**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

**(MarkOne)**

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

**Forthe fiscal year ended December 31, 2004**

**or**

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

**Forthe transition from                         to                        **

**Commissionfile number 0-8771**

**EVANS & SUTHERLAND COMPUTERCORPORATION**

| **Utah**                                                         | **87-0278175**                        |
|------------------------------------------------------------------|---------------------------------------|
| (State or other  jurisdiction of  Incorporation or organization) | (I.R.S. Employer  Identification No.) |
| **600 Komas Drive, Salt Lake City, Utah**                        | **84108**                             |
| (Address of  principal executive offices)                        | (Zip Code)                            |

 

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

Securities registered pursuant to section 12(b) ofthe Act:

**NONE**

Securities registeredpursuant to section 12(g) of the Act:

|                                      | **Title of Class** | ** ** |
|--------------------------------------|--------------------|------------|
| Common Stock, $0.20 par value        |
| 6% Convertible Debentures Due 2012   |
| Preferred Stock Purchase Plan Rights |

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities and Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.  xYes  o No

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of the registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part II of this Form 10-K or any amendment to thisForm 10-K.  o

Indicated by check markwhether the registrant is an accelerated filer (as defined by Rule 12b-2of the Act).  oYes  x No

The aggregate market valueof the voting and non-voting Common Stock held by non-affiliates of theregistrant as of July 2, 2004, the last business day of the registrantsmost recently completed second fiscal quarter was approximately $26,784,717based on the closing market price of the Common Stock on such date as reportedby The NASDAQ Stock Market.

The number of shares ofthe registrants Common Stock outstanding as of February 25,2005 was 10,514,040.

DOCUMENTS INCORPORATED BYREFERENCE

Portionsof the Proxy Statement for the 2005 Annual Meeting of Shareholders to be heldon May 26, 2005, are incorporated by reference into Part III hereof.

 

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**EVANS &SUTHERLAND COMPUTER CORPORATIONFORM 10-KFOR THE YEAR ENDED DECEMBER 31, 2004**
| **PART I**   |
|-------------------|
| ITEM 1.           |   | BUSINESS | 3 |
| ITEM 2.           |   | PROPERTIES | 9 |
| ITEM 3.           |   | LEGAL  PROCEEDINGS | 9 |
| ITEM 4.           |   | SUBMISSIONS  OF MATTERS TO A VOTE OF SECURITY HOLDERS | 9 |
| **PART II**  |
| ITEM  5.          |   | MARKET FOR REGISTRANT’S  COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY  SECURITIES | 10 |
| ITEM  6.          |   | SELECTED FINANCIAL DATA | 11 |
| ITEM  7.          |   | MANAGEMENT’S DISCUSSION AND  ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | 13 |
| ITEM 7A.          |   | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | 34 |
| ITEM  8.          |   | FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA | 35 |
| ITEM 9.           |   | CHANGES  IN AND DISAGREEMENTS WITH ACCOUNTANTS AND ACCOUNTING AND FINANCIAL DISCLOSURE | 64 |
| ITEM 9A.          |   | CONTROLS AND  PROCEDURES | 64 |
| ITEM 9B.          |   | OTHER  INFORMATION | 65 |
| **PART III** |
| ITEM 10.          |   | DIRECTORS  AND EXECUTIVE OFFICERS | 66 |
| ITEM 11.          |   | EXCECUTIVE  COMPENSATION | 66 |
| ITEM 12.          |   | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER  MATTERS | 66 |
| ITEM 13.          |   | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS | 67 |
| ITEM 14.          |   | PRINCIPAL  ACCOUNTANT FEES AND SERVICES | 67 |
| **PART IV**  |
| ITEM 15.          |   | EXHIBITS  AND FINANCIAL STATEMENT SCHEDULES | 67 |
| SIGNATURES        | 74 |

 

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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.” All dollar amounts are in thousands unlessotherwise indicated.

E&S was incorporatedin the state of Utah on May 10, 1968. Our principal offices are located at600 Komas Drive, Salt Lake City, Utah 84108, and our telephone 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 SECat the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington,D.C. 20549. Information on the operation of the Public Reference Room maybe obtained by calling the SEC at 1-800-SEC-0330.

**General**

Evans & Sutherland produces high-qualityvisual systems used to rapidly and accurately display computer-generated imagesof the real world. With a 37-year history in computer graphics, we arewidely regarded as both a pioneer and a leader in providing the world’s mostrealistic visual systems. We design, manufacture, market and support our visualsystems to provide simulation training for a wide range of military andcommercial applications, as well as for planetariums, science centers, andentertainment venues. We use a wide range of hardware, from desktop personalcomputers (PCs) to what we believe are the most advanced image generation anddisplay components in the world.

For more than 30 years, we have had a significantshare of the overall market for visual systems. We estimate that our marketshare has ranged from 20% to 60%, depending on the specific market. We estimatethat the size of the market for visual systems is approximately $300 millionannually. Many visual system providers serve this market, but our mostsignificant competitors are companies that build the entire simulator. Thesecompanies sometimes choose to follow a strategy of vertical integration byproviding their own visual systems. Other competitors include a number ofsmaller companies that generally offer components rather than complete visualsystems. In addition, large contractors and system integrators sometimes buildvisual systems from commercially available components.

Our visual systems are extremely important componentsof a complete simulator because the visual system is the most critical elementin creating a realistic immersive environment—the visual system is, bydefinition, “what you see.” Most of our visual systems are used as part ofvehicle simulators, which are models of actual vehicles, such as aircraftcockpits. These simulators are used for training operators as well as forpracticing tactics or strategy, which may require the coordinated operation ofmultiple simulators. Simulators are used in both commercial and militarysettings and include all types of vehicles operating in space, air, ground, seaor undersea locations. The simulator itself may be built by one of manycompanies, often the same company that built the actual vehicle. We alsoproduce visual systems for digital planetariums, which are based on the sametechnology as our visual systems for training simulation. These systems areessentially simulators of the larger universe, and can create simulated tripsthrough other worlds or through parts of our own world not accessible toexisting vehicles.

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A “visual system” is madeof three major components: a computer, a display system, and a visual database.E&S designs a range of these components at varying prices and performancelevels.

The computer portion of anE&S visual system, the image generator, is a combination of hardware andsoftware we design and either manufacture ourselves or source to a partner whoassembles the image generator from commercially available components. Imagegenerators create computer-generated images in real time and send these imagesto a display system.

The display portionconsists of projectors, display screens, computer monitors and specializedoptics that may include options such as full dome mosaics, collimated displays,rear projection systems, onboard instrument displays and domes offering a 360-degreefield-of-view. The image may be projected by different types of equipment,including multiple projector types.

The visual databaseportion (often referred to as a synthetic environment) is the “content” thatthe system displays. Most customers desire more content (visual databases) toenhance the richness and variety of their training and simulations. Inaddition, visual databases are finding new applications in mission planning,damage assessment, intelligence, and other highly-time-sensitive defense andhomeland security initiatives. We have developed a sophisticated set of toolsto make the development of visual databases more efficient and less costly,whether built by us or by others. We have an extensive library of databases,including airports, vehicles, large geographic areas, oceans and seas withaccurate wave dynamics, and special effects.

**Description ofProducts**

E&S offers a range ofvisual systems for simulation, strategic visualization and digital theaters,with the option to configure systems, subsystems or components for eachcustomer. An E&S visual system consists of an image generator, displaysystem, visual database, and optional tools to create visual databases. Inaddition, we offer installation, integration and customer support servicesalong with each visual system. On occasion, we may sell subsystems and theindividual components to our customers.

**Description ofMarkets**

We are an industry leaderin providing visual systems to an international customer base in the militarysimulation, commercial simulation and digital theater markets. In each of thesemarkets we face highly competitive conditions, where some competitors havesubstantial financial resources and technological capabilities. In all ourmarkets we compete on features, performance and price. In the military andcommercial simulation markets we additionally compete on service and productavailability, while in the digital theater market we also compete on showcontent, access to customers, and distribution channels. We believe our rangeof visual systems and services at various price and performance levels, ourresearch and development investments, and our ability to design and manufacturevalue-added visual systems enable us to compete effectively.

***Military Simulation***

The military simulationmarket includes several large competitors such as Lockheed Martin, ThalesTraining and Simulation, and CAE, Inc. Some of these large competitors notonly provide visual systems, but also provide entire simulators and act asprime contractors. In such cases, these competitors provide their own visual system.To compete in this environment, our strategy is to provide the best performancepossible at a competitive price.

Overall, this market hasdeclined in size over the last several years. In addition, we believe thenumber of military contracts has also decreased. These two effects adverselyaffected our profitability and our sales have declined. However, we do expectto see market growth during 2005.

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We believe our productstrategy is succeeding in this declining market, as demonstrated by the successof our EPX based visual systems. Our EPX technology has captured significantcontracts during 2004, and has assisted us in gaining international helicopterand fast jet customers. We have sold over two thousand channels of EPXtechnology and were awarded one of the largest ground warfare programs by theU.S. government in 2004, the Close Combat Tactical Trainer. One of theadvantages of the EPX technology is that it can run across a full range ofhardware platforms, using the same software and databases. This commonalityoffers customers the significant capability to match hardware performance andcost while maintaining software, database and training commonality. Inaddition, we continue to market and sell other visual systems in this marketbased on our Harmony 2, simFUSION and ESIG image generators.

***Commercial Simulation***

We are a market leader in supplying visual systems tothe world’s commercial airlines, airframe manufacturers, and independenttraining providers for commercial pilot training. While the commercialsimulation market is made up of a few large competitors, our main competitor isCAE. CAE has expanded into training services where only their products,including visual systems, are supplied to their training centers. Nevertheless,2004 was a very successful orders year, with orders of 13 visual systems fornew simulators and 15 visual systems as upgrades to existing simulators.

The overall market for commercial simulators wasrelatively flat in 2004 as a result of a decline in new simulators for commercialairlines, which was offset by growth in demand for visual system upgrades. Weexpect demand for new and upgraded visual systems to remain flat in 2005 andgrow in 2006.

In 2004, we introduced andbooked our first order for an airline visual system that will include a widedisplay version of our E&S Laser Projector (the “ESLP”), currently underdevelopment. While not expected to be in production until 2006, customers havealready shown substantial interest in the ESLP wide display version because ofits many benefits, including improved performance, its ability to replace threeconventional projectors, and significant projected cost savings for maintenanceand consumables. In addition, we introduced and sold a forward-looking infrared(“FLIR”) add-on option for incorporation into previously sold visual systems. Weexpect demand for this option will increase as FLIR-enhanced vision systems areintroduced to the commercial aircraft fleet worldwide. Additionally, wesuccessfully completed and received regulatory approval of a commercialhelicopter simulator containing our EP based visual system.

***Digital Theater***

In the digital theater market our products competewith traditional optical-mechanical products and digital display systemsoffered by Konica-Minolta Planetarium Co. Ltd., GOTO Optical Mfg. Co., CarlZeiss Inc., Spitz, Inc. and Sky-Skan, Inc. During 2004, the digitaltheater market grew and our products gained market share. We believe this wasthe result of a rebounding worldwide economy and positive customerresponse to our Digistar 3 Laser visual system that includes our ESLPprojector. We believe the Digistar 3 Laser has the potential to broaden themarket and further increase our market share, resulting in continuedgrowth in 2005.

Sales of Digistar 3 visualsystems in 2004 were strong, with Digistar 3 now sold to or installedin nearly 50 locations around the world. Revenues for Digistar contentalso grew in 2004.

**Backlog**

On December 31, 2004,our backlog was $84,232 compared with $64,684 on December 31, 2003. The2004 ending backlog contains no government firm, unfunded orders. The 2003ending backlog contained $9,810 of government firm, unfunded orders. Weanticipate that approximately 55% of the 2004 backlog will be converted tosales in 2005.

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**Significant Customers**

Worldwide customers using our products include U.S.and international armed forces, aerospace companies, major airlines,laboratories, museums, planetariums, and science centers. We measure andidentify our significant customers based on direct sales.

Salesto two customers represented 12% and 11% of total sales during 2004. Sales toone customer represented 18% of total sales during 2003. Sales to threecustomers represented 29%, 16%, and 14% of total sales during 2002. Sales to noother customers represented 10% or more of our total sales during fiscal years 2004,2003 and 2002.

**Seasonality**

We believe there is noconsistent, inherent seasonal pattern to our business. Sales volume mayfluctuate quarter-to-quarter because of relatively large and nonrecurringindividual sales, timing of customer funding awards, and individual marketdriven shipping dates.

**Intellectual Property**

We own a number of patentsand trademarks and we are a licensee under several others. Our portfolio ofpatents and trademarks is, as a whole, material to our business. However, noone piece of intellectual property is critical to our business, thus noindividual piece of our intellectual property is discussed on its own. 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 79 patents, of which 60 are still active. In addition, we have 19patent applications currently on file with the U.S. Patent and TrademarkOffice.

**Research & Development**

We consider the timely development and improvement ofour visual system technology to be essential to maintain a competitive positionand to capitalize on market opportunities. We continue to fund essentially allresearch and development (“R&D”) efforts internally. We consider continuedR&D key to ensuring that we maintain our technical excellence, leadershipand market competitiveness.

As planned, we completed the EP (EnvironmentProcessor) software development for our visual systems utilizing our EPX-50and EPX-500 PC image generator technology in 2004. Also, the firstrelease of the associated toolset to complement these products, EnvironmentCreation Tool, ECTTM, was completed. We plan to continue enhancing our EPsoftware technology and expect these enhancements to increase the industryleading performance and functionality of our EP and EPX visual systems in 2005.

In 2004, we initiated a project to lower cost andincrease performance of our EP-1000CT hardware platform. We expect thiseffort to reduce costs by 10% and increase output quality. Completion of thiseffort is expected in 2005.

Also in 2004, we completed the design of the nextgeneration simFUSION platform to use commercial off the shelf graphics cards invarious combinations for improved performance. This platform will be the basisfor the next generation EPX-500 PC image generator technology to beintroduced in mid-2005.

Another significant focusfor our R&D in 2004 was the development of our laser projector, the ESLP. In2004, we completed the second generation prototype laser projector and beganwork on planetarium 

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and widedisplay applications. We expect to begin delivery of the ESLP to planetariumsin 2005. We expect to complete the R&D efforts for wide displayapplications for the commercial simulation market in 2006.

**Dependence on Suppliers**

Most of our current parts and assemblies are readilyavailable through multiple sources in the open market; however, a limitednumber are available only from a single source. In these cases, we either stockadequate inventory to cover the future product demands, or obtain the agreementof the vendor to maintain adequate stock for future demands, and/or attempt todevelop alternative components or sources where appropriate.

Our cathode ray tube (“CRT”)based projectors; the ESCP and TargetView, previously built by us are now onlyavailable from a single source supplier, Video Display Corporation (“VDC”), asa result of VDC’s 2004 acquisition of the assets related to the development andmanufacture of these projectors from us.

**International Sales**

International sales arecalculated based on the location of the purchasing customer and were $40,399 in2004, $45,196 in 2003 and $48,358 in 2002. International sales accounted for58%, 53% and 39% of total sales in 2004, 2003 and 2002, respectively. Webelieve that any inherent risk that may exist in our foreign operations is notmaterial. For additional information on international sales and long-livedassets, see Note 19 of Notes to Consolidated Financials Statementsincluded in Part II of this annual report on Form 10-K.

**Employees**

As of December 31,2004, Evans & Sutherland and its subsidiaries employed a total of 340persons compared to 366 employees as of December 31, 2003. We believe ourrelations with our employees are good. None of our employees are subject tocollective bargaining agreements.

**Environmental Standards**

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.

**Strategic Relationships**

In the normal course ofbusiness we develop and maintain various types of relationships with keycustomers and technology partners. In 2004, we entered into a limited number ofteaming agreements and product development agreements. The teaming agreementsare with industry partners and are intended to improve our position for thepursuit of key program opportunities. The product development agreementsenhance our products by the cooperative development of new features andcapabilities necessary to maintain our industry leading position. Thisphilosophy will continue in 2005.

**Acquisitions and Dispositions**

In June 2004, we sold an office building that wedetermined was no longer needed for our operations for $8,288 in net proceeds. Aspart of the sale, we entered into a three-year rental guarantee with the buyer,obligating us to make certain monthly payments through June 2007 based onspace available for lease in the building we sold. The rental guarantee maydecrease as available space is leased by the buyer, based on terms of therental guarantee. As of December 31, 2004, 100% of the rentable space wasavailable. Further information concerning the sale of this building and therelated rental guarantee is 

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provided in Note 22 of theNotes to Consolidated Financial Statements and in Management’s Discussion and Analysisof Financial Position and Results of Operations included in Part II ofthis annual report on Form 10-K.

In October 2004, wesold our CRT based projector display system product line, the ESCP andTargetView, to VDC for $5,250. As a result, VDC has acquired the assets relatedto the development and manufacture of these projectors. We completed thisdisposition to focus our efforts and resources on the development and sale ofvisual displays based on our laser projector technology. We will continue to offerand support the CRT based visual displays with VDC as our supplier.

**BusinessSubject to Government Contract Renegotiation**

A significant portion of the visual simulationbusiness is dependent on contracts and subcontracts associated with governmentbusiness. The U.S. government and other governments may terminate any of ourgovernment contracts and, in general, subcontracts, at their convenience aswell as for default based on lack of performance. If any of our governmentcontracts were terminated for convenience, we generally would be able torecover our costs, receive allowable termination or cancellation costs, andreceive a negotiated profit for work performed. Depending on the contract, ifsuch an event were to occur, it could materially affect our sales, profits, andcash flow. Historically, our experience indicates that termination forconvenience is a rare occurrence. In 2004, we had no contracts or subcontractsterminated.

U.S. government contractsalso are conditioned upon the continuing availability of congressionalappropriations. Long-term government contracts and related orders are subjectto cancellation or restructuring if appropriations for subsequent performanceperiods become unavailable or are reduced from planned levels. As of December 31,2004 all contracts subject to this continuing appropriation of funds were fullyfunded for their option year.

**Recent Development**

Since 2001, both ourmilitary and commercial markets have consistently decreased in size primarilyas a result of diversion of military funds to other needs and reductions incommercial airline purchases of new aircraft. While we expect orders in thesemarkets to increase in 2005 and 2006, we do not expect these market increasesto be themselves sufficient to return the Company to profitability in 2005. Inorder to improve our profitability and cash flow based on our projections for2005, we initiated a restructuring plan in March 2005 to reduce costs fromcost of sales and operating expenses and to improve our cash flow fromoperations. The largest cost driver of our business is our labor and labor-relatedcosts. As a result, we reduced our aggregate labor force by approximately 60full-time equivalent employees, at an expected cost of $1,625 in severancebenefits to be paid out over the next two years. We expect this action toreduce our labor and labor-related costs by approximately $5,140 per year. Thisplan has been fully executed as of the filing of this annual report on Form 10-K.Due to the timing of the restructuring, we expect to reduce our costsapproximately $3,860 in 2005. Our labor reductions were executed primarily inprogram management, program engineering and R&D engineering.

**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” and similar expressions. See Management’s Discussion andAnalysis of Financial Condition and Results of Operations included in Part IIof this annual report for a list of some of 

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theforward-looking statements included in this Form 10-K and factorsthat may affect these forward-looking statements.

**EXECUTIVEOFFICERS OF THE REGISTRANT**

Thefollowing sets forth certain information regarding the executive officers ofE&S as of February 25, 2005.
| **Name**           | ** ** | ** ** | ** ** | **Age**                                          | ** ** | **Position** |
|--------------------|------------|------------|------------|--------------------------------------------------|------------|--------------|
| James R. Oyler     |       | 58         |       | President and Chief  Executive Officer           |
| Kevin A. Paprzycki |       | 34         |       | Chief Financial  Officer and Corporate Secretary |
| Bob Morishita      |       | 54         |       | Vice President Human  Resources                  |

 

James R. Oyler was appointed President and ChiefExecutive Officer of E&S and a member of the Board of Directors in November 1994.Earlier, Mr. Oyler served as a Senior Vice President for HarrisCorporation. He has 10 years of service with E&S.

Kevin A. Paprzycki was appointed Chief FinancialOfficer and Corporate Secretary of E&S in August 2004. Mr. Paprzyckijoined E&S in 1999 as Director of Finance, Manufacturing Controller andlater served as Director of Financial Planning & Analysis. Mr. Paprzyckiis a Certified Public Accountant, Certified Management Accountant, andCertified Financial Manager. He has five years of service with E&S.

Bob Morishita is VicePresident of Human Resources. He joined Evans & Sutherland asCompensation Manager in 1982 and was appointed Human Resources Director in 1997and Human Resources Vice President in 2000. He has 23 years of service withE&S.

**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 four buildings totaling approximately260,000 square feet. We currently occupy all four buildings with current plansto sell one of these buildings once we have moved out. The buildings arelocated on land leased from the University of Utah with an initial term of 40years or longer.

We hold leases, includingour subsidiaries, on several sales, operations, service and productionfacilities located throughout the United States, Europe, and Asia. None ofthese are material to our manufacturing, engineering or operating facilities. Webelieve that these properties are suitable for our immediate needs and we donot currently plan to expand our facilities or relocate.

**ITEM 3.**                LEGAL PROCEEDINGS

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.

**ITEM 4.**                SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of securityholders during the fourth quarter of fiscal year 2004.

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**PART II**

**ITEM 5.**                MARKET FORREGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OFEQUITY SECURITIES

Our common stock trades on the NASDAQ Stock Marketunder the symbol “ESCC.” On February 25, 2005, there were 604 holders ofrecord of our common stock. Because brokers and other institutions hold many ofour shares on behalf of shareholders, we are unable to estimate the totalnumber of shareholders represented by these record holders.

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

Additional informationrequired by this item is incorporated by reference to the table captioned *Quarterly Financial Data (Unaudited)* in Item 6 and the tablecaptioned *Securities Authorized for Issuance Under EquityCompensation Plans* in Item 12 of Part II of this annual reporton Form 10-K.

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**ITEM 6.**                SELECTED FINANCIALDATA

Thefollowing selected financial data for the most recent five fiscal years ended December 31are derived from our consolidated financial statements. The selected financialdata should be read in conjunction with our consolidated financial statementsand related notes included elsewhere in this annual report on Form 10-K. Alsosee *Management’s Discussion and Analysis of FinancialCondition and Results of Operations.*
| ** **                                             | ** ** | **2004**                                                              | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
|--------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| ** **                                             | ** ** | **(in thousands, except per share amounts)** | ** ** |
| Sales                                                  |       | $                                                                     | 69,159     |     | $          | 84,776   |       | $        | 122,578    |     | $          | 145,263 |   | $ | 166,980 |   |
| Cost of sales                                          |       | 44,119                                                                |       | 53,252   |       | 78,052   |       | 115,823  |       | 137,532  |       |
| Inventory  impairment                                  |       | —                                                                |       | 14,566   |       | 1,392    |       | —   |       | —   |       |
| Gross profit                                           |       | 25,040                                                                |       | 16,958   |       | 43,134   |       | 29,440   |       | 29,448   |       |
| Expenses:                                              |       |                                                                  |       |     |       |     |       |     |       |     |       |
| Selling, general  and administrative                   |       | 23,786                                                                |       | 27,039   |       | 27,131   |       | 31,374   |       | 34,406   |       |
| Research and  development                              |       | 16,621                                                                |       | 21,730   |       | 25,970   |       | 32,828   |       | 44,264   |       |
| Restructuring  charges (recoveries)                    |       | (491                                                                  | )          | 3,416    |       | 4,492    |       | 2,843    |       | (761     | )          |
| Impairment loss                                        |       | —                                                                |       | 1,151    |       | 311      |       | 220      |       | —   |       |
| Operating expenses                                     |       | 39,916                                                                |       | 53,336   |       | 57,904   |       | 67,265   |       | 77,909   |       |
| Gain on sale of  assets held for sale                  |       | 3,488                                                                 |       | 1,406    |       | 1,212    |       | 9,000    |       | —   |       |
| Gain on sale of  assets                                |       | 3,817                                                                 |       | —   |       | 253      |       | —   |       | —   |       |
| Gain on sale of  business unit                         |       | —                                                                |       | —   |       | —   |       | 774      |       | 1,918    |       |
| Gain on  curtailment of pension plan                   |       | —                                                                |       | —   |       | 3,575    |       | —   |       | —   |       |
| Operating loss                                         |       | (7,571                                                                | )          | (34,972  | )          | (9,730   | )          | (28,051  | )          | (46,543  | )          |
| Other income  (expense), net                           |       | (1,184                                                                | )          | (1,987   | )          | (2,454   | )          | (2,578   | )          | (4,004   | )          |
| Loss before income taxes                               |       | (8,755                                                                | )          | (36,959  | )          | (12,184  | )          | (30,629  | )          | (50,547  | )          |
| Income tax  expense (benefit)                          |       | 112                                                                   |       | (971     | )          | (463     | )          | (3,172   | )          | 19,023   |       |
| Net loss                                               |       | (8,867                                                                | )          | (35,988  | )          | (11,721  | )          | (27,457  | )          | (69,570  | )          |
| Accretion of  redeemable preferred stock               |       | —                                                                |       | —   |       | —   |       | —   |       | 228      |       |
| Net loss applicable to common stock                    |       | $                                                                     | (8,867     | )        | $          | (35,988  | )          | $        | (11,721    | )        | $          | (27,457 | ) | $ | (69,798 | ) |
| Net loss per common  share:                            |       |                                                                  |       |     |       |     |       |     |       |     |       |
| Basic and diluted                                      |       | $                                                                     | (0.84      | )        | $          | (3.44    | )          | $        | (1.12      | )        | $          | (2.70 | ) | $ | (7.45 | ) |
| Average weighted number  of common shares outstanding: |       |                                                                  |       |     |       |     |       |     |       |     |       |
| Basic and diluted                                      |       | 10,498                                                                |       | 10,471   |       | 10,422   |       | 10,169   |       | 9,372    |       |
| At End of Year:                                        |       |                                                                  |       |     |       |     |       |     |       |     |       |
| Total assets                                           |       | $                                                                     | 73,771     |     | $          | 93,382   |       | $        | 127,576    |     | $          | 177,353 |   | $ | 216,078 |   |
| Long-term debt,  less current portion                  |       | 18,015                                                                |       | 18,015   |       | 20,685   |       | 18,086   |       | 25,563   |       |
| Redeemable  preferred stock                            |       | —                                                                |       | —   |       | —   |       | —   |       | 24,000   |       |
| Stockholders’ equity                              |       | 3,763                                                                 |       | 15,566   |       | 53,363   |       | 64,659   |       | 67,634   |       |

 

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**Quarterly Financial Data (Unaudited)**

(Inthousands, except per share information)
| ** **                                    | ** ** | **Quarter Ended** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|
| ** **                                    | ** ** | **April 2**       | ** ** | **July 2** | ** ** | **Oct. 1** | ** ** | **Dec. 31(3)** | ** ** |
| **2004**                                      | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Sales                                         |       | $                      | 17,790     |   | $ | 16,816 |   | $ | 15,882 |   | $ | 18,671 |   |
| Gross profit                                  |       | 6,882                  |       | 5,861 |   | 5,201 |   | 7,096 |   |
| Net income (loss)  before income taxes        |       | (3,002                 | )          | (2,240 | ) | (4,856 | ) | 1,343 |   |
| Net income (loss)  applicable to common stock |       | (3,040                 | )          | (2,298 | ) | (4,894 | ) | 1,365 |   |
| Basic and diluted  income (loss) per share(1) |       | (0.29                  | )          | (0.22 | ) | (0.47 | ) | 0.13 |   |
| Common stock  price range(2)                  |       |                   |       |   |   |   |   |   |   |
| High                                          |       | 6.25                   |       | 5.49 |   | 5.49 |   | 7.74 |   |
| Low                                           |       | 4.08                   |       | 4.25 |   | 4.00 |   | 5.00 |   |
|                                               |            |                        |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                    | ** ** | **Quarter Ended** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|
| ** **                                    | ** ** | **March 28**      | ** ** | **June 27** | ** ** | **Sep. 26** | ** ** | **Dec. 31(4)** | ** ** |
| **2003**                                      | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Sales                                         |       | $                      | 22,578     |   | $ | 16,010 |   | $ | 20,765 |   | $ | 25,423 |   |
| Gross profit                                  |       | (6,986                 | )          | 6,086 |   | 7,393 |   | 10,465 |   |
| Net income (loss)  before income taxes        |       | (24,543                | )          | (5,005 | ) | (8,228 | ) | 817 |   |
| Net income (loss)  applicable to common stock |       | (24,275                | )          | (5,124 | ) | (8,040 | ) | 1,451 |   |
| Basic and diluted  income (loss) per share(1) |       | (2.32                  | )          | (0.49 | ) | (0.77 | ) | 0.14 |   |
| Common stock  price range(2)                  |       |                   |       |   |   |   |   |   |   |
| High                                          |       | 6.90                   |       | 6.42 |   | 6.74 |   | 6.20 |   |
| Low                                           |       | 5.00                   |       | 3.30 |   | 5.25 |   | 3.92 |   |
|                                               |            |                        |            |  |  |  |  |  |  |  |  |  |  |

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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)          This is the range of thehigh and low bids per share of our common stock for the fiscal quartersindicated as reported by the NASDAQ Stock Market. Quotations reflectinter-dealer prices, without mark-up, mark-down or commission and may notnecessarily reflect actual transactions.

(3)          In the fourth quarter of2004, we recorded a gain of $3,662 on the sale of our cathode ray tube (CRT)based projector display system product line, ESCP and TargetView. Thistransaction required that we transfer all assets related to the development andmanufacture ofthese products. We continue support and sell these display systems.

(4)          In the fourth quarter of2003, we reversed $498 in restructuring charges that were originallycharged as a result of our restructuring in the third quarter of 2003. Thischarge was related to a liability for a license agreement for a certainsoftware tool that we determined to be of no future value to us as a result ofthe restructuring. However, in the fourth quarterof 2003, we were able to negotiate out of the liability related to thissoftware tool license.

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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 herein under Item 8 ofthis annual report on Form 10-K. Information set forth in “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”includes forward-looking statements that involve risks and uncertainties. Manyfactors could cause actual results to differ materially from those contained inthe forward-looking statements. See “Forward-Looking Statements” and “FactorsThat May Affect Future Results” for additional information concerningthese items. All dollar amounts are in thousands unless otherwise indicated.

**Executive Summary**

We had several keyaccomplishments in 2004, the most significant being our improvement in neworders. The strong market performance of our EP, EPX, and Digistar 3 visualsystem technologies drove significant new orders and allowed us to increase ourbacklog during the year by 30%. With the increase in orders and backlog, we arenow confident that 2004 was the low point in revenue, and that we will seerevenue growth in 2005. We additionally made good progress in bringing ourrecently announced laser projector to market, and deliveries are expected toalso contribute to revenue growth in both 2005 and beyond. Overall, we improvedupon our 2003 net loss of $35,958 to finish 2004 with a net loss of $8,867. Thiswas driven by the absence of impairments and our continued focus on reducingoperating expenses. Our financial position also improved significantly in 2004as we generated positive cash flow and completely repaid our short-term debt of$7,685. With our strong new products, higher backlog, and good customeracceptance of our visual systems, we believe that we will achieve growth andprofitability in 2005.

**MajorFactors in Historical Performance**

The three major factors affecting performance of thecompany in 2002, 2003 and 2004 were declines in the market following September 11,2001, problems with several large military programs using an older technologycalled Harmony 1, and a migration to off-the-shelf PCs driven by militarycustomers.

Following September 11, we received few ordersfrom major North American airlines which were formerly large customers of ourcommercial simulation products. This market has not yet fully recovered, buthas been partially offset by gains in other commercial markets. Additionally,military events following that time have also affected U.S. military markets,primarily because a number of large weapons programs have been either cancelledor delayed, causing reductions in the number of new military simulators needingvisual systems.

With respect to the Harmony 1 product, during 1998 and1999 we won six major military programs with total revenue of over $130 million.These “Big Six” programs” had a negative impact on our prior years’ financialresults because we experienced difficulties completing the programs. The sixprograms fell behind schedule and required significantly more resources thanexpected. As a result, our gross margins were depressed in 2002 and 2001. Wealso incurred liquidated damages and late penalties on these programs. We hadreserve balances of $562 in 2004, $1,734 in 2003 and $1,050 in 2002, to coverthese potential costs. In 2003, we settled with one customer for approximately$1,200 in goods and services which were fully delivered in 2004. In addition,our actual incurred costs in 2003 and 2002 were $1,166 and $600, respectively.

At the end of 2002, costs and estimated earnings inexcess of billings on uncompleted contracts relating to the Big Six programswas $8,000. Our collections in 2003 were $13,300. At the end of 2003, cost andestimated earnings in excess of billings on uncompleted contracts relating tothe Big Six programs was 

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$2,100. Our collections in2004 were $3,200. At the end of 2004, there were no costs and estimatedearnings in excess of billings on uncompleted contracts relating to the Big Sixprograms. Related accounts receivable at the end of 2004 totaled $2,700 ofwhich $2,000 was collected in February 2005.

We received acceptance on the remaining two Big Sixprograms during 2004 and our work is now very near completion. Deliverablesscheduled for performance in 2004 on these programs have been fully performedand invoiced. A few minor deliverables scheduled in 2005 remain and theirimpact on our 2005 financial results is expected to be immaterial.

We have historicallyproduced visual systems required by military customers with proprietaryhardware. In the past few years, a few major military customers have beendriving producers of visual systems to provide systems offering similarcapabilities that are based on off-the-shelf PC hardware in order to reducetheir acquisition and replacement costs. As a result, visual systems that wereonce sold for hundreds of thousands of dollars have been replaced by PC-basedvisual systems which are sold at much lower prices. We have been successful inthis product transition; however, the volume of sales from off-the-shelf PC-basedvisual systems has not been sufficient to replace the revenue lost from theseproducts’ lower prices. We expect this trend to continue.

**Results of Operations**

Our 2004 sales decreased by 18%, primarily as a resultof the spending constraints by customers in our military market which haveexisted since 2001. However, strong new orders during the year drove asignificant $19,548 increase in our backlog. This increase is expected to leadto growth in our 2005 sales and drive our return towards profitability. Ourgross margins improved by 15% over 2003. This increase was primarily driven bythe $14,566 inventory impairment we took in 2003

Continuing to focus on improving our cost structure,we reduced 2004 operating expenses by 25%. The major factor in this reductionwas the execution of our 2003 restructuring plan. We also reduced costs throughboth headcount attrition and reductions in development expenditures as ourlaser projector technology nears production.

Lastly, we recognized gains of $7,305 on the sale oftwo assets in 2004. A building was sold for a gain of $3,488, and our cathoderay tube (“CRT”) based projector assets were sold for a gain of $3,817 as weshifted our focus towards our new laser projector technology.

More detailed explanationsof our 2004 results are provided below.

***Consolidated Sales***

Thefollowing table summarizes our consolidated sales for fiscal year:
| ** ** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------|------------|----------|------------|----------|------------|----------|------------|
| Sales      |       | $        | 69,159     |     | $          | 84,776   |       | $ | 122,578 |   |
|            |            |          |            |          |            |          |            |  |  |  |

 

*Fiscal 2004 vs. 2003*

The primary reason for the 18% decrease in 2004 saleswas a continued reduction in sales to military customers, which decreased by$15,071 from 2003. In addition, service and support sales decreased by $2,510as a result of the continued depression in sales to military customers. Thesedecreases were offset by a $2,197 increase in sales to planetarium customers asa result of the success of our Digistar 3 visual system technology. Sales tocommercial customers remained relatively consistent with 2003 levels.

Military markets continued to shrink as military fundshave been diverted to other needs. We believe this market will begin to improvein 2005 as military training requirements increase and we expect improvement in2005 orders and sales from these customers. A few large prime contractors thatare both 

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customers and competitorsof ours have moved towards providing their own visual systems in an effort toprotect their revenues and margins. We also believe that there has been anincrease in military contracts awarded directly to incumbents and acorresponding reduction in contracts being placed for open bid. To competeagainst these trends, we strive to offer superior visual systems at competitiveprices.

Airlines have reduced purchases of new aircraft,resulting in a decrease in the number of new simulators required for training. However,since many airlines are upgrading their current simulators, we have offsetmarket trends as a result of the compatibility of our EP-1000CT productwith our large installed visual system base. Our 2004 orders improved over 2003levels and we expect this higher order volume to continue through 2005.

While our overall salesdecreased in 2004, new orders received significantly increased during the year.As a result, backlog increased by 30% from $64,684 to $84,232. We believe thisincrease in backlog will result in higher revenues in 2005 and beyond.

*Fiscal 2003 vs. 2002*

Sales in 2003 declined 31% from $122,578 in 2002. Thiswas primarily the result of a $35,096 reduction in sales from militarycustomers due to military spending constraints from 2001 through 2003. We alsohad a $6,403 decrease in sales to commercial customers as a result ofreductions in overall aircraft purchases and a $1,015 decrease in our serviceand support sales also resulting from military spending constraints. Thesedecreases were offset by a $3,931 increase in sales to planetarium customers asa result of the successful introduction of our new Digistar 3 technology intoour visual systems.

While sales decreased in2003, backlog increased over 2002 from $59,672 to $64,684.

***Gross Margin***

Thefollowing table summarizes our gross margin and the percentage to total salesduring for fiscal year:
| ** **              | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------|------------|----------|------------|----------|------------|----------|------------|
| Gross margin            |       | $        | 25,040     |     | $          | 16,958   |       | $ | 43,134 |   |
| Gross margin percentage |       | 36.2     | %          | 20.0     | %          | 35.2     | %          |
|                         |            |          |            |          |            |          |            |  |  |  |

 

*Fiscal 2004 vs. 2003*

Our gross marginpercentage improved to 36.2% in 2004, compared with 20.0% in 2003. Our 2003gross margins were depressed as a result of a $14,566 inventory impairment loss.In 2004, gross margins from sales to our military customers decreased 7.5% dueto a change in product mix. Significant deliveries were made in 2004 on largemilitary contracts with a high proportion of subcontract pass-through salesresulting in lower gross margins. Gross margins from sales to our planetariumcustomers decreased 6.3% and our service and support gross margins decreased6.1% in 2004. Both decreases were a result of unique, high-margin deliveriesduring 2003. We achieved a 1.7% gross margin increase in sales to commercialcustomers as a result of improved cost performance. Also offsetting thesedecreases was a 1.7% gross margin increase due to reductions in warrantyexpense as we improved product reliability.

*Fiscal 2003 vs. 200*2

Our gross margin percentagedecreased to 20.0% in 2003, compared with 35.2% in 2002. This was primarily theresult of a $14,566 of inventory impairment. Offsetting this impairmentdecrease was improvement in gross margins related to military customers as aresult of progress made on the Big Six programs. Gross margin percentages onsales to commercial airline customers decreased by 13.9% in 2003 as a result ofincreased pricing pressure in the commercial simulation market and program costoverruns. 

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Inaddition, we experienced a 2.2% gross margin decrease as a result of increasesin warranty and support costs due to two vendor part failures. These decreaseswere slightly offset by a 4.2% increase in our service & support grossmargin percentages as a result of several high-margin spares shipments in 2003.

***Operating Expenses***

Thefollowing table summarizes our operating expenses during fiscal year:
| ** **                                                  | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Selling, general  and administrative (“SG&A”) |       | $        | 23,786     |     | $          | 27,039   |       | $ | 27,131 |   |
| Research and  development (“R&D”)             |       | 16,621   |       | 21,730   |       | 25,970   |       |
| Restructuring  charges (recoveries)                         |       | (491     | )          | 3,416    |       | 4,492    |       |
| Impairment loss                                             |       | —   |       | 1,151    |       | 311      |       |
| Operating expenses                                          |       | $        | 39,916     |     | $          | 53,336   |       | $ | 57,904 |   |

 

***SG&A Expenses***

*Fiscal 2004 vs. 2003*

SG&A expensesdecreased 12% during 2004. As anticipated, we achieved $2,534 in SG&Aexpense reductions from reduced headcount, $543 in reduced equipment costs andthe remainder from various cost reductions. We expect further reductions inSG&A expenses in 2005 as we continue to streamline our selling efforts andreduce overall expenses (see Recent Development).

*Fiscal 2003 vs. 200*2

In 2003, SG&A expensesremained relatively consistent with 2002. In 2003, we achieved $1,539 in laborsavings which were offset by a $654 increase in net rent expenses due to a lossof rental income, and a $1,130 increase in bad debt expense resulting from theabsence of favorable expense reversals recorded in 2002.

***R&D Expenses***

*Fiscal 2004 vs. 2003*

R&D expenses decreased24% during 2004. We achieved reductions during 2004 of $3,800 in labor andassociated overheads, $709 in development expenses as our laser projector nearscompletion, and $600 in software and miscellaneous expenses. We expect furtherreductions in R&D expenses in 2005 as we move our laser projector intoproduction (see Recent Development).

*Fiscal 2003 vs. 2002*

R&D expenses decreased16% during 2003 as a result of $2,921 reduction in labor costs and $1,447reduction in development expenditures for materials and software.

***Restructuring Charges (Recoveries)***

*Fiscal 2004 vs. 2003*

We did not record any restructuring charges in 2004. Dueto declines in our two primary markets and the resulting decrease in our 2001through 2004 sales, we implemented restructuring plans in 2003 and 2002 toreduce our labor costs and drive down both cost of sales and operatingexpenses, therefore reducing our net losses. These plans were also implementedto reduce our labor cash outflows and improve our cash flow from operations.

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During 2003, we recordedrestructuring charges of $3,416 related to reductions in force of approximately120 full-time equivalent employees. Our labor reductions were executedthroughout the Company, with headcount reductions occurring in direct programmanagement and program engineering, R&D engineering, marketing efforts andG&A support. This restructuring resulted in a reduction of approximately$7,500 per year in our labor costs, which was partially achieved in 2003 andentirely in 2004, through reductions in cost of sales and operating expenses.

*Fiscal 2003 vs. 2002*

During 2002, we recordedrestructuring charges of $4,492 related to a reduction in force ofapproximately 230 employees. This labor reduction was also executed throughoutthe Company, with headcount reductions occurring in direct program managementand program engineering, R&D engineering, marketing efforts and G&Asupport. This restructuring resulted in a reduction of approximately $14,000per year in our labor costs, which was partially achieved in 2002, and entirelyin 2003, through reductions in cost of sales and operating expenses.

***Impairment Loss***

*Fiscal 2004 vs. 2003*

During 2004, we did notincur any impairment charges. In 2003, we recognized an impairment loss of$1,151 on certain fixed assets specifically used to build, test and demonstrateour Harmony 1 product.

*Fiscal 2003 vs. 2002*

During 2002, we recognizedan impairment loss of $311 on software licenses that were no longer used.

***Gains***

Thefollowing table summarizes our gains during fiscal year:
| ** **                           | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Gain on sale of  assets              |       | $        | 3,817      |     | $          | —   |       | $ | 253 |   |
| Gain on assets  held for sale        |       | 3,488    |       | 1,406    |       | 1,212    |       |
| Gain on curtailment of  pension plan |       | —   |       | —   |       | 3,575    |       |
|                                      |            |          |            |          |            |          |            |  |  |  |

 

In 2004, we recognizedgains on the sale of two assets totaling $7,305. A building held for sale wassold resulting in a gain of $3,488. We sold our CRT based projector assets toVDC recognizing a gain of $3,817 as we shifted our focus to our new laserprojector. In 2003, we also sold a building and recognized a gain of $1,406. Wehad no other sale of assets in 2003. During 2002, we recognized a gain on theamendment of our pension plan of $3,575. In order to match current marketpractices, the pension plan was amended to curtail accrual of future benefits. Atthe same time, the E&S 401(k) plan was amended to permit the Board ofDirectors to grant additional discretionary matching contributions based onprofitability as well as other financial and operational considerations. Additionally,we recognized a gain on assets held for sale of $1,212 on the sale of abuilding during 2002.

***Other Income and Expense***

Thefollowing table summarizes our other income and expense during fiscal year:
| ** **                   | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Other income  (expense), net |       | $        | (1,184     | )        | $          | (1,987   | )          | $ | (2,454 | ) |
|                              |            |          |            |          |            |          |            |  |  |  |

 

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We reduced our otherexpenses in 2004 by 40% due to the absence of a $500 loss recorded in 2003 forthe write-off of an investment, a $192 reduction in interest expense due toreduced debt levels, and an increase in currency gains. The 2003 reduction of19% was primarily a $575 reduction in interest expense due to reduced debt levels.

***Income Taxes***

Thefollowing table summarizes our income taxes during fiscal year:
| ** **                    | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Income tax  expense (benefit) |       | $        | 112        |     | $          | (971     | )          | $ | (463 | ) |
|                               |            |          |            |          |            |          |            |  |  |  |

 

The income tax expense in2004 was primarily attributable to foreign income taxes. The income tax benefitin 2003 was primarily due to the favorable resolution of certain worldwideincome tax contingencies. The 2002 income tax benefit was the result of achange in the U.S. tax law, which allows us to use additional net operatinglosses to offset taxable income. Deferred tax assets arising from net operatingloss carryforwards are fully reserved through a valuation allowance.

**Recent Development**

Since 2001, both ourmilitary and commercial markets have consistently decreased in size primarilyas a result of diversion of military funds to other needs and reductions incommercial airline purchases of new aircraft. While we expect orders in thesemarkets to increase in 2005 and 2006, we do not expect these market increasesto be themselves sufficient to return the Company to profitability in 2005. Inorder to improve our profitability and cash flow based on our projections for2005, we initiated a restructuring plan in March 2005 to reduce costs fromcost of sales and operating expenses and to improve our cash flow fromoperations. The largest cost driver of our business is our labor and labor-relatedcosts. As a result, we reduced our aggregate labor force by approximately 60full-time equivalent employees at an expected cost of $1,625 in severancebenefits to be paid out over the next two years. We expect this action toreduce our labor and labor-related costs by approximately $5,140 per year. Thisplan has been fully executed as of the filing of this annual report on Form 10-K.Due to the timing of the restructuring, we expect to reduce our costsapproximately $3,860 in 2005. Our labor reductions were executed primarily inprogram management, program engineering and R&D engineering.

**Liquidity andCapital Resources**

Summaryinformation concerning our financial position as of fiscal year-end:
| ** **                          | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|
| Cash and cash  equivalents          |       | $        | 10,147     |     | $          | 9,714 |   |
| Restricted cash                     |       | 3,414    |       | 765      |       |
| Line of credit  agreements          |       | —   |       | (7,685   | )          |
| Net short term cash  (indebtedness) |       | 13,561   |       | 2,794    |       |
| Long-term debt                      |       | (18,015  | )          | (18,015  | )          |
| Net cash (indebtedness)             |       | $        | (4,454     | )        | $          | (15,221 | ) |
| Stockholders’ equity           |       | $        | 3,763      |     | $          | 15,566 |   |

 

In 2004, we continued toimprove our overall liquidity, paid off our lines of credit, reduced ourreliance on short-term debt, and allowed our credit facilities to expire. Weaccomplished this by improving our cash flows from operations, selling anoffice building, and selling our CRT based projector assets. Our improvedliquidity has assisted our ability to continue to issue letters of credit asrequired. In addition we believe our products are performing well and we expectto meet our delivery requirements. As a result, we do not foresee anyliquidated damages or late delivery penalties in 2005.

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***Outlook***

For 2005, we project operations will fund themselvesas well as our investing activities because we expect our sales to increase asa result of our strong orders in 2004 and significant increase in backlog atyear end and because of the restructuring we initiated in March 2005. See “RecentDevelopment” for further information concerning this restructure. Circumstancesthat could materially affect liquidity in 2005 include, but are not limited to:(i) our ability to successfully deliver new technologies and products, (ii) ourability to meet 2005 forecasted sales levels, and (iii) our ability tocontinue to reduce costs and expenses.

For years beyond 2005, webelieve cash from operations will be sufficient for our planned needs. Wefurther believe our long-term investment in research and development and ourcurrent product strategy will allow our business to grow. We also expect toaugment our cash position with the sale of an additional office building during2005 or 2006. In addition, we may supplement our cash resources with additionalcredit facilities, if available with terms that are satisfactory to us.

***Cash Flow***
| ** **                                        | ** ** | **Year ended December 31** | ** ** |
|---------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                        | ** ** | **2004**                                  | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net cash provided by  (used in):                  |       |                                      |       |   |   |   |   |
| Operating activities                              |       | $                                         | (484       | ) | $ | (771 | ) | $ | 12,039 |   |
| Investing activities                              |       | 11,536                                    |       | 997 |   | (656 | ) |
| Financing activities                              |       | (10,619                                   | )          | 2,113 |   | (12,725 | ) |
| Increase (decrease) in  cash and cash equivalents |       | $                                         | 433        |   | $ | 2,339 |   | $ | (1,342 | ) |

 

Cash and cash equivalentsincreased $433 to $10,147 during fiscal year 2004, primarily as a result ofcash provided by investing activities. During 2004, we sold a building whichwas held for sale and our CRT based projector assets.

*Operating Activities*

Operating activities used $484 of cash during 2004. Thisprimarily resulted from a net loss of $7,421 (adjusted for non-cash items of$1,446) offset by changes in working capital. Changes in working capitalprovided $6,847 of cash during 2004. Our accounts receivable decrease provided$6,870 mainly due to collections on several large contracts. Our inventorydecrease provided $1,849 due to the sale of $1,090 of CRT based projectorinventory in the sale to Video Display Corporation, and due to improvedinventory management. Our net costs and estimated earnings in excess ofbillings on uncompleted contracts decrease provided $5,510, primarily due tothe completion of the remaining two Big Six programs. Our accounts payabledecrease used $1,991 as a result of our continued focus on reducing ouroutstanding trade payables and our improved liquidity. Our accrued expensedecrease used $4,648. During 2004, we met the requirements of a settlementagreement we entered into at the end of 2003 with one of our customersconcerning the delivery of Harmony 1 based visual systems. We had accrued $1,200and our settlement costs were approximately $1,200. In addition we charged$1,007 against our warranty reserve, and our payments for severance benefitsduring 2004 related to prior years’ restructure plans was approximately $1,066.

Operating activities used $771 of cash during 2003. Thisprimarily resulted from a net loss of $10,538 (adjusted for non-cash items of$25,450) offset by changes in working capital. Changes in working capitalprovided $9,660 of cash during 2003. Our net costs and estimated earnings inexcess of billings on uncompleted contracts decrease provided $11,638 due tothe completion and billing of all but two of the Big Six programs. Our accountspayables decrease used $1,225 as a result of improved liquidity in 2003 as wellas due to a shrinkage of our business. Our accrued expense decrease used $3,320of cash. This was the 

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result of warranty claimsof $1,952 and the result of compensation and benefits accruals decreasing$1,816. Compensation and benefits accruals decreased partially, due to reducedheadcounts in 2003 and 2002 as a result of restructurings implemented duringthat time. Also, our accrued liquidated damages and late penalties increaseddue to reaching a $1,200 settlement with one of our Big Six program customers. Inaddition, we had a net decrease of $414 in restructure charges, withapproximately $3,830 in severance benefits paid.

Operating activitiesprovided $12,039 of cash during 2002. This primarily resulted from a net lossof 4,033 (adjusted for non-cash items of $7,688) offset by changes inworking capital. Changes in working capital provided $15,858 of cash during2002. Our accounts receivable decrease provided $8,769 due primarily tocollections on the Big Six programs and improved collections overall. Ourdecrease in inventories provided $3,898 due to a decrease in raw materialrequirements and a reduction in program related work-in-process. The decreasein raw material requirements and program related work-in-process were relatedto lower sales volume and improved inventory management during 2002. Inaddition, the decrease in work-in-process was also affected by progress made onthe Big Six programs as these costs were converted to cost of sales. Our netcosts and estimated earnings in excess of billings on uncompleted contractsprovided $11,900 due to a decrease in costs and estimated earnings in excess ofbillings on uncompleted contracts of $25,678 and a decrease in billings inexcess of costs and estimated earnings on uncompleted contracts of $13,779. Thedecrease in costs and estimated earnings in excess of billings was primarily aresult of the successful near completion of the Big Six programs. The decreasein billings in excess of costs and estimated earnings on uncompleted contractsdecreased $9,600 primarily due to deliveries made to customers in 2002 relatedto orders received in 2001. Our accrued expense decrease used $4,553 of cash. Thiswas the result of warranty claims of $1,615 and the result of compensation andbenefits accruals at year-end decreasing $3,140 partially due to reducedheadcounts in 2002 and 2001 as a result of restructures during that time. Thiswas offset by a net increase of $1,042 in restructure charges, withapproximately $3,450 in severance benefits paid. Our accounts payables decreased$1,832 due an improvement in liquidity during 2002.

*Investing Activities*

Investing activities provided $11,536 of cash during2004. This primarily resulted from the sale of assets. We sold one of ouroffice buildings that was no longer in use for $8,288 in cash. We sold our CRTbased projector assets, the ESCP and TargetView, for $5,250 in cash as a resultof deciding to focus our efforts on the development of our new laser basedprojector. We sold an investment for $633 in cash. This was offset by the useof $1,827 of cash for the purchase of property, plant and equipment and the useof $871 of cash for a deposit. The deposit was required in relation to the saleof our office building and the rental guarantee we entered into with the buyer.

Investing activities provided $997 of cash during 2003.This primarily resulted from the sale of one of our office buildings that wasno longer in use for $4,760 in cash. This was offset by the use of $3,767 ofcash for the purchase of investments in property, plant and equipment.

Investing activities used$656 of cash during 2002. This was primarily the result of our investment inproperty, plant, and equipment of $3,394. This was offset by the cash providedby the sale of one of our office buildings that was no longer in use for$2,917.

*Financing Activities*

Financing activities used $10,619 of cash during 2004.This was primarily due to the paying off of our lines of credit during 2004 anddue to an increase in restricted cash requirements in 2004. We are required underour credit agreements with our banks to collateralize any letter of credit weissue with cash equal to 100% of the value of the outstanding value of theletter of credit.

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Financing activities provided $2,113 of cash during2003. This was primarily a result of a restricted cash requirement under ourline of credit agreements.

Financing activities used$12,725 of cash during 2002 primarily as a result of paying down our line ofcredit borrowings.

***Credit Ratings***

Our credit ratings were lowered by Moody’s InvestorServices (“Moody’s”) during 2003. Our 6% Convertible Subordinate Debentures due2012 credit rating was downgraded from B2 to Caa2. Our Long-Term Senior ImpliedRating was downgraded from Ba to B3. These credit rating downgrades may affectour future ability to renew our credit facilities, negotiate new creditfacilities, and issue debt and equity securities.

With respect to Moody’s, issuers with a Ba rating arejudged to have speculative elements and are subject to substantial credit risk.Issuers with a B rating are judged to have speculative elements and are subjectto high credit risk. Issuers with Caa ratings are subject to very high creditrisk. The “1,2,3” modifiers show relative standing within the major categories,1 being the highest, or best, modifier in terms of credit quality.

Moody’s Long-Term SeniorImplied Ratings are generally employed for speculative grade corporate issuers.The Long-Term Senior Implied Rating is Moody’s opinion of a corporate family’sability to honor its financial obligations and is assigned to a corporatefamily as if it had a single class of debt and a single consolidated legalentity structure.

***Credit Facilities***

Our credit facilities expired in December 2004and we are currently in negotiations to obtain new line of credit facilities. However,there can be no assurances that we will be successful in negotiating lines ofcredit on terms that will be acceptable to us. While we currently do notbelieve we will require access to a line of credit facility in the next 12 months,our needs may change in the future.

During 2004, we had two secured line of creditfacilities, one of which provided for borrowings and the issuance of letters ofcredit up to $25,000 and the other provided for borrowings up to $2,500. Wewere in compliance with all financial covenants and ratios required by thesefacilities in 2004.

The ability to issue letters of credit and bankguarantees has become more important to our business as sales in countriesother than in North America and Western Europe have increased. Letters ofcredit and bank guarantees in many countries are required as part of any finalcontract. Letters of credit and bank guarantees are issued to ensure ourperformance to third parties.

We currently have one 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.

As of December 31,2004, our outstanding letters of credit totaled $3,144. Letters of credit thatexpire in 2005 total $2,736 and those that expire in 2006-2007 total $408.

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***6% Convertible Subordinated Debentures due 2012***

As of December 31,2004, we had approximately $18,015 of 6% Convertible Subordinated Debentures(the “6% Debentures”) outstanding that are due in 2012. The 6% Debentures areunsecured and are convertible at each bondholder’s option into shares of ourcommon stock at a conversion price of $42.10 per share for an aggregate of428,000 shares of our common stock if all outstanding 6% Debentures areconverted, subject to adjustment. The 6% Debentures are redeemable at ouroption, in whole or in part, at par.

***Rental Guarantee***

During 2004, we enteredinto a three year building rental guarantee with the buyer of a building thatwas available for sale. Under terms of the rental guarantee, our maximumobligation will be reduced as the buyer leases out space in this building. Asof December 31, 2004, we had accrued $1,755 for this obligation and 100%of the leasable space in this building was available.

***Other***

In 2005, we expect capital expenditures to be similarto 2004, or approximately $2,000 to $3,000. There were no material capitalexpenditure commitments at the end of 2004, nor do we anticipate any over thenext several years.

Our Board of Directors has authorized the repurchaseof 1,600,000 shares of our common stock. As of February 25, 2005, 463,500shares remained available for repurchase under the plans approved by the Boardof Directors. No shares were repurchased during 2004, 2003, or 2002. 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.

In the event we were unable to make timely deliveriesof products 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, 2004, our totalindebtedness was $18,015 consisting of long-term debt. Both of our creditfacilities expired in December 2004, and we are currently inrenegotiations to extend one of these credit facilities. However, there can beno assurance that we will be successful in renegotiating this credit facility. Ourcash and restricted cash, subject to various restrictions set forth in thisannual report on Form 10-K, are available for working capital needs,capital expenditures, strategic investments, mergers and acquisitions, stockrepurchases and other potential cash needs as they may arise

***Effects of Inflation***

The effects of inflationwere not considered material during fiscal years 2004, 2003, and 2002, and arenot expected to be material for fiscal year 2005.

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**Off-Balance Sheet Arrangements**

As part of our ongoing business, we normally do notparticipate in transactions that generate relationships with unconsolidatedentities or financial partnerships, such as entities often referred to asstructured finance or special purpose entities (“SPE’s”), which can beestablished for the purpose of facilitating off-balance sheet arrangements orother contractually narrow or limited purposes.

In 2000, we formed a joint venture with Quadrant Groupplc (“Quadrant”) known as Quest Flight Training Limited. (“Quest”). Questprovides certain equipment, software, training, and other goods and services tothe United Kingdom Ministry of Defence (“U.K. MOD”) and other relatedgovernmental entities with regard to an upgrade of the U.K. MOD E-3D Facilityand E-3D Sentry Aircrew Training Services. We have a 50% interest in Questwhich is accounted for as an investment under the equity method and thereforeis not consolidated in our financial statements. The financial position andoperating results of Quest are immaterial to our financial results.

In connection with theservices of Quest to the U.K. MOD, during fiscal year 2000 we entered intoguarantees of various obligations of Quest. As of December 31, 2004, wehad four guarantees outstanding related to Quest. Pursuant to the firstguarantee, we have guaranteed, jointly and severally with Quadrant, theperformance of Quest in relation to its contract with the U.K. MOD. If Questfails to meet its obligations under the contract then we (and Quadrant) arerequired to perform under the terms of the contract. Due to the length of thecontract and the uncertainty of performance for which we would be liable ifQuest fails to perform, we cannot estimate the maximum amount of possiblefuture payments. This guarantee is in place until 2030. Pursuant to the secondguarantee, we have guaranteed, jointly and severally with Quadrant, up to amaximum amount of £1,000 (approximately $1,903), the performance of Quest wherenot subcontracted, and the performance of Quest where subcontracted but wherethe subcontractor is not liable to meet its obligation due to any limitation ofliability in the sub-contract agreement. This guarantee is in place until 2020.Pursuant to the third guarantee, we have pledged our equity shares in Quest toguarantee payment by Quest of a loan agreement executed by Quest. The loanagreement terminates in 2020. The pledge of our equity shares in Quest willexpire at such time as Quest’s obligations under the loan agreement are satisfiedor the date on which the loan agreement is otherwise terminated. In the eventof default on this loan agreement, the lending institution can request that thetrustee holding such equity shares surrender them to the lending institution inorder to satisfy all amounts then outstanding under the loan agreement. As of December 31,2004, the outstanding loan balance was £4,889 (approximately $9,304). Quadranthas made identical guarantees for this obligation of Quest. Pursuant to thefourth guarantee, we have guaranteed payment, up to a maximum of £125(approximately $238), in the event that Quest has a default event, as definedby its loan agreement. This guarantee is in place until 2020. Quadrant has madeidentical guarantees for this obligation of Quest. As of December 31,2004, no amounts have been accrued for any estimated losses under theseguarantees because we believe that Quest will meet all of its performance andfinancial obligations in relation to its contract with the U.K. MOD. However,if we are required to perform under any or all of the four guarantees, it couldhave a material adverse impact on our operating results and liquidity.

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**Contractual Obligations**

Theimpact that our contractual obligations as of December 31, 2004 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)    |       | $                                         | 26,122     |   |   | $ | 1,081 |   |   |   | $ | 2,162 |   |   |   | $ | 2,162 |   |   |   | $ | 20,717 |   |   |
| Operating lease  obligations(2)                  |       | 11,878                                    |       |   | 1,660 |   |   |   | 2,215 |   |   |   | 738 |   |   |   | 7,265 |   |   |
| Purchase  obligations(3)                         |       | 5,265                                     |       |   | 3,823 |   |   |   | 1,442 |   |   |   | — |   |   |   | — |   |   |
| Pension and post  retirement plan obligations(4) |       | 475                                       |       |   | 475 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Total(5)                                         |       | $                                         | 43,740     |   |   | $ | 7,039 |   |   |   | $ | 5,819 |   |   |   | $ | 2,900 |   |   |   | $ | 27,982 |   |   |

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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 or bond premiums or discounts.

(2)          The majority of theoperating lease obligations are land leases for periods up to 40 years on theland underlying our buildings.

(3)          Purchase obligationsinclude agreements to purchase goods or services that are enforceable andlegally binding on E&S and that specify all significant terms, including:fixed or minimum quantities to be purchased and the approximate timing of thetransaction. Purchase obligations exclude agreements that are cancelablewithout penalty. Our maximum rental guarantee payments are included in purchaseobligations.

(4)          Our policy is to makecontributions to pension and post-retirement plans only if required to bystatutory funding requirements.

(5)          Notincluded in the table above are our guarantees related to Quest. See “OffBalance Sheet Arrangements” for further information on these guarantees.

**Restatementof 2003 Quarterly Financial Statements**

In this annual report on Form 10-Kand our prior year annual report on Form 10-K, the financial datafor the first three quarters of 2003 reflects the restatement of amounts forthe correction of certain accounting errors previously reported for the firstthree fiscal quarters of 2003. All information presented in this Management’sDiscussion and Analysis of Financial Condition and Results of Operations inboth the current and prior year annual reports reflects the restatement.

***Restatement of Financial Information***

The aggregate effect ofthe restatement increased previously reported net loss for the quarters endedMarch 28, 2003, June 27, 2003 and September 26, 2003 by $1,243,$2,552 and $1,883, respectively. The aggregate effect of the restatementincreased previously reported basic and diluted loss per share for the quartersended March 28, 2003, June 27, 2003 and September 26, 2003, by$0.12, $0.24 and $0.18, respectively.

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***Discussion of Accounting Principles***

During our 2003year-end close process and review of the financial statements of ourwholly-owned subsidiary, Evans & Sutherland Computer Limited (“E&SLtd.”), we identified errors in E&S Ltd.’s 2003 quarterly financial statementsdue to the misapplication of the percentage-of-completion methodology asprescribed in American Institute of Public Accountant’s Statement of Position81-1, “Accounting for Performance of Construction-Type and CertainProduction-Type Contracts,” (“SOP 81-1”), percentage-of-completion methodAlternative B as described in paragraphs 80 and 81 for recognition ofrevenue on our long-term projects. The following definitions, discussions, andcalculations show the accounting treatments involved.

i)                  **Earned revenue** is the amount of gross profit earned on acontract for a period plus the costs incurred on the contract during theperiod.

ii)              **Cost ofearned revenue** is our actual cost incurred during the period,including materials, labor, subcontractors, and other costs.

iii)          **Gross profitearned** on a contract is computed by multiplying the total estimatedgross profit on the contract by the percentage of completion utilizing thecost-to-cost method. The excess of that amount over the amount of gross profitreported in prior periods is the earned gross profit recognized in the incomestatement for the current period.

Specifically, ourpercentage of completion, gross profit earned, and earned revenue arecalculated with the following formulas:
| *a) Total Cost of Earned Revenue to Date*                                                                                                                                             | * * | *=*      | *c) Percentage of Completion                    to  Date* | * *                                                                                                                                                                                  |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------|----------|-----------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *b) Total Estimated Cost at  Completion*                                                                                                                                              | * * |
| *d) Total Estimated Earned Revenue                   at  Completion*                             | * * | *-*      | *b) Total Estimated Costs                at  Completion*                      | *=   e) Total Estimated Gross              Profit  at Completion*                                                   |
| *c) Percentage of Completion to Date*                                                                                                                                                 | * * | *×* | *e) Total Estimated Gross        Profit at Completion*                                                                | *=   f) Gross Profit Earned to                        Date * |
| *a) Total Cost of Earned Revenue                         to  Date* | * * | *+*      | *f) Gross Profit Earned              to  Date*                                          | *=   g) Earned Revenue to Date*                                                                                                                                                 |

 

***Discussion of Accounting Errors***

The accountingerrors identified in 2003 by management requiring adjustment in previouslyissued financial statements as a result of the misapplication of thepercentage-of-completion methodology as prescribed in SOP 81-1 percentage-of-completion methodAlternative B are described below.

i)                  **Early Recognition of Costs**.   During the first threequarters of 2003, costs were erroneously recorded to certain long-term projectsbefore the underlying costs were actually incurred causing our Cost of EarnedRevenue to Date to be overstated. These errors caused our a) Total Costs ofEarned Revenue to Date numerator to be overstated, therefore overstating our c)Percentage of Completion to Date . This overstatement of the c) Percentage ofCompletion to Date then drove overstatements in both our f) Gross Profit Earnedto Date and g) Earned Revenue to Date for these projects. These overstatementsof sales, costs of sales, and gross profit occurred during 2003 and wereincluded in the Company’s previously issued 10-Q filings for the first threequarters of 2003.

ii)              **Understatementof Total Estimated Costs at Completion**.   During the first threequarters of 2003, b) Total Estimated Costs at Completion wereunderestimated therefore overstating our c) Percentage of Completion to Date. Thisoverstated c) Percentage of Completion to Date then drove 

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overstatements in both ourf) Gross Profit Earned to Date and g) Earned Revenue to Date for these projects.In these circumstances, our a) Total Cost of Earned Revenue to Date on theseprojects was accurately measured. These overstatements in sales and grossprofit were included in the Company’s previously issued Form 10-Q filingsfor the first three quarters of 2003.

iii)          **Recognition of Revenue and Gross Profit Earned in Excess of TotalContract Amounts**.   During the first three quarters of 2003,costs were recorded to certain long-term projects and not included in each ofthese project’s b) Total Estimated Costs at Completion. As a result, a) TotalCosts of Revenue Earned to Date numerator exceeded the b) Total Estimated Costat Completion denominator, deriving the c) Percentage of Completion to Date inexcess of 100%. The application of this incorrect c) Percentage of Completionto Date resulted in the recognition of f) Gross Profit Earned to Date in excessof the e) Estimated Gross Profit at Completion and the recognition of g) EarnedRevenue to Date in excess of Total Estimated Contract Value at Completion. Inthese circumstances, our a) Total Cost of Earned Revenue to Date on theseprojects was accurately measured. These overstatements of sales and grossmargin were included in the Company’s previously issued Form 10-Q filingsfor the first three quarters of 2003.

***Background on the Restatement***

Our U.S. finance group discovered these errors as partof the 2003 year-end close process and application of our normal year-endinternal control processes. In consultation with our audit committee, we thenperformed an in-depth review and analysis of E&S Ltd.’spercentage-of-completion calculations, its financial results and processes todetermine how these errors occurred and which periods they affected.

To ensure that 2002 financial results were notdistorted by similar errors, we performed a thorough review of all of ourlong-term contracts with E&S Ltd. for which revenue was recognized. Weconfirmed contract values, verified costs incurred, reviewed estimates of totalcosts, and recalculated percentage-of-completion ratios for each contract. Further,we confirmed that the operating results of E&S Ltd. during 2002 weresubject to the normal close process and related controls of the U.S. financegroup both on an interim and year-end basis (the same procedures applied duringthe 2003 year-end close which identified the errors). Based on theseprocedures, we concluded that during the 2002 interim and annual periods, allof our long-term contracts complied with the percentage-of-completion method ofaccounting prescribed by SOP 81-1 and sales, cost of sales, and gross profitswere correctly stated.

As a result of theprocedures performed for both 2003 and 2002, we identified two key factorsunderlying the errors in 2003 at E&S Ltd.:

i)                  The incorrectapplication of the percentage-of-completion method of accounting as outlined inSOP 81-1; and

ii)              The inconsistentoperation of internal controls to provide timely identification and correctionof this error.

We believe bothfactors were caused by changes in key accounting personnel and financialreporting relationships at E&S Ltd. during the first three quarters of2003:

i)                  At the beginningof 2003, financial reporting responsibilities were revised such that theE&S Ltd. Finance Director no longer reported directly to the US financegroup and ultimately to our Chief Financial Officer, but rather reportedprimarily to the E&S Ltd. General Manager. This revision in reportingresponsibilities, in part, resulted in the financial reporting process onlong-term contracts not being subject to the timely performance of the USfinance group’s internal control processes on an interim basis.

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ii)              In July 2003, anew CFO was appointed in the United States. As he started in his new position,the CFO concentrated initially on the United States operations, policies andprocedures and deferred a similar analysis of E&S Ltd.’s operations to alater date.

These personnel-relateditems have been addressed as the E&S Ltd. Finance Director again reportsdirectly to the CFO in the United States. Additionally, we performed anevaluation of the E&S Ltd. internal controls and procedures related to therestatement. Actions taken in response to our evaluation are more thoroughlydescribed in Item 9A of Part III of this annual report on Form 10-K.

**Applicationof Critical Accounting Estimates**

The applications ofaccounting 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 2 to the Consolidated Financial Statements in this annualreport on Form 10-K. For all of these policies, management cautions thatfuture results rarely develop exactly as forecast, and the best estimatesroutinely require adjustment.

***Revenue Recognition***

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 lower thanmanagement’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.

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***Contract Damages and Penalties***

Accrued liabilitiesinclude amounts for liquidated damages and late delivery penalties. Whilecurrent contracts could include additional liquidated damages and late deliverypenalties, we have included all amounts we believe we are liable for as of December 31,2004. These liquidated damages are based primarily on estimates of projectcompletion dates. To the extent completion dates are not consistent with ourestimates, these damage and penalty accruals may require additionaladjustments.

***Allowance for Doubtful Accounts***

We specifically analyzeaccounts receivables and consider historical experience, customercreditworthiness, facts and circumstances specific to outstanding balances,current economic trends, and payment term changes when evaluating adequacy ofthe allowance for doubtful accounts. Changes in these factors could result inmaterial adjustments to the expense recognized for bad debts.

***Income Taxes***

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.

***Impairment of 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, wedetermine the estimated fair value of such assets. The amount of impairmentrecognized is the amount by which the carrying amount of the assets exceedstheir estimated fair value. Assets held for sale are reported at the lower oftheir carrying amount or fair value less costs to sell.

***Restructuring Charges***

Restructuring charges that occurred prior to January 1,2003 were recorded under EITF issue No. 94-3, “Liability Recognitionfor Certain Employee Termination Benefits and Other Costs to Exit an Activity(including Certain Costs Incurred in a Restructuring).” As a result,restructuring charges, other than amounts for severance and benefits, can berecorded when a detailed restructuring plan to exit specific activities hasbeen approved by management prior to the financial reporting date and theCompany has the ability to reasonably estimate costs. Estimated amounts forseverance and benefits are accrued once the potentially affected employees havebeen notified of the termination and severance benefits have been communicated.The communication must include, at a minimum, the number of impacted employees,the job functions and the locations that are affected. If actual costs differfrom the estimated costs, adjustments to the restructuring charges arerequired.

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Restructuring charges thatoccurred after December 31, 2002 were recorded under SFAS No. 146, “Accountingfor Costs Associated with Exit or Disposal Activities.” As a result, aliability for the estimated costs associated with an exit or disposal activityis recognized when the liability is incurred. Thus estimated amounts forseverance and benefits are accrued once the affected employees have beennotified of the termination; for contract terminations costs are accrued oncethe contract is terminated or the Company ceases receiving any benefit from thecontract; and for leased property costs are accrued once the Company has exitedthe facility and is no longer receiving any benefit from the lease. If actualcosts differ from the estimated costs, adjustments to the restructuring chargesare required.

***Depreciation and Amortization of Fixed Assets andIntangibles***

Purchasesof property and equipment are recorded at cost and major improvements arecapitalized. Depreciation is included in cost of goods sold, research anddevelopment or selling, general and administrative expenses depending on thenature of the asset. Depreciation is expensed based on the straight-line methodover the following estimated useful lives of the property:
| Manufacturing  machinery and equipment |   | 3 - 8 years |   |
|----------------------------------------|--------|----------------------------|--------|
| Office furniture  and equipment        |   | 8  years                   |   |
| Buildings and  improvements            |   | 40 years                   |   |

 

**Recent Accounting Pronouncements**

In November 2004, the Financial AccountingStandards Board (“FASB”) issued Financial Accounting Standard No. 151, “InventoryCosts—an amendment to ARB No. 43, Chapter 4” (“SFAS 151”). SFAS 151amends ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify theaccounting for abnormal amounts of idle facility expense, freight, handlingcosts, and wasted material (spoilage). Paragraph 5 of ARB 43, Chapter 4,previously stated that “. . . under some circumstances, items such as idlefacility expense, excessive spoilage, double freight, and rehandling costs maybe so abnormal as to require treatment as current period charges. . . .” SFAS151 requires that those items be recognized as current-period chargesregardless of whether they meet the criterion of “so abnormal.” In addition,SFAS 151 requires that allocation of fixed production overhead to the costs ofconversion be based on the normal capacity of the production facilities. SFAS151 is effective for inventory costs incurred during fiscal years beginningafter June 15, 2005 and earlier application is permitted. We do not expectthe adoption of this statement to have a material impact on our financialstatements.

In December 2004, FASB issued FinancialAccounting Standard No. 153 (“SFAS 153”), “Exchanges of Nonmonetary Assets—anamendment of APB Opinion No. 29.” The guidance in APB Opinion No. 29,“Accounting for NonmonetaryTransactions,” is based on the principle that exchanges of nonmonetaryassets should be measured based on the fair value of the assets exchanged. Theguidance in that Opinion, however, included certain exceptions to thatprinciple. SFAS 153 amends APB Opinion 29 to eliminate the exception fornonmonetary exchanges of similar productive assets and replaces it with ageneral exception for exchanges of nonmonetary assets that do not havecommercial substance. A nonmonetary exchange has commercial substance if thefuture cash flows of the entity are expected to change significantly as aresult of the exchange. SFAS 153 is effective for nonmonetary asset exchangesoccurring in fiscal periods beginning after June 15, 2005 and earlierapplication is permitted. We do not expect the adoption of this statement tohave a material impact on our financial statements.

In December2004, FASB issued Financial Accounting Standard No. 123R (“SFAS 123R”),“Share-Based Payment.”  SFAS123R is a revision of SFAS 123.  SFAS 123R establishes standards for theaccounting for transactions in which an entity exchanges its equity instrumentsfor goods or services.  Primarily, SFAS123R focuses on accounting for transactions in which an entity obtains employeeservices in share-based payment transactions. It also addresses transactions in which an entity incurs liabilities in 

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exchange for goods orservices that are based on the fair value of the entity’s equity instruments orthat may be settled by the issuance of those equity instruments. 

SFAS 123R requires us to measure the cost of employeeservices received in exchange for an award of equity instruments based on thegrant-date fair value of the award (with limited exceptions). That cost will berecognized over the period during which an employee is required to provideservice in exchange for the award—the requisite service period (usually thevesting period).  No compensation cost isrecognized for equity instruments for which employees do not render the requisiteservice.  Therefore, if an employee doesnot ultimately render the requisite service, the costs recognized related tounvested options will be reversed.    

SFAS 123R is effective for us as of the beginning ofthe first interim or annual reporting period that begins after June 15,2005.  Under these guidelines we willadopt SFAS 123R as of the beginning of the third quarter of 2005.  We do not expect the adoption of SFAS 123R tohave a material impact on our financial position or cash flows; however it willhave a material impact on our results of operations as we are required torecognize stock-based compensation to our employees as compensation expenseover their service period.

**Forward-Looking Statements**

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 Exchange Act of 1934, as amended,including among others, those statements preceded by, followed by or includingthe words estimates, “believes”, “expects”, “plans”, “projects”, and similarexpressions.

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

·       Ourbelief that our range of visual systems and services at various price andperformance levels, our research and development investments, and our abilityto design and manufacture value-added visual systems will enable us to competeeffectively.

·       Our beliefthat 2004 was the low point in our revenues.

·       Ourbelief that revenue will grow in 2005, that revenue growth is the start of agrowth trend in revenue, and as a result of this and other actions we willreturn to profitability.

·       Ourbelief that the progress we have made towards bringing our laser projector(ESLP) to market will result in deliveries in 2005, that these deliveries in2005 will contribute to revenue growth, and that as a result our R&D costswill decrease.

·       Ourbelief that the impact of the Big Six programs will be immaterial to ourfinancial condition in 2005.

·       Ourbelief that the restructuring plan initiated in March 2005 will reduce ourlabor and labor-related costs approximately $3,860 in 2005 and approximately $5,140per year thereafter.

·       Ourbelief and projections that the military markets will improve in 2005 resultingin increased orders and sales and that the commercial market will remain flat,but we will see higher order volume in 2005 than in 2004 from this market.

·       Ourbelief that our Digistar 3 Laser visual system has the potential to broaden thedigital theater market and further increase our market share, resulting ingrowth in 2005.

·       Ourbelief that we can continue to reduce costs in our operating expenses.

·       Ourbelief that our products are performing well, that we will meet all ourdelivery requirements, and as a result we will incur no liquidated damages orlate delivery penalties in 2005.

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·       Ourbelief that for years beyond 2005 cash from operations will be sufficient forour planned needs, that our long-term investment in research and developmentand our current product strategy will allow our business to grow, and that wewill augment our cash position with the sale of an additional office building,which we believe will occur during 2005 or 2006.

·       Ourbelief that capital expenditures during 2005 will be similar to capitalexpenditures incurred during 2004.

·       Ourbelief that our existing cash, restricted cash, borrowings available under ourborrowing facilities, and expected cash from future operations will be sufficientto meet our anticipated working capital needs, routine capital expenditures andcurrent debt service obligations.

·       Ourbelief that we will make no contributions to our Pension Plan in fiscal year2005, unless required by statutory funding requirements.

·       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 2005 orfuture years.

·       Ourbelief that Quest will meet all of its performance and financial obligations inrelation to its contract with the U.K. MOD and we will therefore incur nolosses as a result of our guarantees.

·       Ourbelief that the effects of inflation will not be material for fiscal year 2005.

·       Ourbelief that a limited number of customers will account for a substantialportion of our international sales in the foreseeable future.

·       Ourbelief that approximately 55% of our backlog will be converted to sales in2005.

·       Ourbelief that we will complete development of certain products, that we willlower the manufacture cost by 10% and increase the performance of our EP-1000CThardware platform in 2005, and that we will introduce the next generation EPX-500PC image generator technology in mid 2005.

Forward-looking statementsare inherently subject to risks and uncertainties, some of which cannot bepredicted or quantified. Future events and actual results could differmaterially from those set forth in, contemplated by, or underlying theforward-looking statements. Our actual results could differ materially fromthese forward-looking statements. In addition to the other risks described in “FactorsThat May Affect Our Future Results” discussed below, important factors toconsider in evaluating such forward-looking statements include risks of productdemand, market acceptance, economic conditions, competitive products andpricing, difficulties in product development, and product delays. In light ofthese risks and uncertainties, there can be no assurance that the eventscontemplated by the forward-looking statements contained in this annual reportwill, in fact, occur.

**FactorsThat May Affect Our Future Results**

Our domestic andinternational businesses operate in highly competitive markets that involve anumber of risks, some of which are beyond our control. While we are optimisticabout our long-term 

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prospects,the following discussion highlights some risks and uncertainties that should beconsidered in evaluating our growth outlook.

***Our Business Model Is Changing and May NotProduce Consistent Earnings***

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. Inmost of our markets we are experiencing increased competition, and we expectthis trend to continue.

When new systems are ordered, prices are usually belowour comparable, last generation systems. Success in this environment requires abusiness model that emphasizes smaller systems and associated hardware revenue,with greater dependence on software, databases, and support services.

We have made significantprogress in adapting to this new business model and introducing productsemphasizing the new factors for success. However, there is no assurance thatthis model will succeed and ensure profitability in the future.

***Competitors May Infringe E&S IntellectualProperty***

Throughout its historyE&S has been awarded 79 patents, with 60 still active. Another 19applications are pending. While we have not had any significant intellectualproperty infringement by competitors, we are entering production stage of a newproduct, the E&S Laser Projector. We have a number of patents either issuedor pending on this technology, but it represents a new field for us and mayattract competitors with a risk of infringement and costly legal processes todefend our intellectual property rights.

***Migration to PC’s in the Commercial Simulation Market May NegativelyImpact our Revenues***

Currently, off-the-shelfPC technology is not used in visual systems for Level D certification in thecommercial simulation market. However, advances in technology could make itpossible to attain Level D certification with such systems. If this occurs,E&S would expect to deliver a range of products at different prices, withthe risk of lower average prices and lower total revenue for the mix ofcommercial systems.

***Prime Contractors May Continue Bring Workshareinto Their Own Company and Decrease the Demand for E&S Products***

Large prime contractors in the defense and aerospaceindustry have encountered the same competitive pressures described earlier forsimulation and training revenue. To protect their own revenue and margins, mosthave responded by putting pressure on smaller suppliers, as well as bringingwork in-house to protect established engineering organizations whereverpossible.

This trend has, in effect, created new competitors forour traditional business. These in-house engineering groups attempt to do onlythe most profitable work, such as software and databases, and leave lessprofitable hardware development to others. Often the costs of these efforts arenot visible to the end customer because they are part of a much largercontract.

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If these trends continueand the end customers accept the results, they could reduce demand for the mostprofitable future portions of our revenue stream and business model, softwareand databases.

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

During 2005, we intend tointroduce several important newproducts, including the simFUSION 7000 and the E&S LaserProjector. Delays in introducing and delivering theseproducts could reduce their planned revenue and profit contribution.

***Changes in Government Priorities May FurtherImpact the Military Simulation Market***

During the last severalyears significant changes have taken place in budget priorities for both U.S.and international government spending, especially military spending. Some ofthese changes have resulted in delays or reductions of visual system purchases.While we have downsized our company in accordance with these changes, we haveno assurance that such delays will not continue to occur or accelerate and causefurther declines in our revenue from this market.

***We Depend on Several Significant Customers and our NetSales Could Suffer if Their Purchases Decline***

We currently derive asignificant portion of our sales from a limited number of non-U.S. government customers.The loss of any one or more of these customers could have a material adverseeffect on our business, financial condition and results of operations. We weredependent on four of our non-U.S. government customers for approximately 25% ofour consolidated sales in 2004. We expect that sales to a limited number ofcustomers will continue to account for a substantial portion of our sales inthe foreseeable future. We have no assurance that sales from this limitednumber of customers will continue to reach or exceed historical levels in thefuture. We do not have supply contracts with any of our significant customers.

***Our Operations Could Be Hurt by Terrorist Attacks andOther Activities that Make Air Travel Difficult or Reduce the Willingness ofOur Commercial Airline Customers to Purchase Our Simulation Products***

During 2004, $22.3million, or 32.3% of our total revenue generated, was derived from sales of ourvisual systems to commercial airline companies and other third parties in thecommercial airline industry. The demand for our various commercial simulationproducts and services is heavily dependent upon new orders from thesecommercial airline customers. In the event terrorist attacks or otheractivities make air travel difficult or reduce the demand or willingness of ourcustomers to purchase our commercial simulation products, our revenue maydecline substantially.

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

We may be subject to theUtah Control Shares Acquisition Act which provides that any person who acquires20% or more of the outstanding voting shares of a publicly held Utahcorporation will not have voting rights with respect to the acquired sharesunless a majority of the disinterested shareholders of the corporation votes togrant such rights. This could deprive shareholders of opportunities to realizetakeover premiums for their shares or other advantages that large accumulationsof stock would provide because anyone interested in acquiring E&S couldonly do so with the cooperation of our board of directors and a majority ofdisinterested shareholders.

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**ITEM 7A.**        QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK

The principal market risks to which we are exposed arechanges in foreign currency exchange rates and changes in interest rates. Ourinternational sales, which in fiscal years 2004, 2003 and 2002 accounted for58%, 53% and 39% of our totals sales, respectively, are concentrated in theUnited Kingdom, continental Europe, and Asia. In general, we enter into saleagreements with our international customers denominated in U.S. dollars. Foreigncurrency purchase and sale contracts may be entered into for periods consistentwith related underlying exposures and do not constitute positions independentof those exposures. We do not enter into foreign currency contracts for tradingpurposes and do not use leveraged contracts. As of December 31, 2004, wehad sales contracts in Euros with approximately €4,100 remaining tocollect, sales contracts in GBP with approximately £1,200 remaining to invoiceand collect, and we had entered into one foreign currency derivative contract. Werecognized a loss of $34 related to the foreign currency derivative as of December 31,2004. As no settlement provision is permitted under the contract, we recordedan amount due from a financial services company as prepaid expenses anddeposits and a liability for the amount owed by us to the financial servicecompany as accrued expense in the amounts of $368 and $402, respectively,as of December 31, 2004. The contract expires in January 2005.

We reduce our exposure to changes in interest rates bymaintaining a high proportion of our debt in fixed-rate instruments. As of December 31,2004, our fixed-rate instruments consist solely of our 6% convertibledebentures due in 2012. The outstanding balance of the 6% convertibledebentures as of December 31, 2004 was $18,015. The fair value of the 6%convertible debentures, based on quoted market prices was $12,250 as of December 31,2004.

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**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

**CONSOLIDATEDBALANCE SHEETS(In thousands, except share data)**
| ** **                                                                                                          | ** ** | **December 31** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                                                          | ** ** | **2004**             | ** ** | **2003** | ** ** |
| **ASSETS**                                                                                                          | ** ** | ** **           | ** ** | ** ** | ** ** |
| Current assets:                                                                                                     |       |                 |       |   |   |
| Cash                                                                                                                |       | $                    | 10,147     |   | $ | 9,714 |   |
| Restricted cash                                                                                                     |       | 3,414                |       | 765 |   |
| Accounts receivable, net                                                                                            |       | 15,102               |       | 22,298 |   |
| Costs and estimated earnings in excess of billings  on uncompleted contracts                                        |       | 5,616                |       | 10,922 |   |
| Inventories, net                                                                                                    |       | 10,802               |       | 15,973 |   |
| Prepaid expenses and deposits                                                                                       |       | 4,655                |       | 4,731 |   |
| Assets held for sale                                                                                                |       | —               |       | 2,463 |   |
| Total current assets                                                                                                |       | 49,736               |       | 66,866 |   |
| Property, plant  and equipment, net                                                                                 |       | 20,753               |       | 24,115 |   |
| Investments                                                                                                         |       | 1,933                |       | 2,011 |   |
| Other assets                                                                                                        |       | 1,349                |       | 390 |   |
| Total assets                                                                                                        |       | $                    | 73,771     |   | $ | 93,382 |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                      |       |                 |       |   |   |
| Current liabilities                                                                                                 |       |                 |       |   |   |
| Line of credit agreements                                                                                           |       | $                    | —     |   | $ | 7,685 |   |
| Accounts payable                                                                                                    |       | 6,454                |       | 8,446 |   |
| Accrued liabilities                                                                                                 |       | 11,032               |       | 12,526 |   |
| Billings in excess of costs and estimated earnings  on uncompleted contracts                                        |       | 11,703               |       | 11,499 |   |
| Customer deposits                                                                                                   |       | 2,968                |       | 3,928 |   |
| Total current liabilities                                                                                           |       | 32,157               |       | 44,084 |   |
| Convertible  subordinated notes                                                                                     |       | 18,015               |       | 18,015 |   |
| Pension and  retirement obligations                                                                                 |       | 19,836               |       | 15,717 |   |
| Total liabilities                                                                                                   |       | 70,008               |       | 77,816 |   |
| Stockholders’ equity:                                                                                          |       |                 |       |   |   |
| 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; 10,864,042 and 10,836,072 shares issued, respectively |       | 2,173                |       | 2,167 |   |
| Additional paid-in-capital                                                                                          |       | 49,707               |       | 49,575 |   |
| Common stock in treasury, at cost 352,500 shares                                                                    |       | (4,709               | )          | (4,709 | ) |
| Accumulated deficit                                                                                                 |       | (38,015              | )          | (29,148 | ) |
| Accumulated other comprehensive loss                                                                                |       | (5,393               | )          | (2,319 | ) |
| Total stockholders’ equity                                                                                     |       | 3,763                |       | 15,566 |   |
| Total liabilities  and stockholders’ equity                                                                    |       | $                    | 73,771     |   | $ | 93,382 |   |

 

See notes to consolidated financial statements.

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**CONSOLIDATEDSTATEMENTS OF OPERATIONS(In thousands, except per share data)**
| ** **                                                    | ** ** | **Year ended December 31** | ** ** |
|---------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                    | ** ** | **2004**                                  | ** ** | **2003** | ** ** | **2002** | ** ** |
| Sales                                                         |       | $                                         | 69,159     |   | $ | 84,776 |   | $ | 122,578 |   |
| Cost of sales                                                 |       | 44,119                                    |       | 53,252 |   | 78,052 |   |
| Inventory  impairment                                         |       | —                                    |       | 14,566 |   | 1,392 |   |
| Gross profit                                                  |       | 25,040                                    |       | 16,958 |   | 43,134 |   |
| Expenses:                                                     |       |                                      |       |   |   |   |   |
| Selling, general and administrative                           |       | 23,786                                    |       | 27,039 |   | 27,131 |   |
| Research and development                                      |       | 16,621                                    |       | 21,730 |   | 25,970 |   |
| Restructuring charges (recoveries)                            |       | (491                                      | )          | 3,416 |   | 4,492 |   |
| Impairment loss                                               |       | —                                    |       | 1,151 |   | 311 |   |
| Operating expenses                                            |       | 39,916                                    |       | 53,336 |   | 57,904 |   |
| Gain on sale of  assets                                       |       | 3,817                                     |       | — |   | 253 |   |
| Gain on sale of  assets held for sale                         |       | 3,488                                     |       | 1,406 |   | 1,212 |   |
| Gain on  curtailment of pension plan                          |       | —                                    |       | — |   | 3,575 |   |
| Operating loss                                                |       | (7,571                                    | )          | (34,972 | ) | (9,730 | ) |
| Other income (expense):                                       |       |                                      |       |   |   |   |   |
| Interest income                                               |       | 90                                        |       | 412 |   | 25 |   |
| Interest expense                                              |       | (1,296                                    | )          | (1,376 | ) | (1,839 | ) |
| Impairment of investment securities                           |       | —                                    |       | (500 | ) | (16 | ) |
| Gain on sale of investment securities                         |       | 133                                       |       | — |   | 27 |   |
| Other                                                         |       | (111                                      | )          | (523 | ) | (651 | ) |
| Total other income (expense), net                             |       | (1,184                                    | )          | (1,987 | ) | (2,454 | ) |
| Loss before  income taxes                                     |       | (8,755                                    | )          | (36,959 | ) | (12,184 | ) |
| Income tax  expense (benefit)                                 |       | 112                                       |       | (971 | ) | (463 | ) |
| Net loss                                                      |       | $                                         | (8,867     | ) | $ | (35,988 | ) | $ | (11,721 | ) |
| Basic and diluted net loss per common share                   |       | $                                         | (0.84      | ) | $ | (3.44 | ) | $ | (1.12 | ) |
| Basic and diluted  weighted average common shares outstanding |       | 10,498                                    |       | 10,471 |   | 10,422 |   |

 

See notes to consolidated financial statements.

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**CONSOLIDATED STATEMENTS OFSTOCKHOLDERS’ EQUITY AND COMPREHENSIVE LOSS**

**(In thousands)**
| ** **                                | ** ** | ** **                         | ** ** | ** **  | ** ** | **Additional** | ** ** | ** **       | ** ** | **Retained  Earnings** | ** ** | **Accumulated  Other** | ** ** | ** ** | ** ** |
|-------------------------------------------|------------|------------------------------------|------------|-------------|------------|----------------|------------|------------------|------------|------------------------|------------|------------------------|------------|------------|------------|
| ** **                                | ** ** | **Common Stock**              | ** ** | **Paid-in** | ** ** | **Treasury**   | ** ** | **(Accumulated** | ** ** | **Comprehensive**      | ** ** | ** **             | ** ** |
| ** **                                | ** ** | **  Shares  ** | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **Stock**        | ** ** | **Deficit)**           | ** ** | **Loss**               | ** ** | **Total**  | ** ** |
| Balance at December 31, 2001         |       |                               | 10,740     |        |       |           | $          | 2,148            |       |                   |       | $                      | 49,030     |       |       |   | $ | (4,709 | ) |   |   | $ | 18,561 |   |   |   | $ | (371 | ) |   | $ | 64,659 |   |
| Components of  comprehensive loss:        |       |                               |       |        |       |           |       |             |       |                   |       |                   |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                  |       |                               | —     |        |       |           | —     |             |       |                   | —     |                   |       |       | —     |   |   |   | (11,721 | ) |   |   | — |   |   | (11,721 | ) |
| Unrealized gains on marketable securities |       |                               | —     |        |       |           | —     |             |       |                   | —     |                   |       |       | —     |   |   |   | — |   |   |   | 29 |   |   | 29 |   |
| Total comprehensive loss                  |       |                               |       |        |       |           |       |             |       |                   |       |                   |       |       |       |   |   |   |   |   |   |   |   |   |   | (11,692 | ) |
| Issuance of common stock for cash    |       |                               | 66         |        |       |           | 13         |             |       |                   | 383        |                   |       |       | —     |   |   |   | — |   |   |   | — |   |   | 396 |   |
| Balance at December 31, 2002         |       |                               | 10,806     |        |       |           | 2,161      |             |       |                   | 49,413     |                   |       |       | (4,709     | ) |   |   | 6,840 |   |   |   | (342 | ) |   | 53,363 |   |
| Components of  comprehensive loss:        |       |                               |       |        |       |           |       |             |       |                   |       |                   |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                  |       |                               | —     |        |       |           | —     |             |       |                   | —     |                   |       |       | —     |   |   |   | (35,988 | ) |   |   | — |   |   | (35,988 | ) |
| Unrealized gains on marketable securities |       |                               | —     |        |       |           | —     |             |       |                   | —     |                   |       |       | —     |   |   |   | — |   |   |   | 444 |   |   | 444 |   |
| Additional minimum pension liability      |       |                               | —     |        |       |           | —     |             |       |                   | —     |                   |       |       | —     |   |   |   | — |   |   |   | (2,421 | ) |   | (2,421 | ) |
| Total comprehensive loss                  |       |                               |       |        |       |           |       |             |       |                   |       |                   |       |       |       |   |   |   |   |   |   |   |   |   |   | (37,965 | ) |
| Issuance of common stock for cash    |       |                               | 30         |        |       |           | 6          |             |       |                   | 162        |                   |       |       | —     |   |   |   | — |   |   |   | — |   |   | 168 |   |
| Balance at December 31, 2003         |       |                               | 10,836     |        |       |           | 2,167      |             |       |                   | 49,575     |                   |       |       | (4,709     | ) |   |   | (29,148 | ) |   |   | (2,319 | ) |   | 15,566 |   |
| Components of  comprehensive loss:        |       |                               |       |        |       |           |       |             |       |                   |       |                   |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                  |       |                               | —     |        |       |           | —     |             |       |                   | —     |                   |       |       | —     |   |   |   | (8,867 | ) |   |   | — |   |   | (8,867 | ) |
| Unrealized gains on marketable securities |       |                               | —     |        |       |           | —     |             |       |                   | —     |                   |       |       | —     |   |   |   | — |   |   |   | 99 |   |   | 99 |   |
| Foreign currency translation              |       |                               | —     |        |       |           | —     |             |       |                   | —     |                   |       |       | —     |   |   |   | — |   |   |   | 244 |   |   | 244 |   |
| Additional minimum pension liability      |       |                               | —     |        |       |           | —     |             |       |                   | —     |                   |       |       | —     |   |   |   | — |   |   |   | (3,417 | ) |   | (3,417 | ) |
| Total comprehensive loss                  |       |                               |       |        |       |           |       |             |       |                   |       |                   |       |       |       |   |   |   |   |   |   |   |   |   |   | (11,941 | ) |
| Issuance of common stock                  |       |                               | 28         |        |       |           | 6          |             |       |                   | 132        |                   |       |       | —     |   |   |   | — |   |   |   | — |   |   | 138 |   |
| Balance at  December 31, 2004        |       |                               | 10,864     |        |       |           | $          | 2,173            |       |                   |       | $                      | 49,707     |       |       |   | $ | (4,709 | ) |   |   | $ | (38,015 | ) |   |   | $ | (5,393 | ) |   | $ | 3,763 |   |

 

See notes to consolidated financial statements.

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**CONSOLIDATED STATEMENTS OFCASH FLOWS**

**(In thousands)**
| ** **                                                                                    | ** ** | **Year ended December 31** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                    | ** ** | **2004**                                  | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net loss                                                                                      |       | $                                         | (8,867     | ) | $ | (35,988 | ) | $ | (11,721 | ) |
| Adjustments to reconcile  net loss to net cash provided by (used in) operating activities:    |       |                                      |       |   |   |   |   |
| Depreciation and amortization                                                                 |       | 5,104                                     |       | 6,782 |   | 9,311 |   |
| Gain on sale of assets                                                                        |       | (3,817                                    | )          | — |   | (253 | ) |
| Gain on sale of assets held for sale                                                          |       | (3,488                                    | )          | (1,406 | ) | (1,212 | ) |
| Gain on curtailment of pension plan                                                           |       | —                                    |       | — |   | (3,575 | ) |
| Inventory impairment                                                                          |       | —                                    |       | 14,566 |   | 1,392 |   |
| Impairment loss                                                                               |       | —                                    |       | 1,151 |   | 311 |   |
| Loss on disposal of property, plant, and equipment                                            |       | 35                                        |       | 16 |   | 40 |   |
| Gain on sale of investment securities                                                         |       | (133                                      | )          | — |   | (27 | ) |
| Impairment of investment                                                                      |       | —                                    |       | 500 |   | 16 |   |
| Provision for losses on accounts receivable                                                   |       | 326                                       |       | 68 |   | (734 | ) |
| Provision for excess and obsolete inventory                                                   |       | 2,231                                     |       | 1,499 |   | 1,802 |   |
| Provision for warranty expense                                                                |       | 1,188                                     |       | 2,274 |   | 617 |   |
| Other                                                                                         |       | 90                                        |       | 107 |   | 214 |   |
| Change in operating  assets and liabilities:                                                  |       |                                      |       |   |   |   |   |
| Decrease in accounts receivable                                                               |       | 6,870                                     |       | 333 |   | 8,769 |   |
| Decrease inventories                                                                          |       | 1,849                                     |       | 141 |   | 3,898 |   |
| Decrease in costs and estimated earnings in excess of  billings on uncompleted contracts, net |       | 5,510                                     |       | 11,638 |   | 11,900 |   |
| Decrease (increase) in prepaid expenses and deposits                                          |       | 218                                       |       | (328 | ) | (181 | ) |
| Decrease in accounts payable                                                                  |       | (1,991                                    | )          | (1,225 | ) | (1,832 | ) |
| Decrease in accrued liabilities                                                               |       | (4,648                                    | )          | (3,320 | ) | (4,553 | ) |
| (Decrease) increase in customer deposits                                                      |       | (961                                      | )          | 2,421 |   | (2,143 | ) |
| Net cash provided by (used in) operating activities                                           |       | (484                                      | )          | (771 | ) | 12,039 |   |
| Cash flows from investing  activities:                                                        |       |                                      |       |   |   |   |   |
| Proceeds from sale of assets                                                                  |       | 5,250                                     |       | — |   | — |   |
| Proceeds from sale of investment securities                                                   |       | 633                                       |       | — |   | 39 |   |
| Purchases of property, plant and equipment                                                    |       | (1,827                                    | )          | (3,767 | ) | (3,394 | ) |
| Proceeds from sale of property, plant and equipment                                           |       | 63                                        |       | 4 |   | — |   |
| Proceeds from sale of assets held for sale                                                    |       | 8,288                                     |       | 4,760 |   | 2,917 |   |
| Increase in other assets                                                                      |       | (871                                      | )          | — |   | (218 | ) |
| Net cash provided by (used in) investing activities                                           |       | 11,536                                    |       | 997 |   | (656 | ) |
| Cash flows from  financing activities:                                                        |       |                                      |       |   |   |   |   |
| Net repayments on line of credit agreements                                                   |       | (7,685                                    | )          | (250 | ) | (12,965 | ) |
| Decrease (increase) in restricted cash                                                        |       | (3,057                                    | )          | 2,195 |   | (156 | ) |
| Proceeds from issuance of common stock                                                        |       | 123                                       |       | 168 |   | 396 |   |
| Net cash provided by (used in) financing activities                                           |       | (10,619                                   | )          | 2,113 |   | (12,725 | ) |
| Net change in cash and cash equivalents                                                       |       | 433                                       |       | 2,339 |   | (1,342 | ) |
| Cash and cash equivalents at beginning of year                                                |       | 9,714                                     |       | 7,375 |   | 8,717 |   |
| Cash and cash equivalents at end of year                                                      |       | $                                         | 10,147     |   | $ | 9,714 |   | $ | 7,375 |   |
| *Supplemental  Disclosure of Cash Flow Information*                                           |       |                                      |       |   |   |   |   |
| Cash paid (received)  during the year for:                                                    |       |                                      |       |   |   |   |   |
| Interest                                                                                      |       | $                                         | 1,295      |   | $ | 1,376 |   | $ | 1,839 |   |
| Income taxes                                                                                  |       | 140                                       |       | (209 | ) | (534 | ) |

 

See notes to consolidated financial statements.

38

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

Alldollar amounts are in thousands unless otherwise indicated.

**Note 1:   Businessand Background**

***Description of Business***

Evans &Sutherland Computer Corporation referred to in these notes as “E&S,” “we,” “us,”“our” or the “Company,” produces visual systems used to rapidly and accuratelydisplay images of the real world. We design, manufacture, market and supportour visual systems to provide simulation training for a wide range of militaryand commercial applications, as well as for planetariums, science centers, andentertainment venues. Our products and solutions range from the desktop PC towhat we believe are the most advanced visual systems in the world.

**Note 2:   Summaryof Significant Accounting Policies**

***Basis of Presentation***

Evans &Sutherland has a fiscal year end which ends on December 31. Theconsolidated financial statements include the accounts of Evans &Sutherland and its wholly owned subsidiaries. All inter-company accounts andtransactions have been eliminated in consolidation. Certain reclassificationshave been made in the 2003 and 2002 consolidated financial statements and notesto conform to the 2004 presentations.

***Use of Estimates***

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions that affect the amounts reported in the consolidated financialstatements and accompanying notes. The accounting estimates that requiremanagement’s most difficult and subjective judgments include revenuerecognition based on the percentage-of completion method, inventory reserves,accruals for liquidated damages and late penalties, allowance for doubtfulaccounts, income tax valuation allowance, restructuring charges, impairment oflong-lived assets, and useful life of depreciable assets. Actual results coulddiffer from those estimates.

***Restricted Cash***

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, 2004 was $408. Therewas no long-term restricted cash at December 31, 2003.

***Trade Accounts 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 in excess of billings, and consider history, customer creditworthiness,facts and circumstances specific to outstanding balances, current economic trends,and payment term changes when evaluating adequacy of the allowance for doubtfulaccounts. Changes in these factors could result in material differences to baddebt expense. Past due balances are reviewed individually for collectibility.

39

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

For uncollectible accounts receivable we record a lossagainst the allowance for doubtful accounts only after exhaustive efforts havebeen made to collect and with management’s approval. Generally, realized losseshave been within the range of management’s expectations.

Thetable below represents changes in our allowance for doubtful receivables duringfiscal year:
| ** **                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------|------------|----------|------------|----------|------------|
| Beginning balance                            |       | $        | 351        |     | $          | 856 |   |
| Provision for  losses on accounts receivable |       | 326      |       | 68       |       |
| Charges against  the reserve                 |       | (27      | )          | (573     | )          |
| Ending balance                               |       | $        | 650        |     | $          | 351 |   |

 

***Inventories***

Inventory includesmaterials at standard costs, which approximates average costs, as well asinventoried costs on programs and long-term contracts. Inventoried costsinclude material, direct engineering and production costs, and applicableoverhead, not in excess of estimated realizable value. In accordance withindustry practice, inventoried costs include amounts relating to programs andcontracts with long production cycles, a portion of which is not expected to berealized within one year. Spare parts and general stock materials are stated atcost not 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. See Note 3 and Note23 for further information concerning inventory.

***Property, Plant and Equipment***

Property, plant andequipment are stated at cost. Depreciation and amortization are computed usingthe straight-line method based on the estimated useful lives of the relatedassets. Expenditures that materially increase values or capacities or extenduseful lives of property and equipment are capitalized. Routine maintenance,repairs and 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 goods sold, research and development or selling, generaland administrative expenses depending on the nature of the asset and isexpensed based on the straight-line method over the following estimated usefullives of the property.

***Software Development 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 securitiesare included in results of operations and are determined on the specific-

40

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

identification basis. Adecline in the market value that is deemed other than temporary results in acharge to results of operations and the establishment of a new cost basis forthe investment.

We account for ourinvestments in nonmarketable securities using the cost and equity methods. Inassessing the fair value cost method of such investments, we consider recentequity transactions that investees have entered into, the status of eachinvestee’s technology and strategies in place to achieve their objectives, aswell as the investee’s financial condition and results of operations. To theextent there are changes in these assessments, adjustments may need to berecorded. For our investment accounted for using the equity method, adjustmentsare made to the carrying amount of the investment to account for our equity inundistributed earnings (losses) of the investee. Investments are periodicallyevaluated for a decline in value that is considered other-than-temporary. Anysuch decline is recognized as a loss in the statement of operations. In 2003,we determined that the value of a nonmarketable investment had experienced adecline in value that was deemed to be other-than-temporary. As a result werecorded a loss on the write-down of this investment of $500 representing thetotal value of this investment.

***Accounting for Impairment of 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.

***Warranty Reserve***

We provide a warranty reserve for estimated futurecosts of servicing products under warranty agreements extending for periodsfrom 90 days to one year. Anticipated costs for product warranties are basedupon estimates derived from experience factors and are recorded at the time ofsale or over the period revenues are recognized for long-term contracts. Warrantyreserves are classified as accrued liabilities in the accompanying financialstatements.

Thetable below reflects changes in our warranty reserves during fiscal year:
| ** **                            | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|
| Beginning balance                     |       | $        | 1,290      |     | $          | 968 |   |
| Provision for  warranty expense       |       | 1,188    |       | 2,274    |       |
| Warranty charges  against the reserve |       | (1,007   | )          | (1,952   | )          |
| Ending balance                        |       | $        | 1,471      |     | $          | 1,290 |   |

 

41

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

***Revenue Recognition***

Oursales include revenue from system hardware, software, database products andservice contracts. The following table provides information on revenue byrecognition method applied during fiscal years:
| **Revenue recognition method** | ** ** | ** ** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| Percentage-of-completion                 |       | $          | 42,208     |     | $          | 38,358   |       | $        | 63,263     |   |
| Completed  contract                      |       | 25,010     |       | 40,590   |       | 54,939   |       |
| Time and  materials                      |       | 716        |       | 4,602    |       | 1,168    |       |
| Other                                    |       | 1,225      |       | 1,226    |       | 3,208    |       |
| Total sales                              |       | $          | 69,159     |     | $          | 84,776   |       | $        | 122,578    |   |

 

*Percentage-of-Completion.  *Inarrangements that are longer in term and require significant production,modification or customization, revenue is recognized in accordance with theprovisions of Statement of Position 81-1, “Accounting for Performance ofConstruction-Type and Certain Production-Type Contracts” (“SOP 81-1”),using the percentage-of-completion method. In applying the provisions of SOP 81-1,we utilize cost-to-cost methodology whereby we estimate the percent complete bycalculating the ratio of costs incurred (consisting of material, labor andsubcontracting costs, as well as an allocation of indirect costs) to management’sestimate of total anticipated costs. This ratio is then utilized to determinethe amount of gross profit earned based on management’s estimate of totalestimated gross profit at completion. We routinely review estimates related topercentage-of-completion contracts and adjust for changes in the periodrevisions are made. Billings on uncompleted percentage-of-completion contractsmay be greater than or less than incurred costs and estimated earnings and arerecorded as an asset or liability in the accompanying consolidated balancesheets.

*Completed Contract.  *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, provided persuasive evidenceof an arrangement exists, title and risk of loss has transferred, the fee isfixed and determinable, and collection is reasonably assured.

*Time and Materials.  *Whenservices are sold to customers on a time and materials or cost-plus basisrevenues are recognized as the related services and material costs areincurred.

*Other.  *Other revenueconsists primarily of amounts earned under maintenance contracts that aregenerally sold as a single element to our customers. Revenue from productmaintenance contracts, including separately priced extended warranty contracts,is deferred and recognized on a straight-line basis over the contract period. Revenuefrom research and development funding is recognized as we earn reimbursementfrom our efforts.

*Anticipated Losses.  *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).

*MultipleElement Arrangements*.   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.

42

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

***Stock-Based Compensation***

We have adopted the footnote disclosure provisions ofStatements of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock Based Compensation” (“SFAS123”) and SFAS No. 148, “Accounting for Stock Based Compensation—Transitionand Disclosure—an amendment of FASB Statement No. 123” (“SFAS 148”). SFAS123 encourages entities to adopt a fair value based method of accounting forstock options or similar equity instruments. However, it also allows an entityto continue measuring compensation cost for stock-based compensation using theintrinsic-value method of accounting prescribed by Accounting Principles BoardOpinion No. 25, “Accounting forStock Issued to Employees” (“APB 25”). We have elected to continue to apply the provisions of APB 25and provide pro forma footnote disclosures required by SFAS 123 and SFAS 148.

Stock-based compensation granted to non-employees(consultants and independent contractors) is determined as either the fairvalue of the consideration received or the fair value of the equity instrumentsissued, whichever is more reliably measurable. The measurement date for theseissuances is the earlier of either the date at which a commitment by therecipient to earn the equity instruments is reached or the date at which therecipient’s performance is complete.

Weaccount for our stock options granted to employees under APB 25, whereby nocompensation cost has been recognized as all options granted have an exerciseprice equal to or greater than the market value of the underlying common stockon the date of grant. Had compensation cost for these options been determinedconsistent with SFAS 123, our net loss and loss per common share would havebeen changed to the following pro forma amounts during fiscal year:
| ** **                                                                                                      | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net loss as  reported                                                                                           |       | $        | (8,867     | )        | $          | (35,988  | )          | $ | (11,721 | ) |
| Deduct: Total  stock based employee compensation expense determined under the fair value  method for all awards |       | (397     | )          | (442     | )          | (688     | )          |
| Pro forma net  loss                                                                                             |       | $        | (9,264     | )        | $          | (36,430  | )          | $ | (12,409 | ) |
| Basic and diluted net loss per common share—as  reported                                                   |       | $        | (0.84      | )        | $          | (3.44    | )          | $ | (1.12 | ) |
| Basic and diluted net  loss per common share—pro forma                                                     |       | (0.88    | )          | (3.48    | )          | (1.19    | )          |

 

***Income Taxes***

We use the asset andliability method of accounting for income taxes. Under the asset and liabilitymethod, deferred income tax assets and liabilities are recognized for thefuture income tax consequences attributable to differences between thefinancial statement carrying amounts of existing assets and liabilities andtheir respective income tax bases and operating loss and income tax creditcarry-forwards. Deferred income tax assets and liabilities are measured usingenacted tax rates expected to apply to taxable income in the years in whichthose temporary differences are expected to be recovered or settled. The effecton deferred income tax assets and liabilities of a change in income tax ratesis recognized in the period that includes the enactment date.

***Derivatives***

We enter into readilymarketable forward contracts with financial institutions to minimize the impactof foreign currency fluctuations on certain sales contract. We do not enterinto derivative instruments for speculative or trading purposes. Realized andunrealized gains or losses are recorded in results of operations. In 2004, weentered into one foreign currency hedge transaction. We recognized a loss of$34 

43

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

as of December 31,2004. As there is no net settlement provision in the contract, we recorded anamount due from a financial institution as prepaid expenses and deposits and aliability for the amount owed by us to the financial institutions as accruedexpense in the amounts of $368 and $402, respectively, as of December 31,2004. The contract expires in January 2005.

***Other Comprehensive Loss***

We have applied paragraph 36(b) of SFAS 109 (“SFAS109”), “Accounting for Income Taxes,” to our gains and losses included in othercomprehensive loss but excluded from our net loss. On a net basis for 2004,2003 and 2002, there was a deferred income tax asset as a result of the itemsreflected in comprehensive income. However, in applying paragraph 17 of SFAS109 we determined that it is more likely than not that we will not realize suchnet deferred income tax assets and have therefore established a valuationallowance against the full amount of the net deferred income tax asset. Accordingly,the net income tax effect of the items included in other comprehensive loss iszero. Therefore, we have included no income tax expense or benefit in relationto items reflected in other comprehensive loss.

Thecomponents of accumulated other comprehensive loss were as follows as of yearend:
| ** **                                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------------|------------|----------|------------|----------|------------|
| Additional minimum  pension liability                         |       | $        | (5,838     | )        | $          | (2,421 | ) |
| Net unrealized holding  gain on available-for-sale securities |       | 568      |       | 469      |       |
| Net foreign currency  translation                             |       | (123     | )          | (367     | )          |
| Total accumulated  other comprehensive loss                   |       | $        | (5,393     | )        | $          | (2,319 | ) |

 

***Recent Accounting Pronouncements***

In December 2004, FASB issued Financial AccountingStandard No. 123R (“SFAS 123R”), “Share-Based Payment.” SFAS 123R is arevision of SFAS 123. SFAS 123R establishes standards for the accounting fortransactions in which an entity exchanges its equity instruments for goods orservices. Primarily, SFAS 123R focuses on accounting for transactions in whichan entity obtains employee services in share-based payment transactions. Italso addresses transactions in which an entity incurs liabilities in exchangefor goods or services that are based on the fair value of the entity’s equityinstruments or that may be settled by the issuance of those equity instruments.

SFAS 123R requires us to measure the cost of employeeservices received in exchange for an award of equity instruments based on thegrant-date fair value of the award (with limited exceptions). That cost will berecognized over the period during which an employee is required to provideservice in exchange for the award—the requisite service period (usually thevesting period). No compensation cost is recognized for equity instruments forwhich employees do not render the requisite service. Therefore, if an employeedoes not ultimately render the requisite service, the costs recognized relatedto unvested options will be reversed.

SFAS 123R is effective forus as of the beginning of the first interim or annual reporting period thatbegins after June 15, 2005. Under these guidelines we will adopt SFAS 123Ras of the beginning of the third quarter of 2005. We do not expect the adoptionof SFAS 123R to have a material impact on our financial position or cash flows;however it will have a material impact on our results of operations as we arerequired to recognize stock-based compensation to our employees as compensationexpense over their service period.

44

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

**Note 3:   Inventories**

Inventoriesnet of reserves at fiscal year-end were as follows:
| ** **      | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------|------------|----------|------------|----------|------------|
| Raw materials   |       | $        | 5,078      |     | $          | 6,950 |   |
| Work-in-process |       | 1,300    |       | 3,301    |       |
| Finished goods  |       | 4,424    |       | 5,722    |       |
| Total inventory |       | $        | 10,802     |     | $          | 15,973 |   |

 

**Note 4:   Property,Plant and Equipment**

The cost and estimateduseful lives of property, plant and equipment and the total accumulateddepreciation and amortization at fiscal year-end:
| ** **                                      | ** ** | **Estimated  useful lives** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|----------|------------|----------|------------|
| Buildings and  improvements                     |       | 40  years                        |       | $        | 29,300     |     | $          | 29,249 |   |
| Manufacturing  machinery and equipment          |       | 3 to  8 years                    |       | 53,134   |       | 73,231   |       |
| Office furniture  and equipment                 |       | 8  years                         |       | 4,902    |       | 5,454    |       |
| Construction-in-process                         |       | —                           |       | 1        |       | 1,702    |       |
|                                            |       |                             |       | 87,337   |       | 109,636  |       |
| Less accumulated  depreciation and amortization |       |                             |       | (66,584  | )          | (85,521  | )          |
| Total property,  plant and equipment, net       |       |                             |       | $        | 20,753     |     | $          | 24,115 |   |

 

**Note 5:   Impairments**

***Fiscal2003***

During the first quarter of 2003 customers canceledseveral significant orders that we expected to receive as of December 31,2002 and in early 2003. We believe these cancellations were primarily theresult of a re-alignment of military spending priorities which occurred duringthe first quarter of 2003. The future demand for our Harmony 1, ESIG, andTargetView inventory significantly decreased compared to our prior projectionsbecause of these cancellations. As a result, during fiscal 2003, we recorded a$14,566 impairment to specific inventory and a $1,151 impairment to certainfixed assets related to the manufacture of these types of visual systems.

Approximately $10,000 of the 2003 impairment relatedto our Harmony 1 inventory. Through the end of 2002 and into early 2003, weexpected to finalize a sale of two Harmony 1 based visual systems, one as anoption to a current U.S. government contract and another to a European primecontractor. During March 2003, we received notification from thesecustomers that they would not purchase the Harmony 1 system, as had beenforecasted, due to a decision to migrate to a more current technology,specifically commercial off-the-shelf PCs or our next-generation Harmony, theHarmony 2. Thus, the loss of these orders coupled with the overall shift inmarket demand resulted in our determination that we had excess Harmony 1inventory on hand. We have extremely limited prospects to sell this excessHarmony 1 inventory, and these components cannot be used in the manufacture ofour other products. Accordingly, we determined that $10,000 of inventoryrelated to these systems was impaired. In addition, because we did not expectto sell any additional Harmony 1 based visual systems, we determined we had nofurther need for certain fixed assets specifically used to build, test, anddemonstrate our Harmony 1 based visual systems 

45

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

and recorded an impairmentof $1,151 related to these fixed assets, as we believe this equipment had noalternative use.

Approximately $3,300 of the 2003 impairment related toour ESIG inventory. Through the end of 2002 and into early 2003, we expected tofinalize the sale of as many as nine ESIG based visual systems to a particularcommercial customer. During 2003, we received notification from this customerthat it would not purchase the ESIG based visual systems as had been forecasteddue to its interest in our next-generation EP-1000CT based visual system,which provides enhanced functionality at a comparable price. While we continueto have ESIG related inventory on hand for other forecasted ESIG based visualsystems, the loss of this order, coupled with the increased demand for ournext-generation EP-1000CT based visual systems, caused us to determinethat we had inventory in excess of our current purchase orders and forecasteddemand. Therefore, we determined that $3,300 of inventory related to thesesystems was impaired.

Approximately $1,266 of 2003 impairment related to ourTargetView 100 inventory. In 2003, we became convinced that the TargetView 100technology had been superseded by newer technology. Accordingly, our businessopportunities for TargetView 100 systems had been nearly eliminated and we determinedthat we had excess inventory on hand. Therefore, we determined that $1,266 ofinventory related to these systems was impaired.

During the fourth quarterof 2004, our entire TargetView inventory, including impaired inventory, wassold along with our ESCP assets to Video Display Corporation (see Note 23).

***Fiscal2002***

In 2002, we recorded an inventory impairment loss of$1,392 related to our decision to discontinue the simFUSION 4000 based visualsystem. This impairment encompassed the total value of the simFUSION 4000inventory on hand. This decision was based on anticipated reduced demand as aresult of customer migration to the next-generation simFUSION products.

In 2002, we recorded an impairment loss of $311related to software licenses that were no longer being used.

While we continue topursue opportunities to sell our Harmony 1, ESIG, and simFUSION 4000 inventory,we currently do not anticipate sales generating from these impaired inventories.We plan, however, to continue storing this inventory in the event a futureopportunity was to arise. If and when we conclude that no opportunities areavailable, we plan to physically scrap the impaired inventory. Additionally, wewill continue to hold the impaired Harmony 1 fixed assets in the event a futuresales opportunity arises and drives a requirement for our fixed assets.

46

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

**Note 6:   Costsand Estimated Earnings on Uncompleted Contracts**

Comparative informationwith respect to uncompleted contracts at fiscal year-end:
| ** **                                                               | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Total accumulated costs  and estimated earnings on uncompleted contracts |       | $        | 186,249    |     | $          | 229,970 |   |
| Less total billings on  completed contracts                              |       | (192,336 | )          | (230,547 | )          |
|                                                                     |       | $        | (6,087     | )        | $          | (577 | ) |

 

The above amounts arereported in the consolidated balance sheet as follows:
| ** **                                                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Costs and  estimated earnings in excess of billings on uncompleted contracts |       | $        | 5,616      |     | $          | 10,922 |   |
| Billings in  excess of costs and estimated earnings on uncompleted contracts |       | (11,703  | )          | (11,499  | )          |
|                                                                         |       | $        | (6,087     | )        | $          | (577 | ) |

 

**Note 7:   Leases**

We occupy real property and use certain equipmentunder lease arrangements that are accounted for as operating leases. Rentalexpenses for all operating leases for 2004, 2003 and 2002 were $1,807, $3,942and $3,900, respectively.

Futureminimum lease payments under operating leases that have initial or remainingnoncancelable lease terms in excess of one year are as follows:
| **Fiscal year** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------|------------|------------|------------|------------|------------|
| 2005                 |       | $          | 1,767      |       |
| 2006                 |       | 1,475      |       |
| 2007                 |       | 787        |       |
| 2008                 |       | 377        |       |
| 2009                 |       | 369        |       |
| Thereafter           |       | 7,265      |       |
| Total                |       | $          | 12,040     |       |

 

Lease rental income forall operating leases for 2004, 2003 and 2002 was $362, $840 and $1,300,respectively. At December 31, 2004, we had no future lease rental incomefrom operating leases that have initial or remaining noncancelable lease terms.

47

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

**Note 8:   Investments**

***Marketable Securities Available-for-Sale***

Marketablesecurities, consisting of equity securities, are recorded at fair value asfollows:
| ** **              | ** ** | ** **   | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | **Estimated** | ** ** |
|-------------------------|------------|--------------|------------|----------------|------------|----------------|------------|---------------|------------|
| ** **              | ** ** | **Adjusted** | ** ** | **unrealized** | ** ** | **unrealized** | ** ** | **fair**      | ** ** |
| ** **              | ** ** | **cost**     | ** ** | **gains**      | ** ** | **losses**     | ** ** | **value**     | ** ** |
| December 31,  2004 |       |         | $          | 88             |       |           |       | $             | 568        |   |   |   | $ | — |   |   |   | $ | 656 |   |   |
| December 31, 2003  |       |         | 88         |           |       |           | 469        |          |       |   | — |   |   |   | 557 |   |   |

 

Unrealized gains were dueto market-price movement and foreign exchange movement related to onemarketable security that is traded on a foreign exchange and priced in Euros.

***Nonmarketable Securities***

Eachinvestment in nonmarketable securities was made either toenhance a current technology of E&S or to complement E&S’ strategicdirection. Nonmarketable securities at fiscal year end:
| ** **                      | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|
| Quest Flight  Training Limited  |       | 1,277    |       | 938      |       |
| Total Graphics  Solutions, N.V. |       | —   |       | 500      |       |
| Other                           |       | —   |       | 16       |       |
| Total  nonmarketable securities |       | $        | 1,277      |     | $          | 1,454 |   |
|                                 |            |          |            |          |            |  |  |

 

We have a 50% interest in Quest Flight TrainingLimited (“Quest”), a joint venture with Quadrant Group plc (“Quadrant”),providing aircrew training services for the United Kingdom Ministry of Defence(“U.K. MOD”) under a 30-year contract. The investment is accounted for underthe equity method. The carrying value of Quest at December 31, 2004 and 2003was $1,277 and $938, respectively. Equity in earnings of Quest of $95, $64 and$46 is recorded in other income (expense) in 2004, 2003, and 2002, respectively.In 2004, we recorded $244 of foreign currency translation in accumulated othercomprehensive income on the investment in Quest. The financial position andoperating results of Quest are immaterial to our financial results. Also one member of our board of directorsis on the board of directors of Quest andQuadrant.

In connection with the services of Quest to the U.K.MOD, during fiscal year 2000, we entered into guarantees of various obligationsof Quest. As of December 31, 2004, we had four guarantees outstandingrelated to Quest. Pursuant to the first guarantee, we have guaranteed, jointly andseverally with Quadrant, the performance of Quest in relation to its contractwith the U.K. MOD. If Quest fails to meet its obligations under the contractthen we (and Quadrant) are required to perform under the terms of the contract.Due to the length of the contract and the uncertainty of performance for whichwe would be liable if Quest fails to perform, we cannot estimate the maximumamount of possible future payments. This guarantee is in place until 2030. Pursuantto the second guarantee, we have guaranteed, jointly and severally withQuadrant, up to a maximum amount of £1,000 (approximately $1,903), theperformance of Quest where not subcontracted, and the performance of Questwhere subcontracted but where the subcontractor is not liable to meet itsobligation due to any limitation of liability in the sub-contractagreement   This guarantee is in placeuntil 2020. Pursuant to the third guarantee, we have pledged our equity sharesin Quest to guarantee payment by Quest of a loan agreement executed by Quest. Theloan agreement terminates in 2020. The pledge of our equity shares in Questwill expire at such time as Quest’s 

48

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

obligations under the loanagreement are satisfied or the date on which the loan agreement is otherwiseterminated. In the event of default on this loan agreement, the lendinginstitution can request that the trustee holding such equity shares surrenderthem to the lending institution in order to satisfy all amounts thenoutstanding under the loan agreement. As of December 31, 2004, theoutstanding loan balance was £4,889 (approximately $9,304). Quadrant has madeidentical guarantees for this obligation of Quest. Pursuant to the fourthguarantee, we have guaranteed payment, up to a maximum of £125 (approximately$238), in the event that Quest has a default event, as defined by its loanagreement. This guarantee is in place until 2020. Quadrant has made identicalguarantees for this obligation of Quest. As of December 31, 2004, noamounts have been accrued for any estimated losses under these guaranteesbecause we believe that Quest will meet all of its performance and financialobligations in relation to its contract with the U.K. MOD. However, if we arerequired to perform under any or all of the four guarantees, it could have amaterial adverse impact on our operating results and liquidity.

Total Graphics Solutions,N.V. (“TGS”) develops and markets portable graphics software tools, whichprovide hardware independence for application developers. In 2004, we sold ourinvestment in TGS for $633 and recognized a gain on the sale of $133.

**Note 9:   Accrued Liabilities**

Accruedliabilities at fiscal year-end were as follows:
| ** **                               | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------|------------|----------|------------|----------|------------|
| Compensation and  benefits               |       | $        | 4,275      |     | $          | 3,924 |   |
| Building rental  guarantee (see Note 22) |       | 1,755    |       | —   |       |
| Other                                    |       | 5,002    |       | 8,602    |       |
| Total accrued  liabilities               |       | $        | 11,032     |     | $          | 12,526 |   |

 

**Note10:   Employee Retirement Benefit Plans**

***Pension Plan***

In 2002, the Board ofDirectors approved the redesign of our employee retirement plans to matchcontemporary market practices and to improve our competitive position byaligning future funding for employee retirement benefits into the 401(k) deferredsavings plan. This action was implemented by amending the Pension Plan tocurtail accrual of future benefits under the Pension Plan. At the same time,the 401(k) deferred savings plan was amended to permit the Board ofDirectors to grant additional discretionary matching contributions based on ourprofitability and other financial and operational considerations. This changeto the Pension Plan had no effect on the benefits vested to current and previousemployees for past service. Those benefits will be paid on retirement. Retireesreceiving pension payments at the time of the curtailment were also unaffected.Benefits at normal retirement age (65) are based upon the employee’s years ofservice, as of the date of the curtailment for employees not yet retired, andthe employee’s compensation prior to the curtailment. The Pension Plan is afunded noncontributory defined benefit pension plan. Our funding policy is tocontribute amounts sufficient to satisfy regulatory funding standards, basedupon independent actuarial valuations.

49

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

***Supplemental Executive 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) Deferred Savings 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 age 18 or older. We make matching contributions onemployee contributions. The 401(k) plan was amended in 2002 to permit theBoard of Directors to grant additional discretionary matching contributionsbased on our profitability and other financial and operational considerations. Ourcontributions to 401(k) plan for 2004, 2003 and 2002 were $625, $647 and$907, respectively.

***Executive Savings Plan***

The Executive Savings Plan (“ESP”) is an unfundeddeferred compensation plan that allows tax-deferred retirement savingsbeyond the 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, 2004 and2003, prepaid expenses and deposits included our investments in the policies of$2,260 and $2,233, respectively. Net life insurance expense was $160 in 2004,$340 in 2003, and $260 in 2002.

***Obligations and Funded Status***

E&S uses a December 31 measurement date forboth the Pension Plan and SERP.

50

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

As of December 31,2004 and 2003 the projected benefit obligations related to our defined benefitpension plans were equal to the accumulated benefit obligations. Informationconcerning the obligations, plan assets and funded status of employeeretirement defined benefit plans are provided below:
| ** **                                           | ** ** | **Pension Plan** | ** ** | **SERP**   | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|------------|------------|
| ** **                                           | ** ** | **2004**              | ** ** | **2003**   | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Changes in benefit obligation**                    | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Accumulated  benefit obligation at beginning of year |       | $                     | 38,820     |       | $          | 38,585 |   | $ | 7,665 |   | $ | 6,545 |   |
| Service cost                                         |       | —                |       | —     |       | 519 |   | 451 |   |
| Interest cost                                        |       | 2,498                 |       | 2,533      |       | 508 |   | 480 |   |
| Actuarial loss                                       |       | 2,050                 |       | 3,591      |       | — |   | 135 |   |
| Benefits paid                                        |       | (2,041                | )          | (5,889     | )          | (419 | ) | (334 | ) |
| Assumption change                                    |       | —                |       | —     |       | 30 |   | 388 |   |
| Accumulated  benefit obligation at end of year       |       | $                     | 41,327     |       | $          | 38,820 |   | $ | 8,303 |   | $ | 7,665 |   |
| **Changes  in plan assets**                          | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fair value of  plan assets at beginning of year      |       | $                     | 31,028     |       | $          | 36,663 |   |   |   |   |   |
| Actual return on  plan assets                        |       | 929                   |       | 254        |       |   |   |   |   |
| Benefits paid                                        |       | (2,041                | )          | (5,889     | )          |   |   |   |   |
| Fair value of  plan assets at end of year            |       | $                     | 29,916     |       | $          | 31,028 |   |   |   |   |   |
| **Net  Amount Recognized**                           |       |                  |       |       |       |   |   |   |   |
| Funded (unfunded)  status                            |       | $                     | (11,411    | )          | $          | (7,792 | ) | $ | (8,303 | ) | $ | (7,665 | ) |
| Unrecognized net  actuarial loss                     |       | 5,838                 |       | 2,421      |       | 693 |   | 615 |   |
| Unrecognized net  periodic benefit                   |       | —                |       | —     |       | (815 | ) | (875 | ) |
| Net amount  recognized                               |       | $                     | (5,573     | )          | $          | (5,371 | ) | $ | (8,425 | ) | $ | (7,925 | ) |

 

Amounts recognized in theconsolidated balance sheet consist of:
| ** **                              | ** ** | **Pension Plan** | ** ** | **SERP** | ** ** |
|-----------------------------------------|------------|-----------------------|------------|----------|------------|
| ** **                              | ** ** | **2004**              | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Prepaid benefit  cost                   |       | $                     | (11,411    | )        | $          | (7,792 | ) | $ | (8,425 | ) | $ | (7,925 | ) |
| Accumulated other  comprehensive income |       | 5,838                 |       | 2,421    |       | — |   | — |   |
| Net amount recognized                   |       | $                     | (5,573     | )        | $          | (5,371 | ) | $ | (8,425 | ) | $ | (7,925 | ) |

 

**Componentsof net periodic benefit cost**
| ** **                               | ** ** | **Pension Plan** | ** ** | **SERP** | ** ** |
|------------------------------------------|------------|-----------------------|------------|----------|------------|
| ** **                               | ** ** | **2004**              | ** ** | **2003** | ** ** | **2002** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Service cost                             |       | $                     | —     |     | $          | — |   | $ | 700 |   | $ | 519 |   | $ | 451 |   | $ | 454 |   |
| Interest cost                            |       | 2,498                 |       | 2,533    |       | 2,442 |   | 508 |   | 480 |   | 446 |   |
| Expected return  on assets               |       | (2,362                | )          | (2,813   | )          | (3,462 | ) | — |   | — |   | — |   |
| Amortization of  actuarial loss          |       | 67                    |       | —   |       | — |   | — |   | — |   | — |   |
| Amortization of  prior year service cost |       | —                |       | —   |       | (16 | ) | (59 | ) | (59 | ) | (59 | ) |
| Curtailment gain                         |       | —                |       | —   |       | (3,575 | ) | — |   | — |   | — |   |
| Amortization of  transition              |       | —                |       | —   |       | 10 |   | — |   | — |   | — |   |
| Net periodic benefit  cost (benefit)     |       | $                     | 203        |     | $          | (280 | ) | $ | (3,901 | ) | $ | 968 |   | $ | 872 |   | $ | 841 |   |

 

51

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

**Additional information**

The increases to ourminimum liability recorded in other comprehensive income of $3,417 and $2,421during 2004 and 2003, respectively, arose from the difference between thereturn on Pension Plan assets during those periods and the benefits paid out ofthe Pension Plan during those periods.

**Assumptions**

The weighted average assumptions used to determinebenefit obligations at December 31, 2004 and 2003, consisted of discountrate of assumptions of 6.00% and 6.25%, respectively, for the Pension Plan andSERP. The weighted average assumptions used to determine net periodic cost foryears ended December 31, 2004 and 2003, consisted of discount rateassumptions of 6.25% and 6.75%, respectively, for the Pension and SERP and anexpected long-term rate of return on Pension Plan assets of 8.00%.

The long-term rate ofreturn on plan assets was determined 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 the investment managers’ assessment offuture returns. The expectations were compared to historical market returns toensure that the expected return of each class was a conservative estimate.

***Plan Assets***

ThePlan’s weighted-average asset allocations at fiscal year-end, weighted-averageplanned targeted asset allocations going forward, and expected long-termreturns on plan assets:
| ** **                                                            | ** ** | ** ** | ** ** | **2004**    | ** ** | **2003**          | ** ** | **Expected**      | ** ** |
|-----------------------------------------------------------------------|------------|------------|------------|-------------|------------|-------------------|------------|-------------------|------------|
| **Asset allocation category of plan assets** | ** ** | ** ** | ** ** | **Target%** | ** ** | **Actual %** | ** ** | **Actual %** | ** ** | **Return %** | ** ** |
| Cash and cash  equivalents                                            |       |       | 0          |        |       |              | 77         |              |       |   | 100 |   |   |   | — |   |   |
| Fixed income                                                          |       |       | 45         |        |       |              | —     |              |       |   | — |   |   |   | 2.5 |   |   |
| Domestic equity                                                       |       |       |       |        |       |              |       |              |       |   |   |   |   |   |   |   |   |
| Small cap growth                                                      |       |       | 8          |        |       |              | 3          |              |       |   | — |   |   |   | 0.9 |   |   |
| Small cap value                                                       |       |       | 7          |        |       |              | 3          |              |       |   | — |   |   |   | 0.8 |   |   |
| Large cap growth                                                      |       |       | 15         |        |       |              | 6          |              |       |   | — |   |   |   | 1.4 |   |   |
| Large cap value                                                       |       |       | 15         |        |       |              | 7          |              |       |   | — |   |   |   | 1.4 |   |   |
| International  Equities                                               |       |       | 10         |        |       |              | 4          |              |       |   | — |   |   |   | 1.0 |   |   |
|                                                                  |       |       |       |        |       |              |       |              |       |   |   |   |   |   | 8.0 |   |   |
|                                                                       |            |            |            |             |            |                   |            |                   |            |  |  |  |  |  |  |  |  |  |  |

 

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. The assets of the Pension Plan were temporarilyinvested in cash equivalents beginning in September 2002. The Pension PlanAdministrative Committee has implemented a plan in 2004 to return to thetargeted asset allocation. Assets will be invested in a manner that willprovide for long-term growth with a goal to achieve returns equal to or greaterthan applicable benchmarks. Investments will be managed by registeredinvestment advisors. When investing Pension Plan assets, the investmentmanagers of separately managed accounts shall not utilize derivativeinstruments for speculative purposes or to create leveraged positions.

No equity securities ofE&S were part of the Pension Plan assets as of December 31, 2004 or2003.

52

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

***Cash Flow***

**Employer contributions**

E&S expects tocontribute approximately $475 in aggregate to the SERP and make nocontributions to Pension Plan in 2005. Our funding policy is to contributeamounts sufficient to satisfy regulatory funding standards, based uponindependent actuarial valuations. In addition, we are not required to fund the SERP and we do not fund it. All benefitpayments are made by us directly to those who receive benefits from the SERP. Assuch, these payments are treated as both contributions and benefits paid forreporting purposes.

**Estimated future benefit payments**

Thefollowing benefit payments are expected to be paid based on actuarial estimatesand prior experience:
| ** **            | ** ** | **Pension** | ** ** | ** ** | ** ** |
|-----------------------|------------|-------------|------------|------------|------------|
| **Fiscal years** | ** ** | ** **  | ** ** | **Plan**   | ** ** | **SERP** | ** ** |
| 2005                  |       | $           | 2,627      |       | $          | 475 |   |
| 2006                  |       | 3,620       |       | 543        |       |
| 2007                  |       | 2,872       |       | 543        |       |
| 2008                  |       | 3,279       |       | 540        |       |
| 2009                  |       | 3,400       |       | 541        |       |
| 2010-2014             |       | 15,200      |       | 3,342      |       |
|                       |            |             |            |            |            |  |  |  |  |

 

**Note 11:   Debt**

***6% Convertible Subordinated Debentures***

As of December 31,2004 and 2003, $18,015 of 6% Convertible Subordinated Debentures wasoutstanding (the “6% Debentures”). The 6% Debentures, due in 2012, areunsecured and are convertible at each bondholder’s option into shares of ourcommon stock at a conversion price of $42.10 per share for an aggregate of428,000 shares of our common stock if all outstanding 6% Debentures areconverted, subject to adjustment. The 6% Debentures are redeemable at ouroption, in whole or in part, at par.

***Lines of Credit***

Thefollowing is a summary of our line of credit agreements during fiscal year :
| ** **                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|
| Outstanding line  of credit loan balance        |       | $        | —     |     | $          | 7,685 |   |
| Maximum balance outstanding during the year     |       | $        | 7,738      |     | $          | 11,298 |   |
| Average balance  outstanding during the year    |       | $        | 1,026      |     | $          | 3,054 |   |
| Weighted average  interest rate during the year |       | 3.4      | %          | 4.1      | %          |
| Weighted average  interest rate at end of year  |       | —   | %          | 6.1      | %          |

 

The average balanceoutstanding and the weighted average interest rate are computed based on theoutstanding balances and interest rates at month-ends during each year. We hadno outstanding long-term loan balances at the end of fiscal 2004 or 2003related to our lines of credit.

53

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

*WellsFargo Foothill*

On December 14, 2004our secured credit facility (the “Foothill Facility”) with Wells Fargo Foothill(“Foothill”) expired. The Foothill Facility provided for borrowings and theissuance of letters of credit up to $25,000. During 2004 and 2003, the FoothillFacility among other things, (i) required us to maintain certain financialratios and covenants, including a combined cash and borrowing availabilityfinancial covenant that adjusted each quarter and a limitation of $12,000 ofaggregate capital expenditures in any fiscal year; (ii) restricted ourability to incur debt or liens; sell, assign, pledge or lease assets; mergewith another company; and (iii) restricted the payment of dividends andrepurchase of any of our outstanding shares without the prior consent of thelender. During 2004 we were in compliance with all financial covenants andratios.

Borrowings under theFoothill Facility bore interest at the Wells Fargo Bank National Associationprevailing prime rate plus 3.0% to 4.5%, depending on the amount outstanding. Also,at no time were borrowings under the Foothill Facility to bear an interest rateof less than 10.25% per annum. In addition, the Foothill Facility had an unusedline fee equal to 0.375% per annum times the difference between $25,000 and thesum of the average undrawn portion of the borrowings, payable each quarter. TheFoothill Facility provided Foothill with a first priority perfected securityinterest in substantially all of our assets, including, but not limited to, allof our intellectual property.

On June 23, 2004, weamended the Foothill Facility. This amendment changed the terms of the FoothillFacility such that if we exceeded the amount available for letter of creditguarantees, we were required to deposit 105% of the excess with Foothill. Inaddition, we deposited $750 with Foothill for the remaining term of theFoothill Facility.

As of December 31,2004, we had no outstanding borrowings or other obligations related to theFoothill Facility.

*Lloyds*

On December 31, 2004the overdraft facility (the “Overdraft Facility”) with Lloyds Bank plc (“Lloyds”)expired. Borrowings under the Overdraft Facility bore interest at Lloyds’short-term offered rate plus 1.75% per annum. Solely at Lloyds’ discretion, wewere allowed to exceed the $2,500 limit for a very limited amount of time, asdefined by Lloyds at that time. In addition, borrowings over the $2,500 limitbore an interest rate equal to Lloyds’ unauthorized currency borrowing rate,which was 12.0% per annum above Lloyds’ short term offered rate. The OverdraftFacility was subject to reduction or demand repayment for any reason at anytime at Lloyds’ discretion. E&S Ltd executed a letter of negative pledge infavor of Lloyds whereby it agreed not to sell or encumber its assets, except inthe ordinary course of business. Covenants contained in the Overdraft Facilityrestricted dividend payments from E&S Ltd. and required maintenance ofcertain financial covenants. During 2004 we were in compliance with allfinancial covenants. As of December 31, 2004, there were no outstandingborrowings. In addition, at December 31, 2004, we had $677 on deposit withLloyds in a restricted cash collateral account to support certain obligationsthat the bank guarantees.

**Note 12:   IncomeTaxes**

Income (loss) beforeincome taxes consists principally of results of operations in the United States.The income tax expense of $112 for 2004 is primarily attributable to foreignincome taxes. The income tax benefit of $971 for 2003 is primarily attributableto adjustments to prior years’ tax provisions as a result of favorableresolution of certain worldwide income tax contingencies. The income taxbenefit of $463 for 2002 is primarily attributable to the carryback ofalternative minimum tax net operating losses pursuant to the Job Creation andWorkers Assistance Act of 2002.

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:
| ** **                                                | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Tax benefit at  U.S. federal statutory rate               |       | $        | (3,064     | )        | $          | (12,936  | )          | $ | (4,264 | ) |
| Gains of foreign  subsidiaries                            |       | —   |       | —   |       | (325     | )          |
| Adjustment to  prior year tax provisions                  |       | —   |       | (1,002   | )          | —   |       |
| Change in  valuation allowance attributable to operations |       | 3,035    |       | 12,807   |       | 3,582    |       |
| Other, net                                                |       | 141      |       | 160      |       | 544      |       |
| Tax expense (benefit)                                     |       | $        | 112        |     | $          | (971     | )          | $ | (463 | ) |

 

Thetax effects of temporary differences that give rise to significant portions ofthe deferred tax assets and liabilities as of fiscal year-end:
| ** **                                                                   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| **Deferred income tax assets:**                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Warranty,  vacation, and other accruals                                      |       | $          | 3,552      |       | $          | 2,516 |   |
| Inventory  reserves and other inventory related temporary basis  differences |       | 5,785      |       | 9,037      |       |
| Pension accrual                                                              |       | 5,459      |       | 5,931      |       |
| Long-term  contract related temporary differences                            |       | 209        |       | 180        |       |
| Net operating  loss carryforwards                                            |       | 55,105     |       | 48,750     |       |
| Capital loss  carryforwards                                                  |       | —     |       | 44         |       |
| Write-down of  investment securities                                         |       | 1,711      |       | 1,711      |       |
| Credit  carryforwards                                                        |       | 5,719      |       | 3,561      |       |
| Other                                                                        |       | 273        |       | 285        |       |
| Total deferred income tax assets                                             |       | 77,813     |       | 72,015     |       |
| Less valuation allowance                                                     |       | (77,618    | )          | (71,027    | )          |
| Net deferred income tax assets                                               |       | 195        |       | 988        |       |
| **Deferred  income tax liabilities:**                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Plant and  equipment, principally due to differences in depreciation         |       | (172       | )          | (959       | )          |
| Other                                                                        |       | (23        | )          | (29        | )          |
| Total deferred income tax liabilities                                        |       | (195       | )          | (988       | )          |
| Net deferred  income tax assets and liabilities                              |       | $          | —     |       | $          | — |   |

 

We have total federal net operating loss carryforwardsof approximately $143,000 of which, approximately $1,000 expires in 2005,$1,000 expires in 2007, $1,000 expires in 2008 and the remainder expiresbetween 2011 and 2024. We have various federal tax credit carryforwards ofapproximately $3,400 of which expire between 2007 and 2021. We also have statenet operating loss carryforwards of approximately $121,000 and state tax creditcarryforwards of approximately $2,300 that expire depending on the rules of thevarious states to which the loss or credit is allocated.

During the years ended December 31, 2004, 2003 and2002, we increased the valuation allowance on deferred income tax assets byapproximately $6,591, $14,231 and $3,282, respectively, as it is more likelythan not that the net deferred income tax assets will not be realized.

55

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

**Note13:   Disclosures About the Fair Value of Financial Instruments**

The carrying amount ofcash and cash equivalents, receivables, accounts payable, accrued expenses, andforeign currency derivatives approximates fair value because of their shortmaturity. The fair values of marketable securities available for sale are basedon quoted market prices. For nonmarketable securities, consisting ofinvestments in private companies, a reasonable estimate of fair value wasimpracticable. The fair value of our 6% Debentures of $12,250 and $10,291 as ofDecember 31, 2004 and 2003, respectively, is based on quoted marketprices.

**Note14:   Commitments and Contingencies**

In 2003, we entered into a settlement agreement withone of our customers. At the end of fiscal year 2003, we had accruedapproximately $1,200 for this settlement. In fiscal year 2004, the actual costsassociated with this settlement were approximately $1,200.

In 2003, we entered into a purchase agreement with athird party that commits us to purchase a minimum $1,000 of licensed productsand support for design development software. The agreement is effective for aperiod of two years. As of December 31, 2004, our remaining commitmenttotaled $375.

In 2003, we entered into a purchase agreement with athird party that committed us to purchase $1,100 in software licenses andengineering support to be used in product development and future products overa two-year period, with continuous one year extensions optional. As of December 31,2004, we have no remaining commitment.

As of December 31, 2004, we had various purchaseobligations for goods and services. We expect to pay approximately $2,600 and$400 in 2005 and 2006, respectively, related to these purchase obligations.

Certain of our contracts to deliver Harmony imagegenerators contain liquidated damage provisions for delays in delivery. Weincurred $640 in such damages in 2003 that were paid during 2003 and 2004. Nodamages were incurred in 2004 or 2002. In 2004, we completed delivery of ourHarmony image generators.

In 2004, we entered into a three-year rental guaranteewith the buyer of one of our office buildings, obligating us to make certainmonthly payments through June 2004. As of December 31, 2004, we had$1,755 accrued representing the maximum remaining amount under the guarantee. SeeNote 22 for further information.

As of December 31, 2004 and 2003, we hadoutstanding letters of credit and bank guarantees of $3,821. Letters of creditthat expire in 2005 total $2,736 and those that expire in 2006-2007 total$408.

As of December 31,2004, we had guarantees related to Quest. See Note 8 for further details.

**Note 15:   Legal Proceedings**

In March 2004, through mediation, we settled aclaim initiated against us in May 2003 by RealVision, Inc. relativeto matters arising from the sale of a business unit to RealVision, Inc. in2001. Under the agreement reached, RealVision received a settlement ofapproximately $2,425. We paid approximately $850 of the settlement and ourinsurance carrier paid the remainder.

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.

56

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

**Note16:   Stock Option and Stock Purchase Plans**

***Stock Option Plans***

In 2004, shareholders approved the adoption of the2004 Stock Incentive Plan of Evans & Sutherland Computer Corporation (“2004Plan”), which expires in 2014. The 2004 Plan is a stock incentive plan thatprovides for the grant of options and restricted stock awards to employees andfor the grant of options to non-employee directors. Under the 2004 Plannon-employee directors receive an annual option grant for no more than 10,000shares. New non-employee directors receive an option grant for no more than10,000 shares upon their appointment or election. In addition, with theadoption of this plan no additional options can be issued under any of theprior stock-based plans. The 2004 Plan establishes a minimum exercise price foroptions of 110% of fair market value on the date of grant. Restricted stockawards may be qualified as a performance-based award that conditions aparticipant’s award upon achievement by the Company or its subsidiaries ofperformance goals established by our Board of Directors’ CompensationCommittee.

Our prior stock incentive plans provided for the grantof options to employees, officers, consultants, and independent contractors toacquire shares of our common stock at a purchase price generally equal to thefair market on the date of grant. In general, for all our stock incentiveplans, options vest ratably over three years and expire ten years from date ofgrant. As of December 31, 2004, options to purchase 730,895 shares ofcommon stock were authorized and reserved for future grant.

Asummary of activity follows (shares in thousands):
| ** **                                                      | ** ** | **2004**                       | ** ** | **2003**      | ** ** | **2002**                       | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------|------------|---------------|------------|--------------------------------|------------|
| ** **                                                      | ** ** | ** **                     | ** ** | **Weighted-** | ** ** | ** **                     | ** ** | **Weighted-** | ** ** | ** ** | ** ** | **Weighted-** | ** ** |
| ** **                                                      | ** ** | ** **                     | ** ** | **average**   | ** ** | ** **                     | ** ** | **average** | ** ** | ** ** | ** ** | **average** | ** ** |
| ** **                                                      | ** ** | **Number**                     | ** ** | **exercise**  | ** ** | **Number**                     | ** ** | **exercise** | ** ** | **Number** | ** ** | **exercise** | ** ** |
| ** **                                                      | ** ** | ** of shares ** | ** ** | **price**     | ** ** | ** of shares ** | ** ** | **price** | ** ** | ** of shares ** | ** ** | **price** | ** ** |
| Outstanding at  beginning of year                               |       |                           | 2,344      |          |       |                           | $          | 11.33 |   |   |   | 2,410 |   |   |   | $ | 11.58 |   |   |   | 2,510 |   |   |   | $ | 12.22 |   |   |
| Granted                                                         |       |                           | 288        |          |       |                           | 4.79       |   |   |   | 243 |   |   |   | 5.85 |   |   |   | 254 |   |   |   | 5.80 |   |   |
| Exercised                                                       |       |                           | (2         | )             |       |                           | 4.56       |   |   |   | — |   |   |   | — |   |   |   | (12 | ) |   |   | 5.92 |   |   |
| Cancelled                                                       |       |                           | (447       | )             |       |                           | 10.24      |   |   |   | (309 | ) |   |   | 8.83 |   |   |   | (342 | ) |   |   | 12.17 |   |   |
| Outstanding at  end of year                                     |       |                           | 2,183      |          |       |                           | 10.68      |   |   |   | 2,344 |   |   |   | 11.33 |   |   |   | 2,410 |   |   |   | 11.58 |   |   |
| Exercisable at year end                                         |       |                           | 1,758      |          |       |                           | 12.00      |   |   |   | 1,951 |   |   |   | 12.41 |   |   |   | 1,879 |   |   |   | 12.86 |   |   |
| Weighted average  fair value of options granted during the year |       |                           | $          | 1.99          |       |                           |       |   |   |   |   | $ | 2.48 |   |   |   |   |   |   |   | $ | 2.58 |   |   |   |   |   |   |
|                                                                 |            |                                |            |               |            |                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

Thefollowing table summarizes information about fixed stock options outstanding asof December 31, 2004 (options in thousands):
| ** **                                                   | ** ** | **Options outstanding** | ** ** | **Options exercisable** | ** ** |
|--------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                                   | ** ** | ** **                   | ** ** | **Weighted-**                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                   | ** ** | ** **                   | ** ** | **average**                  | ** ** | **Weighted-** | ** ** | ** ** | ** ** | **Weighted-** | ** ** |
| ** **                                                   | ** ** | ** **                   | ** ** | **remaining**                | ** ** | **average** | ** ** | ** ** | ** ** | **average** | ** ** |
| ** **                                                   | ** ** | **Number**                   | ** ** | **contractual**              | ** ** | **exercise** | ** ** | **Number** | ** ** | **exercise** | ** ** |
| **Range of exercise prices**                  | ** ** | ** **                   | ** ** | **outstanding**              | ** ** | **life (years)** | ** ** | **price** | ** ** | **exercisable** | ** ** | **price** | ** ** |
| $  3.15  - $  5.25                       |       |                         | 287        |                         |       |   | 9.09 |   |   |   | $ | 4.54 |   |   |   | 29 |   |   |   | $ | 3.38 |   |   |
|     5.44  -     7.38 |       |                         | 490        |                         |       |   | 7.06 |   |   |   | 6.22 |   |   |   | 333 |   |   |   | 6.37 |   |   |
|     7.50  -   11.00            |       |                         | 256        |                         |       |   | 5.73 |   |   |   | 9.69 |   |   |   | 246 |   |   |   | 9.75 |   |   |
|   11.13  -   13.38                       |       |                         | 190        |                         |       |   | 4.21 |   |   |   | 12.52 |   |   |   | 190 |   |   |   | 12.52 |   |   |
|   13.56  -   15.88                       |       |                         | 840        |                         |       |   | 3.65 |   |   |   | 13.82 |   |   |   | 840 |   |   |   | 13.82 |   |   |
|   17.00  -   32.88                       |       |                         | 120        |                         |       |   | 1.37 |   |   |   | 20.70 |   |   |   | 120 |   |   |   | 20.73 |   |   |
| Total                                                        |       |                         | 2,183      |                         |       |   | 5.30 |   |   |   | 10.68 |   |   |   | 1,758 |   |   |   | 12.00 |   |   |
|                                                              |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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 during 2004, 2003 and 2002:
| ** **                | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|----------|------------|
| Expected life (in  years) |       | 2.6      |       | 2.6      |       | 2.5      |       |
| Risk free  interest rate  |       | 1.8      | %          | 1.5      | %          | 1.4      | %          |
| Expected  volatility      |       | 69       | %          | 69       | %          | 75       | %          |
| Dividend yield            |       | —   |       | —   |       | —   |       |

 

***Stock Purchase Plan***

We have an employee stockpurchase plan whereby qualified employees are allowed to have up to 10% oftheir gross pay withheld each pay period to purchase our common stock at 85% ofthe market value of the stock at the time of the sale. Under this plan, 26,132shares in 2004, 30,031 shares in 2003, and 54,000 shares in 2002 were purchased.During the period of December 24, 2002, through February 18, 2003,the employee stock purchase plan was inadvertently oversubscribed in theamount of 10,373 shares, leaving no shares available for future issuanceunder this plan. On February 27, 2003, our Board of Directors increasedthe number of shares available under this plan from 500,000 to 800,000 shares,and ratified all prior issuances of shares under this plan. As of December 31,2004, there were 239,619 shares available for purchase under this plan.

**Note 17:   Preferred Stock**

***Class A Preferred Stock***

We have 5,000,000 authorized shares of Class APreferred Stock. Prior to 1998, we had reserved 300,000 shares of Class APreferred Stock as Series A Junior Preferred Stock under a shareholderrights plan which expired in November 1998. In November 1998, theBoard of Directors declared a dividend of one preferred stock purchase right (“Right”)for each outstanding share of common stock, par value $0.20 per share ofE&S for shareholders of record on November 19, 1998, and for allfuture issuances of common stock. The Rights are not currently exercisable ortransferable apart from the common stock and do not have voting rights orrights to receive dividends. Each Right entitles the registered holder to 

58

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

purchase from E&S onethousandth 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.

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 B Preferred Stock***

We have 5,000,000authorized shares of Class B Preferred Stock. As of December 31, 2004and 2003, no shares were outstanding.

**Note 18:   Net Loss per Common Share**

Net loss per common share is computed based on theweighted-average number of common shares and, as appropriate, dilutive commonstock equivalents outstanding during the period. Stock options and the 6%Debentures are considered to be common stock equivalents.

Basic net loss per common share is the amount of netloss for the period attributable to each share of common stock outstandingduring the reporting period. Diluted net loss per share is the amount of netloss for the period attributable to each share of common stock outstandingduring the reporting period and to each share that would have been outstandingassuming the issuance of common shares for all dilutive potential common sharesoutstanding during the period.

In calculating net loss per common share, the net losswas the same for both the basic and diluted calculation. The diluted weightedaverage number of common shares outstanding during 2004, 2003 and 2002 excludescommon stock issuable pursuant to outstanding stock options and the 6%Debentures because such inclusions of common stock equivalents would have hadan anti-dilutive effect on loss per common share. The total number of commonstock equivalents excluded from diluted loss per share was approximately2,611,000, 2,772,000 and 2,838,000 in 2004, 2003 and 2002, respectively.

59

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

**Note 19:   Geographic Information**

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**    | ** ** | ** ** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| United States                      |       | $          | 28,760     |     | $          | 39,580   |       | $        | 74,220     |   |
| United Kingdom                     |       | 13,714     |       | 11,924   |       | 25,821   |       |
| Europe (excluding  United Kingdom) |       | 16,663     |       | 15,681   |       | 10,287   |       |
| Pacific Rim                        |       | 8,778      |       | 14,655   |       | 8,889    |       |
| Other                              |       | 1,244      |       | 2,936    |       | 3,361    |       |
| Total sales                        |       | $          | 69,159     |     | $          | 84,776   |       | $        | 122,578    |   |

 

The table below presents net property, plant andequipment by geographic location based on the location of the assets at fiscalyear-end:
| ** **                                | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|
| United States                             |       | $        | 20,512     |     | $          | 23,332 |   |
| Europe                                    |       | 241      |       | 783      |       |
| Total property,  plant and equipment, net |       | $        | 20,753     |     | $          | 24,115 |   |

 

**Note 20:   Significant Customers**

Thetable below summarizes, as a percentage of total sales, sales to customersequal to or exceeding 10% of total sales during fiscal year:
| **Customer** | ** ** | ** ** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| Customer A   |       | 12         | %          | n/a      |       |     | 16         | %        |       |
| Customer B   |       | 11         | %          | 18       | %          |     | 29         | %        |       |
| Customer C   |       | n/a        |       | n/a      |       |     | 14         | %        |       |

 

At December 31, 2004, accounts receivable fromCustomer A and Customer B were 17% and 10%, respectively, of gross receivablesand costs and estimated earnings in excess of billings from Customer A was 22%of the total. In addition, at December 31, 2004, accounts receivable fromone other customer was 19% of gross receivables. Also at December 31,2004, two customers had costs and estimated earnings in excess of billings of15% and 11% of the total.

At December 31, 2003,accounts receivable from one customer was 12% of gross receivables. Also at December 31,2003, three customers had costs and estimated earnings in excess of billings of30%, 23% and 11% of total earnings in excess.

**Note 21:   Restructuring Charges**

Thetable below represents the restructuring provision activity during our fiscalyear:
| ** **           | ** ** | ** **    | ** ** | **Restructuring** | ** ** | **Severance**  | ** ** | ** ** | ** ** |
|----------------------|------------|---------------|------------|-------------------|------------|----------------|------------|------------|------------|
| ** **           | ** ** | **Beginning** | ** ** | **charges**       | ** ** | **benefits**   | ** ** | **Ending** | ** ** |
| **Fiscal Year** | ** ** | ** **    | ** ** | **balance**       | ** ** | **(recovery)** | ** ** | **paid**   | ** ** | **balance** | ** ** |
| 2004                 |       |          | $          | 1,618             |       |           |       | $          | (491       | ) |   |   | $ | 1,066 |   |   | $ | 61 |   |
| 2003                 |       |          | 2,032      |              |       |           | 3,416      |       |       |   | 3,830 |   |   | 1,618 |   |
| 2002                 |       |          | 990        |              |       |           | 4,492      |       |       |   | 3,450 |   |   | 2,032 |   |
|                      |            |               |            |                   |            |                |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

The restructuring charges incurred in fiscal years2003 and 2002 were initiated in order to reduce the overall cost structure ofthe Company. These decisions were based on our analysis of our internaloperations and productivity, our customer commitments, our research anddevelopment strategy, our current and potential markets, our product strategy,and our financial projections for profitability. During this period ourrequirements for six Harmony 1 contracts that required a significant amount ofour resources were decreasing. In addition, the events of September 11,2001, were continuing to negatively affect our markets and therefore ourprofitability. However, as conditions changed both internally in the Companyand externally in our markets we adjusted our analysis for projectedprofitability and organization, which resulted in the decisions to restructure.As such, each restructuring was a separate event, and was not intended to be acontinuing long-term process. The main component of our cost structure is ourlabor costs. As such, in order to reduce labor costs this required a reductionin headcount.

In 2001, we initiated a restructuring plan focused onreducing our operating cost structure. As part of the plan, we recorded acharge of $2,843 relating to a reduction in force of approximately 92 employees.We paid $0, $42 and $901 in fiscal years 2004, 2003 and 2002, respectively. Wehave paid severance benefits of $2,796 related to this restructure plan. In2004, we recovered $18 of our original accrual due to a re-evaluation of ourestimated obligation. At December 31, 2004, we have $29 in severancebenefits accrued for our remaining obligation. We expect this to be paid outover the next four years.

In the second quarter of 2002, we recorded arestructuring charge of $1,921 related to a reduction in force of approximately90 employees. We paid $29, $234 and $1,495 in fiscal years 2004, 2003 and 2002,respectively. In 2004, we recovered $163 of our original accrual due to are-evaluation of our estimated obligations. We have no further obligationsrelated to this restructure. In the fourth quarter of 2002, we recorded arestructuring charge of $2,571 related to a reduction in force of approximately140 employees. We paid $36, $1,380 and $1,054 in fiscal years 2004, 2003 and2002, respectively. In 2004, we recovered $101 of our original accrual due to are-evaluation of our estimated obligation. We have no further obligationsrelated to this restructure.

In the first quarter of2003, we recorded a restructuring charge of $1,279 related to a reduction inforce of approximately 50 employees. We paid $30 and $1,078 in fiscal years2004 and 2003, respectively. In 2004, we recovered $139 of our original accrualdue to a re-evaluation of our estimated obligation. Our estimated remainingobligation as of the 2004 fiscal year-end is $32. We expect this to be paid outover the next four years. In the third quarter of 2003, we recorded arestructuring charge of $2,137. This charge primarily related to a reduction inforce of approximately 70 full-time equivalent employees. We paid $971 and$1,096 in fiscal years 2004 and 2003, respectively. In 2004, we recovered $70of our original accrual due to a re-evaluation of our estimated obligation. Wehave no further obligations related to this restructure.

**Note 22:   Assets Held for Sale**

In June 2004, we sold an office buildingpreviously classified as an asset held for sale with a book value of $2,473 for$8,288 net of closing costs. As part of the sale, we entered into a three-yearrental guarantee with the buyer, obligating us to make certain monthly paymentsthrough June 2007 based on space available for lease in the building sold.As of December 31, 2004, we had a maximum remaining guarantee of $1,755recorded as an accrued liability. The maximum rental guarantee may decrease asavailable space is leased by the buyer, based on terms of the rental guarantee.To the extent the maximum rental guarantee is reduced, additional gain will berealized. As of December 31, 2004, 100% of the leaseable space wasavailable. As a result of the sale, we have initially recognized a gain of$3,488.

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

In 2003, we sold oneoffice building we had classified as assets held for sale for $4,760 net ofclosing costs, resulting in a $1,406 gain. In 2002, we sold one office buildingwe had classified as assets held for sale for $2,917, net of closing costs,resulting in a $1,212 gain.

**Note 23:   Sale of Assets**

In October 2004, wesold our CRT based projector display system assets to Video Display Corporation(“VDC”) for $5,250. As a result, VDC acquired the assets related to thedevelopment and manufacture of these projectors. We recorded a gain of $3,662on the sale of related inventory, including TargetView 100 inventory that wasfully impaired in 2003, and related net fixed assets. We also deferred certainof the proceeds related to the completion of developments and improvements wehave agreed to complete and warranty obligation increases. To the extent thatthe cost to complete these developments and improvements is greater than orless than the amount we have accrued for this purpose, we will adjust therealized gain.

**Note 24:   Subsequent Event**

Since 2001, both our military and commercial marketshave consistently decreased in size primarily as a result of diversion ofmilitary funds to other needs and reductions in commercial airline purchases ofnew aircraft. While we expect orders in these markets to increase in 2005 and2006, we do not expect these market increases to be themselves sufficient toreturn the Company to profitability in 2005. In order to improve ourprofitability and cash flow based on our projections for 2005, we initiated arestructuring plan in March 2005 toreduce costs from cost of sales and operating expenses and to improve our cashflow from operations. The largest cost driver of our business is our labor andlabor-related costs. As a result, weplan to reduce our aggregate labor force by approximately 60 full-timeequivalent employees at an expected cost of $1,625 in severance benefits to bepaid out over the next two years. We expect this action to reduce our labor andlabor-related costs by approximately$5,140 per year. Due to the timing of the restructuring,we expect to reduce our costs approximately $3,860 in 2005. Our laborreductions were executed primarily in program management, program engineeringand R&D engineering.

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

** **

TheBoard of Directors and Stockholders

Evans & Sutherland Computer Corporation:

We have audited the accompanying consolidated balancesheets of Evans & Sutherland Computer Corporation and subsidiaries as ofDecember 31, 2004 and 2003, and the related consolidated statements ofoperations, stockholders’ equity and comprehensive loss, and cash flows foreach of the years in the three-year period ended December 31, 2004.  In connection with our audits of theconsolidated financial statements, we also have audited financial statementschedule II. These consolidated financial statements and financial statementschedule are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these consolidated financial statements and financial statement schedulebased on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (UnitedStates).  Those standards require that weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of Evans & Sutherland ComputerCorporation and subsidiaries as of December 31, 2004 and 2003, and the resultsof their operations and their cash flows for each of the years in thethree-year period ended December 31, 2004, in conformity with U.S. generallyaccepted accounting principles. Also in our opinion, the related financialstatement schedule, when considered in relation to the basic consolidated financial statementstaken as a whole, presents fairly, in all material respects, the informationset forth therein.

/s/   KPMG LLP

SaltLake City, Utah

March 31, 2005

** **

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

None.

**ITEM 9A.**        CONTROLS AND PROCEDURES

At the end of the fiscalquarter ended December 31, 2003, we carried out an evaluation, under thesupervision and with the participation of the principal executive officer andprincipal financial officer, of the effectiveness of the design and operationof our disclosure controls and procedures as of December 31, 2003. Disclosurecontrols and procedures are controls and procedures that are designed to ensurethat information required to be disclosed in our reports filed or submittedunder the Exchange Act of 1934 is recorded, processed, summarized and reportedwithin the time periods specified in the SEC’s rules and forms. Disclosurecontrols and procedures include, without limitation, controls and proceduresdesigned to ensure that information required to be disclosed by us in ourreports filed with the SEC is accumulated and communicated to management,including the chief executive officer and chief financial officer to allowtimely decisions regarding required disclosure.

**Evaluationof Our Internal Controls and Procedures Related to the Restatement**

Our evaluation of our internal controls and proceduresincluded an in depth review of all aspects of the matter of certain materialweaknesses we identified in the internal controls and procedures of ourwholly-owned subsidiary, Evans & Sutherland Computer Limited (“E&S Ltd.”),as more fully disclosed as part of this annual report on Form 10-K, and anin depth review of all aspects of the matter by the Audit Committee, theresults of which are described below.

Management and the AuditCommittee took a leadership role in assessing the underlying issues giving riseto the restatement and in ensuring proper steps were taken to improve ourinternal control environment. Based on all information gathered during our indepth review of all aspects of the matter, we cannot conclude that there wasmisconduct or intentional use of improper accounting practices to manipulateearnings or any fraud or intentional misconduct on the part of our officers oremployees. The Audit Committee, however, also concluded that our accounting,financial reporting and internal control functions needed improvement, includingour system of documenting transactions. The Audit Committee determined that ourmanagement has proactively identified a number of these issues and hasappropriately taken steps to address them.

**ActionsTaken in Response to Our Evaluation**

As a result of our findings described above, during2004, we began implementing the following improvements to our internal controlprocedures and our disclosure controls and procedures to address the issues weidentified in our evaluation of the these controls and procedures and those ofour subsidiary, E&S Ltd.:

·       Wealtered our reporting structure so that the finance director ofE&S Ltd. reports directly to our chief financial officer.

·       Weappointed a Director of Internal Control whose primary responsibilities are tooversee the establishment of formalized policies and procedures throughout ourorganization and to document, assess, and improve our system of internalcontrols.

·       Weinstituted rigorous procedures for quarter-end analysis and review of balancesheet and income statement accounts, period-end reconciliations of subsidiaryledgers, and the investigation and correction of reconciling items in a timelymanner. We are also enhancing our accounting documentation policies andinternal test work of our controls.

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·       Weadopted the process currently employed by E&S for the financial controlsand procedures employed at E&S Ltd., whereby E&S uses monthlysales audit schedules and reconciles such schedules to the general ledger.

·       Weinstituted new procedures around our quarterly reporting processes wherebysignificant accounting issues are discussed and documented, reviewed with ourexternal auditors and the Audit Committee, formally approved by our management,and given timely effect in our books and records.

·       Webegan reconciling, on a monthly basis, operational assessments of the status ofcompletion of each contract program and the financial accounting and reportingof such status.

·       Weestablished several additional internal control processes at E&S Ltd. andwill continue to improve, document and test our UK controls as part of ourSarbanes-Oxley Section 404 compliance process.

We believe that our internal controls and proceduresand our disclosure controls and procedures have improved due to the scrutiny ofsuch controls and procedures by management and the Audit Committee and theimplementation of the actions described above. We believe our internal controlsand procedures and our disclosure controls and procedures will continue toimprove as a result.

Based in part upon these changes, our principalexecutive officer and principal financial officer believe that as of December 31,2004, our disclosure controls and procedures are reasonably designed to ensurethat information required to be disclosed by us in the reports we file orsubmit under the Exchange Act is recorded, processed, summarized and reportedwithin the time periods specified in the rules and forms of the SEC. Itshould be noted that the design of any system of controls is based in part uponcertain assumptions about the likelihood of future events, and there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions, regardless of how remote.

Other than as describedabove, there have been no significant changes in our internal controls andprocedures identified in our in depth review of those accounting practices anderrors giving rise to our restatement that have materially affected, or arereasonably likely to materially affect, our internal controls and proceduressubsequent to the date of our evaluation.

**ITEM 9B.  OTHERINFORMATION**

None.

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**PART III**

**ITEM 10.**         DIRECTORS AND EXECUTIVEOFFICERS

Certain information required by Item 401 of RegulationS-K will be included under the caption “Election of Directors” in the ProxyStatement for our 2005 Annual Meeting of Shareholders and that information isincorporated herein by reference. Information required by Item 405 ofRegulation S-K will be included under the caption “Compliance with Section 16(a) ofthe Securities Exchange Act of 1934” in the Proxy Statement for our 2005 AnnualMeeting of Shareholders and that information is incorporated herein byreference. Certain information required by Item 401 of Regulation S-K isincluded in Part I of this Form 10-K under the caption “ExecutiveOfficers of the Registrant.”

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*. Weintend to disclose future amendments to certain provisions of our Code ofEthics and Business Conduct or waivers of such provisions granted to executiveofficers and directors, on this website within four business daysfollowing the date of such amendment or waiver.

**ITEM 11.**         EXECUTIVE COMPENSATION

The information requiredby this item will be included under the captions “Executive Compensation” and “Electionof Directors” in the Proxy Statement for our 2005 Annual Meeting ofShareholders and that information is herein incorporated by reference.

**ITEM 12.**         SECURITY OWNERSHIP OFCERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

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 2005 Annual Meeting of Shareholders and that information is hereinincorporated by reference.

**SecuritiesAuthorized for Issuance Under Equity Compensation Plans**
| ** **                                                       | ** ** | ** **                           | ** ** | ** **                         | ** ** | **Number of securities**          | ** ** |
|------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                       | ** ** | **Number of securities**   | ** ** | ** **                         | ** ** | **remaining available for**       | ** ** |
| ** **                                                       | ** ** | **to be issued upon** | ** ** | **Weighted average**          | ** ** | **for 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          |       |                                 | 2,183,052  |                               |       |                                        | $          | 10.68 |   |   |   | 730,895 |   |   |
| Equity  compensation plans not approved by security holders |       |                                 | —     |                               |       |                                        | —     |   |   |   | — |   |   |
| Total                                                            |       |                                 | 2,183,052  |                               |       |                                        | $          | 10.68 |   |   |   | 730,895 |   |   |

 

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**ITEM 13.**         CERTAIN RELATIONSHIPS ANDRELATED 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 our2005 Annual Meeting of Shareholders and that information is herein incorporatedby reference.

**ITEM 14.**         PRINCIPAL ACCOUNTANT FEESAND SERVICES

The information requiredby Item 14 will be included under the caption “Report of the Audit Committee ofthe Board of Directors” in the Proxy Statement for our 2005 Annual Meeting ofShareholders and that information is herein incorporated by reference.

**PART IV**

**ITEM 15.**         EXHIBITS AND FINANCIALSTATEMENT 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, 2004 and 2003

·        ConsolidatedStatement of Operations for each of the years in the three-year period ended December 31,2004

·        ConsolidatedStatements of Stockholders’ Equity and Comprehensive Loss for each of the yearsin the three-year period ended December 31, 2004

·        ConsolidatedStatement of Cash Flows for each of the years in the three-year period ended December 31,2004

·        Notesto Consolidated Financial Statements

2.                FinancialStatement Schedules

The followingfinancial statement schedule I filed as part of this report on Form 10-K.

·        ScheduleII—Valuation and Qualifying Accounts

Schedules other than those listed above are omittedbecause of the absence of conditions under which they are required or becausethe required information is presented in the consolidated financial statementsor the notes thereto.

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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.                                                                           |

 

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.                                                                                                                                                                                                 |

 

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Material contracts

Management contracts andcompensatory plans
| 10.1  |   | 1985 Stock Option  Plan, as amended, filed as Exhibit 1 to Evans & Sutherland  Computer Corporation’s Post-Effective Amendment No. 1 to Registration  Statement on Form S-8, SEC File No. 2-76027, and  incorporated herein by this reference.                                                                                            |
|-------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.2  |   | 1989 Stock Option Plan for Non-employee Directors,  filed as Exhibit 10.5 to Evans & Sutherland Computer  Corporation’s Annual Report on Form 10-K, SEC File No. 000-08771,  for the fiscal year ended December 29, 1989, and incorporated herein by  this reference.                                                                     |
| 10.3  |   | 1991 Employee Stock Purchase Plan of  Evans & Sutherland Computer Corporation, as amended as of  February 21, 2001, 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. 33-39632, and  incorporated herein by this reference. |
| 10.4  |   | 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.               |
| 10.5  |   | 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.                         |
| 10.6  |   | 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.                                                                                                                   |
| 10.7  |   | 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.                             |
| 10.8  |   | 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.                                                    |
| 10.9  |   | 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.                                                    |
| 10.10 |   | 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.                            |
| 10.11 |   | Amended and restated employment agreement between  Evans & Sutherland Computer Corporation and David B. Figgins, dated  August 26, 2002, filed as Exhibit 10.37 to Evans &  Sutherland Computer Corporation’s Form 10-K for the year ended  December 31, 2002, and incorporated herein by reference.                             |
| 10.12 |   | Amended and restated employment agreement between  Evans & Sutherland Computer Corporation and E. Thomas Atchison,  dated July 1, 2003, filed as Exhibit 10.1 to Evans &  Sutherland Computer Corporation’s Form 10-Q for the quarter ended  September 26, 2003, and incorporated herein by reference                            |
| 10.13 |   | Employment agreement between Evans &  Sutherland Computer Corporation and Kevin A. Paprzycki, effective  August 19, 2004, filed herein.                                                                                                                                                                                                                       |
| 10.14 |   | Employment agreement between Evans & Sutherland  Computer Corporation and Kirk Johnson, dated August 26, 2002, filed  herein.                                                                                                                                                                                                                                 |

 

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Other material contracts
| 10.15 |   | Overdraft Facility agreement between  Evans & Sutherland Computer Limited and Lloyds TSB Bank plc, dated  March 15, 2004, filed as Exhibit 10.1 to Evans &  Sutherland Computer Corporation’s Form 10-Q for the quarter ended  April 2, 2004, and incorporated herein by reference.                                                                                                                                                                                                                                                               |
|-------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.16 |   | Asset Purchase and  Intellectual Property License Agreement between Real Vision Inc. and Evans &  Sutherland Computer Corporation, dated August 31, 2001, filed as  Exhibit 10.1 to Evans & Sutherland Computer Corporation’s  Form 10-Q for the quarter ended September 28, 2001, and  incorporated herein by reference.                                                                                                                                                                                                                         |
| 10.17 |   | Initial License  Agreement between Real Vision Inc. and Evans & Sutherland Computer  Corporation, dated August 31, 2001, filed as Exhibit 10.2 to  Evans & Sutherland Computer Corporation’s Form 10-Q for  the quarter ended September 28, 2001, and incorporated herein by  reference.                                                                                                                                                                                                                                                          |
| 10.18 |   | Patent Purchase and  License Agreement between Nvidia International Inc., Evans &  Sutherland Computer Corporation, and Evans & Sutherland Graphics  Corporation, dated October 15, 2001, filed as Exhibit 10.57 to  Evans & Sutherland Computer Corporation’s Form 10-K for  the year ended December 31, 2001, and incorporated herein by this  reference.                                                                                                                                                                              |
| 10.19 |   | Patent Cross License  Agreement between Nvidia Corporation and Evans & Sutherland Computer  Corporation, dated October 15, 2001, filed as Exhibit 10.58 to  Evans & Sutherland Computer Corporation’s Form 10-K for  the year ended December 31, 2001, and incorporated herein by this  reference. Certain information in this exhibit was omitted and filed  separately with the Securities and Exchange Commission pursuant to a confidential  treatment request under Rule 24b-2 of the Securities and Exchange  Act of 1934, as amended. |
| 10.20 |   | Amendment Number Five to  Loan and Security Agreement and Waiver by and between Foothill Capital  Corporation and Evans & Sutherland Computer Corporation, dated  July 16, 2003, filed as Exhibit 10.2 to Evans & Sutherland  Computer Corporation’s Form 10-Q for the quarter ended  September 26, 2003, and incorporated herein by reference.                                                                                                                                                                                                   |
| 10.21 |   | Amendment Number Six to  Loan and Security Agreement and Waiver by and between Foothill Capital  Corporation and Evans & Sutherland Computer Corporation, dated  July 25, 2003, filed as Exhibit 10.3 to Evans & Sutherland  Computer Corporation’s Form 10-Q for the quarter ended  September 26, 2003, and incorporated herein by reference.                                                                                                                                                                                                    |
| 10.22 |   | Leasehold Deed of Trust,  Assignment of Rents, Security Agreement and Fixture filing between  Evans & Sutherland Computer Corporation, Chicago Title Company,  Foothill Capital Corporation, dated December 14, 2000, filed as  Exhibit 10.42 to Evans & Sutherland Computer Corporation’s  Form 10-K for the year ended December 31, 2000, and  incorporated herein by this reference herein.                                                                                                                                                    |
| 10.23 |   | Leasehold Deed of Trust,  Assignment of Rents, Security Agreement and Fixture filing between  Evans & Sutherland Computer Corporation, Chicago Title Company,  Foothill Capital Corporation, dated December 14, 2000, filed as  Exhibit 10.43 to Evans & Sutherland Computer Corporation’s  Form 10-K for the year ended December 31, 2000, and  incorporated herein by this reference herein.                                                                                                                                                    |

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| 10.24 |   | Leasehold Deed of Trust, Assignment of Rents,  Security Agreement and Fixture filing between Evans & Sutherland  Computer Corporation, Chicago Title Company, Foothill Capital Corporation,  dated December 14, 2000, filed as Exhibit 10.44 to Evans &  Sutherland Computer Corporation’s Form 10-K for the year ended  December 31, 2000, and incorporated herein by this reference. |
|-------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.25 |   | Absolute Assignment of Sub-Leases and Rent by  Evans & Sutherland Computer Corporation, dated December 14,  2000, filed as Exhibit 10.45 to Evans & Sutherland Computer  Corporation’s Form 10-K for the year ended December 31, 2000,  and incorporated herein by this reference.                                                                                                     |
| 10.26 |   | Absolute Assignment of Sub-Leases and Rent by  Evans & Sutherland Computer Corporation, dated December 14,  2000, filed as Exhibit 10.46 to Evans & Sutherland Computer  Corporation’s Form 10-K for the year ended December 31, 2000,  and incorporated herein by this reference.                                                                                                     |
| 10.27 |   | Absolute Assignment of Sub-Leases and Rent by  Evans & Sutherland Computer Corporation, dated December 14,  2000, filed as Exhibit 10.47 to Evans & Sutherland Computer  Corporation’s Form 10-K for the year ended December 31, 2000,  and incorporated herein by this reference                                                                                                      |
| 10.28 |   | Asset Purchase Agreement between Video Display Corporation  and Evans & Sutherland Computer Corporation, dated October 12,  2004, filed herein. Certain information in this exhibit was omitted and filed  separately with the Securities and Exchange Commission pursuant to a  confidential treatment request under Rule 24b-2 of the Securities  and Exchange Act of 1934, as amended.                      |
| 10.29 |   | Credit Agreement between Evans & Sutherland  Computer Corporation and Wells Fargo Bank, National Association effective  December 1, 2004, filed herein.                                                                                                                                                                                                                                                             |
| 10.30 |   | Security Agreement between Evans &  Sutherland Computer Corporation and Wells Fargo Bank, National Association  effective December 1, 2004, filed herein. Certain information in this  exhibit was omitted and filed separately with the Securities and Exchange  Commission pursuant to a confidential treatment request under Rule 24b-2  of the Securities and Exchange Act of 1934, as amended.            |

 

Subsidiariesof the registrant
| 21.1 |   | Subsidiaries  of Registrant, filed herein. |
|------|--------|--------------------------------------------|

 

Consentof experts and counsel
| 23.1 |   | Consent  of Independent Registered Public  Accounting Firm,  filed herein. |
|------|--------|----------------------------------------------------------------------------|

 

Powerof attorney
| 24.1 |   | Powers  of Attorney for Messrs. James R. Oyler, Kevin A. Paprzycki, Wolf-Dieter Hass,  David J. Coghlan, William Schneider, and James P. McCarthy, 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 1350Certifications
| 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. |
|------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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**TRADEMARKS USED IN THIS FORM 10-K**

E&S, ESLP, Harmony, ESIG, ESCP, ECT, simFUSION,EPX, EP, Environment Processor and Digistar are trademarks or registeredtrademarks of Evans & Sutherland Computer Corporation.  All other product, service, or trade names ormarks are the properties of their respective owners.

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**SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS**

**Evans &Sutherland Computer Corporation and Subsidiaries**
| ** **                                      | ** ** | ** **            | ** ** | **Additions**             | ** ** | **Deductions**  | ** ** | ** **              | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|---------------------------|------------|-----------------|------------|-------------------------|------------|
| ** **                                      | ** ** | ** **            | ** ** | **charged**               | ** ** | **charged**     | ** ** | ** **              | ** ** |
| ** **                                      | ** ** | **Balance**           | ** ** | **(reversed)**            | ** ** | **(recovered)** | ** ** | **Balance**             | ** ** |
| ** **                                      | ** ** | **at beginning** | ** ** | **to cost and** | ** ** | **against**     | ** ** | **at end of** | ** ** |
| ** **                                      | ** ** | **of year**      | ** ** | **expenses**              | ** ** | **provision**   | ** ** | **year**                | ** ** |
| ***Allowance  for doubtful receivables***       |       |                  |       |                      |       |            |       |                    |       |   |   |   |   |   |   |
| December 31,  2004                         |       |                  | $          | 351                       |       |            |       | $                       | 326        |   |   |   | $ | 27 |   |   | $ | 650 |   |
| December 31,  2003                         |       |                  | 856        |                      |       |            | 68         |                    |       |   | 573 |   |   | 351 |   |
| December 31,  2002                         |       |                  | 6,413      |                      |       |            | (734       | )                       |       |   | 4,823 |   |   | 856 |   |
| ***Inventory  reserves***                       |       |                  |       |                      |       |            |       |                    |       |   |   |   |   |   |   |
| December 31,  2004                         |       |                  | $          | 24,256                    |       |            |       | $                       | 2,231      |   |   |   | $ | 11,380 |   |   | $ | 15,107 |   |
| December 31,  2003                         |       |                  | 9,716      |                      |       |            | 16,065     |                    |       |   | 1,525 |   |   | 24,256 |   |
| December 31,  2002                         |       |                  | 7,429      |                      |       |            | 3,194      |                    |       |   | 907 |   |   | 9,716 |   |
| ***Warranty  reserves***                        |       |                  |       |                      |       |            |       |                    |       |   |   |   |   |   |   |
| December 31,  2004                         |       |                  | $          | 1,290                     |       |            |       | $                       | 1,188      |   |   |   | $ | 1,007 |   |   | $ | 1,471 |   |
| December 31,  2003                         |       |                  | 968        |                      |       |            | 2,274      |                    |       |   | 1,952 |   |   | 1,290 |   |
| December 31,  2002                         |       |                  | 1,966      |                      |       |            | 617        |                    |       |   | 1,615 |   |   | 968 |   |
| ***Accrued  liquidated damages and penalties*** |       |                  |       |                      |       |            |       |                    |       |   |   |   |   |   |   |
| December 31,  2004                         |       |                  | $          | 1,734                     |       |            |       | $                       | 115        |   |   |   | $ | 1,287 |   |   | $ | 562 |   |
| December 31,  2003                         |       |                  | 1,050      |                      |       |            | 1,850      |                    |       |   | 1,166 |   |   | 1,734 |   |
| December 31, 2002                          |       |                  | 1,500      |                      |       |            | 150        |                    |       |   | 600 |   |   | 1,050 |   |

 

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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**** ****(REGISTRANT)** |
|-----------------------------------------------------------------------------------|
| ** **                                                                        | By: | /s/ James R.  Oyler |
| ** **                                                                        |   | James R. Oyler—*President and  Chief Executive Officer* |
| ** **                                                                        | By: | /s/ Kevin A.  Paprzycki |
| ** **                                                                        |   | Kevin A. Paprzycki—*Chief Financial Officer* |

 

Date: March 31,2005

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

|    | *                                             |    |
|--------------|-----------------------------------------------|--------------|
| * *     | David J. Coghlan—*Chairman of the Board* |         |
| * *     | *                                             |         |
| * *     | Wolf-Dieter Hass—*Director*              |         |
| * *     | *                                             |         |
| * *     | William  Schneider, Jr.—*Director*  |         |
| * *     | *                                             |         |
| * *     | James P.  McCarthy—*Director*            |         |

 
| By:                       | /s/ Kevin A.  Paprzycki |       | ** ** | ** ** |
|---------------------------|-------------------------|------------|------------|------------|
|                      | *  Attorney-in-Fact     |       | ** ** | ** ** |
| Date: March 31, 2005 | ** **              | ** ** |
|                           |                         |            |            |            |  |

 

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