As Previously  Reported** | ** ** | **Adjustment** | ** ** | **As Restated** | ** ** |
|-------------------------------------------------------------------------------------|------------|------------|------------|----------------------------------|------------|----------------|------------|----------------------|------------|
| Gain on assets  held for sale                                                       |       |       | 389        |                             |       |           | (401       | )                    |       |   | (12 | ) |   |
| Operating loss                                                                      |       |       | (10,617    | )                                |       |           | (401       | )                    |       |   | (11,018 | ) |   |
| Net loss from  continuing operations                                                |       |       | (6,566     | )                                |       |           | (401       | )                    |       |   | (6,967 | ) |   |
| Net income from  discontinued operations                                            |       |       | 32,869     |                             |       |           | 401        |                 |       |   | 33,270 |   |   |
| Basic and diluted:                                                                  |       |       |       |                             |       |           |       |                 |       |   |   |   |   |
| Loss from continuing operations                                                     |       |       | $          | (0.61                            | )          |           |       | $                    | (0.04      | ) |   |   | $ | (0.65 | ) |   |
| Loss from  discontinued operations                                                  |       |       | $          | 3.06                             |       |           |       | $                    | 0.04       |   |   |   | $ | 3.10 |   |   |

 

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**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors andStockholders of Evans & Sutherland Computer Corporation

We have audited the accompanying consolidated balancesheet of Evans & Sutherland Computer Corporation (the Company) as of December 31,2006, and the related consolidated statements of operations, stockholders’equity (deficit) and comprehensive income (loss), and cash flows for the yearthen ended.  These consolidated financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these consolidated financialstatements based on our audit. The consolidated financial statements as of December 31,2005 and for the two years then ended, before the adjustments described in Note2 to the consolidated financial statements, were audited by other auditorswhose report, dated March 31, 2006, expressed an unqualified opinion onthose statements.

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 the consolidated financial statements are free ofmaterial misstatement. An audit includes consideration of internal control overfinancial reporting as a basis for designing audit procedures that areappropriate in the circumstances, but not for the purpose of expressing anopinion on the effectiveness of the Company’s internal control over financialreporting. Accordingly, we express no such opinion. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe consolidated financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall consolidated financial statement presentation. Webelieve that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the consolidatedfinancial position of Evans & Sutherland Computer Corporation as of December 31,2006, and the consolidated results of their operations and their cash flows forthe year then ended in conformity with U.S. generally accepted accountingprinciples.

We also audited theadjustments described in Note 2 that were applied to restate the 2005 and 2004consolidated financial statements for the discontinued operations. In ouropinion, such adjustments are appropriate and have been properly applied. Wewere not engaged to audit, review, or apply any procedures to the 2005 and 2004consolidated financial statements of the Company other than with respect to theadjustments and, accordingly, we do not express an opinion or any other form ofassurance on the 2005 and 2004 consolidated financial statements taken as awhole.

/s/ Tanner LC

Salt Lake City, UtahApril 2, 2007

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**Report ofIndependent Registered Public Accounting Firm**

The Board of Directors and StockholdersEvans & Sutherland Computer Corporation:

We have audited, before the effects of adjustments torestate for discontinued operations described in Note 2, the accompanyingconsolidated balance sheet of Evans & Sutherland Computer Corporationand subsidiaries as of December 31, 2005, and the related consolidatedstatements of operations, stockholders’ equity and comprehensive loss, and cashflows for the years ended December 31, 2005 and 2004 (the 2005 and 2004consolidated financial statements before the effects of the adjustmentsdiscussed in Note 2 are not presented herein). The 2005 and 2004 consolidatedfinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these consolidated financialstatements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the 2005 and 2004 consolidatedfinancial statements referred to above, before the effects of adjustments torestate for discontinued operations described in Note 2, present fairly, in allmaterial respects, the financial position of Evans & SutherlandComputer Corporation and subsidiaries as of December 31, 2005, and theresults of their operations and their cash flows for the years ended December 31,2005 and 2004, in conformity with U.S. generally accepted accountingprinciples.

We were not engaged toaudit, review, or apply any procedures to the adjustments to restate fordiscontinued operations described in Note 2 and, accordingly, we do not expressan opinion or any other form of assurance about whether such adjustments areappropriate and have been properly applied. Those adjustments were audited byTanner LC.

/s/ KPMG LLP

Salt Lake City, UtahMarch 31, 2006

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**ITEM 9.**                CHANGES IN ANDDISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

**ITEM 9A.**        CONTROLSAND PROCEDURES

***Evaluationof Disclosure Controls and Procedures***

We maintain disclosure controls and procedures thatare designed to ensure that information required to be disclosed in its reportsunder the Securities Exchange Act of 1934, as amended, is recorded, processed,summarized and reported within the time periods specified in the rules andforms of the Securities and Exchange Commission, and that such information isaccumulated and communicated to management, including our Chief ExecutiveOfficer and Chief Financial Officer, as appropriate, to allow timely decisionsregarding required disclosure. In designing and evaluating the disclosurecontrols and procedures, management recognized that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives, andmanagement necessarily was required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures.

As required by Securitiesand Exchange Commission Rule 13a-15(b), we carried out anevaluation, under the supervision and with the participation of management,including our Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the design and operation of our disclosure controls andprocedures as of the end of the period covered by this report. Based on theforegoing, the Chief Executive Officer and Chief Financial Officer concludedthat the Company’s disclosure controls and procedures were effective at thereasonable assurance level.

***Changesin Internal Controls***

There have been no changesin our internal control over financial reporting that may have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting. Our process for evaluating controls and procedures iscontinuous and encompasses constant improvement of the design and effectivenessof established controls and procedures and the remediation of any deficiencieswhich may be identified during this process.

**ITEM 9B.**       OTHERINFORMATION

**Entry into aMaterial Definitive Agreement**

On March 30, 2007, E&S executed a Guaranteeof Spitz’ obligation under a mortgage loan agreement First Keystone Bank (“FKB”)dated January 14, 2004. Also on March 30, 2007****E&S,Spitz, and FKB amended the $3,000,000 Line of Credit Agreement (“CreditAgreement”) between Spitz and FKB, and the Mortgage Loan Agreement (“MortgageAgreement”) between Spitz and FKB to replace the requirement that we provideannual audited financial statements of Spitz with a requirement to provideannual audited financial statements of E&S. The Modification to the CreditAgreement, Modification to the Mortgage Agreement, and Guarantee are filed asExhibits 10.28, 10.29 and 10.30 to this Form 10-K and incorporatedherein by reference

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**PART III**

**ITEM 10.**         DIRECTORS,EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

Certain informationrequired by Item 401 of Regulation S-K will be included under the caption “Electionof Directors” in the Proxy Statement for our 2007 Annual Meeting of Shareholdersand that information is incorporated herein by reference. Information requiredby Item 405 of Regulation S-K will be included under the caption “Compliancewith Section 16(a) of the Securities Exchange Act of 1934” in theProxy Statement for our 2007 Annual Meeting of Shareholders and thatinformation is incorporated herein by reference. Certain information requiredby Item 401 of Regulation S-K is included in Part I of this Form 10-Kunder the caption “Executive Officers of the Registrant.” The informationrequired by Item 407(a) of Regulation S-K will be included under the caption “Electionof Directors” in the Proxy Statement for our 2007 Annual Meeting ofShareholders and that information is herein incorporated by reference.

**Code of Ethics**

Evans & Sutherland maintains a Code of Ethicsand Business Conduct which is applicable to all employees, including allofficers, and including our independent non-employee directors with regard toEvans & Sutherland related activities. The Code of Ethics and BusinessConduct incorporates our guidelines designed to deter wrongdoing and to promotehonest and ethical conduct and compliance with applicable laws and regulations.It also incorporates our expectations of our employees that enable us toprovide accurate and timely disclosure in our filings with the Securities andExchange Commission and other public communications. In addition, theyincorporate our expectations of our employees concerning prompt internalreporting of violations of our Code of Ethics and Business Conduct.

The full text of the Evans &Sutherland Code of Ethics and Business Conduct is published on our InvestorsRelations website at www.es.com. We intend to disclose future amendments tocertain provisions of our Code of Ethics and Business Conduct or waivers ofsuch provisions granted to executive officers and directors, on this websitewithin four business days following the date of such amendment or waiver.

**ITEM 11.**         EXECUTIVECOMPENSATION

The information requiredby this item will be included under the captions “Executive Compensation” and “Electionof Directors” in the Proxy Statement for our 2007 Annual Meeting ofShareholders and that information is herein incorporated by reference.

**ITEM 12.**         SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS

The information requiredby Item 403 of Regulation S-K will be included under the caption “SecurityOwnership of Certain Beneficial Owners and Management” in the Proxy Statementfor our 2007 Annual Meeting of Shareholders and that information is hereinincorporated by reference.

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**Securities Authorized for Issuance Under EquityCompensation Plans as of December 31, 2006**

| ** **                                                  | ** ** | ** **                           | ** ** | ** **                        | ** ** | **Number of securities**          | ** ** |
|-------------------------------------------------------------|------------|--------------------------------------|------------|-----------------------------------|------------|---------------------------------------------|------------|
| ** **                                                  | ** ** | **Number of securities**   | ** ** | ** **                        | ** ** | **remaining available for**       | ** ** |
| ** **                                                  | ** ** | **to be issued upon** | ** ** | **Weighted average**         | ** ** | **future issuance**                    | ** ** |
| ** **                                                  | ** ** | **exercise of**                 | ** ** | **exercise price of**   | ** ** | **under equity compensation**     | ** ** |
| ** **                                                  | ** ** | **outstanding options,**        | ** ** | **outstanding options,**     | ** ** | **plans (excluding securities**   | ** ** |
| ** **                                                  | ** ** | **warrants and rights**    | ** ** | **warrants and rights** | ** ** | **reflected in column (a))** | ** ** |
| ** **                                                  | ** ** | **(a)**                              | ** ** | **(b)**                           | ** ** | **(c)**                                     | ** ** |
| Equity  compensation plans approved by security holders     |       |                                 | 1,917,695  |                              |       |                                        | $          | 9.59 |   |   |   | 487,022 |   |   |
| Equity  compensation plans not approved by security holders |       |                                 | —     |                              |       |                                        | —     |   |   |   | — |   |   |
| Total                                                       |       |                                 | 1,917,695  |                              |       |                                        | $          | 9.59 |   |   |   | 487,022 |   |   |

 

**ITEM 13.**         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS

The information requiredby Item 404 of Regulation S-K will be included under the caption “CertainRelationships and Related Party Transactions” in the Proxy Statement for our2007 Annual Meeting of Shareholders and that information is herein incorporatedby reference.

**ITEM 14.**         PRINCIPALACCOUNTANT FEES AND SERVICES

The information required by Item 14 will be includedunder the caption “Report of the Audit Committee of the Board of Directors” inthe Proxy Statement for our 2007 Annual Meeting of Shareholders and thatinformation is herein incorporated by reference.

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**PART IV**

**ITEM 15.**         EXHIBITSAND FINANCIAL STATEMENT SCHEDULES

**(a)****          Listof documents filed as part of this report**

1.                FinancialStatements

The followingconsolidated financial statements are included in Part II, Item 8 of thisreport on Form 10-K.

·        ConsolidatedBalance Sheets as of December 31, 2006 and 2005

·        ConsolidatedStatement of Operations for each of the years in the three-year period ended December 31,2006

·        Consolidated Statements of Stockholders’ Equity andComprehensive Loss for each of the years in the three-year period endedDecember 31, 2006

·        Consolidated Statement ofCash Flows for each of the years in the three-year period ended December 31,2006

·        Notes to ConsolidatedFinancial Statements

2.                FinancialStatement Schedules

There are no schedulesfiled because of the absence of conditions under which they are required orbecause the required information is presented in the consolidated financialstatements or the notes thereto.

3.                Exhibits

| Articles of Incorporation and Bylaws |
|--------------------------------------|
| 3.1.1                                |   | Articles of  Incorporation, as amended, filed as Exhibit 3.1 to Evans &  Sutherland Computer Corporation’s Annual Report on Form 10-K, SEC  File No. 000-08771, for the fiscal year ended December 25,  1987, and incorporated herein by this reference. |
| 3.1.2                                |   | Amendments to Articles  of Incorporation filed as Exhibit 3.1.1 to Evans & Sutherland  Computer Corporation’s Annual Report on Form 10-K, SEC File  No. 000-08771, for the fiscal year ended December 30, 1988,  and incorporated herein by this reference. |
| 3.1.3                                |   | Certificate of  Designation, Preferences and Other Rights of the Class B-1  Preferred Stock of Evans & Sutherland Computer Corporation, filed as  Exhibit 3.1 to Evans & Sutherland Computer Corporation’s  Form 10-Q, SEC File No. 000-08771, for the quarter  ended September 25, 1998, and incorporated herein by this reference. |
| 3.2.1                                |   | Amended and Restated  Bylaws of Evans & Sutherland Computer Corporation, filed as  Exhibit 3.2 to Evans & Sutherland Computer Corporation’s  Form 10-K for the year ended December 31, 2000, and  incorporated herein by this reference. |
| 3.2.2                                |   | Amendment No. 1 to  the Amended and Restated Bylaws of Evans & Sutherland Computer  Corporation, filed as Exhibit 3.3 to Evans & Sutherland  Computer Corporation’s Form 10-K for the year ended  December 31, 2000, and incorporated herein by this reference. |

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| Instruments defining the  rights of security holders |
|------------------------------------------------------|
| 4.1                                                  |   | Form of Rights  Agreement, dated as of November 19, 1998, between Evans &  Sutherland Computer Corporation and American Stock Transfer Trust Company  which includes as Exhibit A, the form of Certificate of Designation for  the Rights, as Exhibit B, the form of Rights Certificate and as  Exhibit C, a Summary of Rights, filed as Exhibit 1 to Evans &  Sutherland Computer Corporation’s Registration Statement on Form 8-A  filed December 8, 1998, and incorporated herein by this reference. |
| 4.2                                                  |   | First Amendment to  Rights Agreement dated as of June 7, 2000 between Evans &  Sutherland Computer Corporation and American Stock Transfer & Trust  Company, filed as Exhibit 10.14 to Evans & Sutherland Computer  Corporation’s Form 10-Q for the quarter ended June 30, 2000,  and incorporated herein by this reference. |
| 4.3                                                  |   | Second Amendment to  Rights Agreement dated as of August 13, 2004 between Evans &  Sutherland Computer Corporation and American Stock Transfer & Trust  Company, filed as Exhibit 4.1 to Evans & Sutherland Computer  Corporation’s Form 8-K filed on August 16, 2004, and  incorporated herein by this reference. |
| Material contracts                                   |
| Management  contracts and compensatory plans         |
| 10.1                                                 |   | Evans &  Sutherland Computer Corporation 1998 Stock Option Plan, as amended as through  May 17, 2000, filed as exhibit 4.1 to Evans & Sutherland  Computer Corporation’s Post Effective Amendment No. 1 to Registration  Statement on Form S-8, SEC File No. 333-58733, and  incorporated herein by this reference. |
| 10.2                                                 |   | Evans &  Sutherland Computer Corporation’s 1995 Long-Term Incentive Equity Plan, filed  as Exhibit 10.11 to Evans & Sutherland Computer Corporation’s  Annual Report on Form 10-K, SEC File No. 000-08771, for  the fiscal year ended December 29, 1995, and incorporated herein by this  reference. |
| 10.3                                                 |   | Evans &  Sutherland Computer Corporation 2004 Stock Incentive Plan, filed as Annex A  to Evans & Sutherland’s Form 14A, SEC File No. 001-14667,  filed on April 19, 2004 and incorporated herein by this reference. |
| 10.4                                                 |   | Amended and restated  Evans & Sutherland Computer Corporation’s Supplemental Executive  Retirement Plan (SERP), dated May 16, 2002, filed as Exhibit 10.38  to Evans & Sutherland Computer Corporation’s Form 10-K  for the year ended December 31, 2002, and incorporated herein by  reference. |
| 10.5                                                 |   | Amended and restated  Evans & Sutherland Computer Corporation’s Executive Savings Plan,  dated May 16, 2002, filed as Exhibit 10.39 to Evans &  Sutherland Computer Corporation’s Form 10-K for the year ended  December 31, 2002, and incorporated herein by reference. |

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| 10.6                     |   | Employment agreement  between Evans & Sutherland Computer Corporation and James R. Oyler,  dated May 16, 2000, filed as Exhibit 10.6 to Evans &  Sutherland Computer Corporation’s Form 10-Q for the quarter ended  June 30, 2000, and incorporated herein by this reference.                                                       |
|--------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.7                     |   | Amendment to employment  agreement between Evans & Sutherland Computer Corporation and James  R. Oyler, dated September 22, 2000, filed as Exhibit 10.1 to  Evans & Sutherland Computer Corporation’s Form 10-Q for  the quarter ended September 29, 2000, and incorporated herein by this  reference.                              |
| 10.8                     |   | Employment agreement  between Evans & Sutherland Computer Corporation and Kirk Johnson,  dated August 26, 2002, filed as Exhibit 10.14 to Evans &  Sutherland Computer Corporation’s Form 10-K for the year ended  December 31, 2004, and incorporated herein by reference.                                                         |
| 10.9                     |   | Employment Agreement,  dated February 8, 2006, by and between Evans & Sutherland  Computer Corporation and Jonathan Shaw, filed as Exhibit 10.1 to  Evans & Sutherland Computer Corporation’s Form 10-Q for  the quarter ended June 30, 2006, and incorporated herein by reference.                                                 |
| 10.10                    |   | Employment Agreement  dated February 8, 2006, by and between Evans & Sutherland  Computer Corporation and Paul Dailey, filed as Exhibit 10.2 to  Evans & Sutherland Computer Corporation’s Form 10-Q for  the quarter ended June 30, 2006, and incorporated herein by reference.                                                    |
| 10.11                    |   | Separation and Release  Agreement, dated June 8, 2006, by and between Evans &  Sutherland Computer Corporation and James R. Oyler, filed as  Exhibit 10.3 to Evans & Sutherland Computer Corporation’s  Form 10-Q for the quarter ended June 30, 2006, and incorporated  herein by reference.                                       |
| 10.12                    |   | Agreement and Release of  ADEA Claims, dated June 8, 2006, by and between Evans &  Sutherland Computer Corporation and James R. Oyler, filed as  Exhibit 10.4 to Evans & Sutherland Computer Corporation’s  Form 10-Q for the quarter ended June 30, 2006, and  incorporated herein by reference.                                   |
| 10.13                    |   | Employment Agreement,  dated August 26, 2002, by and between Evans & Sutherland  Computer Corporation and David H. Bateman, filed herein.                                                                                                                                                                                                                        |
| Other material contracts |
| 10.14                    |   | Confidential Settlement  Agreement and Mutual Release, dated December 28, 2005, by and between  Evans & Sutherland Computer Corporation and Federal Insurance  Company, filed as Exhibit 10.21 to Evans & Sutherland Computer  Corporation’s Form 10-K for the year ended December 31, 2005,  and incorporated herein by reference. |
| 10.15                    |   | Asset Purchase  Agreement, dated February 7, 2006, by and between Evans &  Sutherland Computer Corporation and Rockwell Collins, Inc. filed as  Exhibit 10.1 to Evans & Sutherland Computer Corporation’s  Form 8-K filed February 9, 2006, and incorporated herein by  this reference.                                        |

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| 10.16 |   | Stock Purchase  Agreement, dated February 7, 2006, by and among Evans &  Sutherland Computer Corporation, Spitz, Inc., and Transnational  Industries, Inc. filed as Exhibit 10.2 to Evans &  Sutherland Computer Corporation’s Form 8-K filed February 9,  2006, and incorporated herein by this reference.                           |
|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.17 |   | Line of Credit  Agreement, dated April 28, 2006, between Evans & Sutherland  Computer Corporation, Spitz, Inc. and First Keystone Bank, filed as  Exhibit 10.4 to Evans & Sutherland Computer Corporation’s  Form 10-Q for the quarter ended June 30, 2006, and  incorporated herein by reference.                                         |
| 10.18 |   | Line of Credit Note,  dated April 28, 2006, by and between Evans & Sutherland Computer  Corporation, Spitz, Inc. and First Keystone Bank, filed here with filed  as Exhibit 10.6 to Evans & Sutherland Computer Corporation’s  Form 10-Q for the quarter ended June 30, 2006, and  incorporated herein by reference.                       |
| 10.19 |   | Guaranty, dated  April 28, 2006, by Evans and Sutherland Computer Corporation, filed as  Exhibit 10.7 to Evans & Sutherland Computer Corporation’s  Form 10-Q for the quarter ended June 30, 2006, and  incorporated herein by reference.                                                                                                                |
| 10.20 |   | Pledge Agreement, dated  April 28, 2006, by and between Evans & Sutherland Computer  Corporation, Spitz, Inc. and First Keystone Bank, filed as  Exhibit 10.8 to Evans & Sutherland Computer Corporation’s  Form 10-Q for the quarter ended June 30, 2006, and  incorporated herein by reference.                                          |
| 10.21 |   | Security Agreement,  dated April 28, 2006, by and between Spitz, Inc., filed here with  filed as Exhibit 10.9 to Evans & Sutherland Computer  Corporation’s Form 10-Q for the quarter ended June 30, 2006,  and incorporated herein by reference.                                                                                                   |
| 10.22 |   | Open-end Mortgage and  Security Agreement, dated April 28, 2006, by and between  Spitz, Inc., filed as Exhibit 10.10 to Evans & Sutherland  Computer Corporation’s Form 10-Q for the quarter ended  June 30, 2006, and incorporated herein by reference.                                                                                            |
| 10.23 |   | First Modification Agreement  to Line of Credit Agreements, dated July 28, 2006, by and between  Evans & Sutherland Computer Corporation, Spitz, Inc. and First  Keystone Bank, filed as Exhibit 10.11 to Evans & Sutherland  Computer Corporation’s Form 10-Q for the quarter ended June 30,  2006, and incorporated herein by reference. |
| 10.24 |   | Credit Agreement between  Evans & Sutherland Computer Corporation and Wells Fargo Bank,  National Association effective December 1, 2006, filed herein.                                                                                                                                                                                                                      |
| 10.25 |   | Mortgage Note dated  January 14, 2004, of Transnational Industries, Inc. and  Spitz, Inc. to First Keystone Bank filed herein.                                                                                                                                                                                                                                              |
| 10.26 |   | Open-End Mortgage and  Security Agreement dated January 14, 2004, between Spitz, Inc. and  First Keystone Bank filed herein.                                                                                                                                                                                                                                                     |
| 10.27 |   | Loan Agreement dated as  January 14, 2004, between First Keystone Bank, Transnational  Industries, Inc. and Spitz, Inc filed herein.                                                                                                                                                                                                                                             |

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| 10.28                                             |   | First Modification  Agreement to Mortgage Loan Agreements, dated March 30 2007, by and  between Evans & Sutherland Computer Corporation, Spitz, Inc. and  First Keystone Bank, filed herein.                                                                                   |
|---------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.29                                             |   | Second Modification  Agreement to Line of Credit Agreements, dated March 30 2007, by and  between Evans & Sutherland Computer Corporation, Spitz, Inc.  and First Keystone Bank, filed herein.                                                                                 |
| 10.30                                             |   | Guaranty, dated  March 30, 2007 by Evans and Sutherland Computer Corporation, filed  herein.                                                                                                                                                                                                 |
| Letter re change in  certifying accountant        |
| 16.1                                              |   | Letter from KPMG, LLP to  the United States Securities and Exchange Commission dated October 12,  2006, filed as Exhibit 16.1 to Evans & Sutherland Computer  Corporation’s Form 8-K filed October 12, 2006, and  incorporated herein by this reference herein. |
| Subsidiaries of the  registrant                   |
| 21.1                                              |   | Subsidiaries of  Registrant, filed herein.                                                                                                                                                                                                                                                        |
| Consent of experts and  counsel                   |
| 23.1                                              |   | Consent of Current  Independent Registered Public Accounting Firm, filed herein.                                                                                                                                                                                                                  |
| 23.2                                              |   | Consent of Prior  Independent Registered Public Accounting Firm, filed herein                                                                                                                                                                                                                     |
| Rule 13a-14(a)/15d-14(a) Certifications |
| 31.1                                              |   | Certification of Chief  Executive Officer pursuant to Rule 13a-14(a) and  Rule 15d-14(a) of the Securities Exchange Act, as amended,  filed herein.                                                                                                                           |
| 31.2                                              |   | Certification of Chief  Financial Officer pursuant to Rule 13a-14(a) and  Rule 15d-14(a) of the Securities Exchange Act, as amended,  filed herein.                                                                                                                           |
| Section 1350 Certifications                  |
| 32.1                                              |   | Certification of Chief  Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C.  1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of  2002, filed herein.                                                                                                 |

 

**TRADEMARKS USED INTHIS FORM 10-K**

E&S, ESLP, and Digistar are trademarks orregistered trademarks of Evans & Sutherland Computer Corporation. Allother product, service, or trade names or marks are the properties of theirrespective owners.

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**SIGNATURES**

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the Registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.
|        |   | EVANS & SUTHERLAND COMPUTER CORPORATION |
|--------|--------|--------------------------------------------------|
|   |   | By                                               | * * | /s/ DAVID H. BATEMAN |
|   |   |                                             |   | David H. Bateman |
|   |   |                                             |   | *Chief Executive Officer and Director* |

 

March 30, 2007

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has been signedbelow by the following persons on behalf of the Registrant and in thecapacities and on the dates indicated.
|                                                                                           | **Signature** | ** **                                                | ** ** | ** **           | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|-------------------------------------------------------------------------------------------|---------------|-----------------------------------------------------------|------------|----------------------|-----------|------------|------------|------------|----------|------------|
| /s/      DAVID  H. BATEMAN                                       |          | Chief  Executive Officer  and Director                    |       | March 30, 2007  |
|            David H. Bateman             |          | (Principal  Executive Officer)                            |       |                 |
| /s/      PAUL L. DAILEY                                          |          | Chief Financial Officer  (Principal Financial Officer and |       | March 30,  2007 |
|            Paul L. Dailey               |          | Principal  Accounting Officer)                            |       |                 |
| /s/      DAVID J. COGHLAN                                        |          | Chairman of the Board                                     |       | March 30,  2007 |
|            David J. Coghlan             |          |                                                      |       |                 |
| /s/      WILLIAM SCHNEIDER, JR.                             |          | Director                                                  |       | March 30,  2007 |
|            William  Schneider, Jr. |          |                                                      |       |                 |
| /s/      JAMES P. MCCARTHY                                       |          | Director                                                  |       | March 30,  2007 |
|            James P. McCarthy            |          |                                                      |       |                 |

 

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