**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

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

 

**Commissionfile number 0-8771**

**EVANS &SUTHERLAND COMPUTER CORPORATION**

(Exact name of registrantas specified in its charter)

| **Utah**                                  |   | **87-0278175**       |
|-------------------------------------------|--------|----------------------|
| (State or other  jurisdiction of          |   | (I.R.S. Employer     |
| Incorporation or  organization)           |   | Identification  No.) |
| **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 registeredpursuant to Section 12(b) of the 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 mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act.  o Yes    x No

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

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

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) 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 III of this Form 10-K or any amendment tothis Form 10-K.  o 

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

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

 

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

The aggregate market value of the voting and non-votingcommon stock of the registrant held by non-affiliates of the registrant as of July 1,2005, the last business day of the registrants most recently completed secondfiscal quarter was approximately $26,755,491, closing market price of thecommon stock on such date as reported by The Nasdaq Stock Market.

The number of shares of the registrant’s Common Stockoutstanding as of March 24, 2006 was 10,538,464.

 

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**EVANS &SUTHERLAND COMPUTER CORPORATIONFORM 10-KFOR THE YEAR ENDED DECEMBER 31, 2005**

|            | ** ** | **PART I**                                                                                                    | ** ** | ** ** | ** ** |
|------------|------------|--------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
| ITEM 1.    |       | BUSINESS                                                                                                           |       | 3          |       |
| ITEM  1A.  |       | RISK  FACTORS                                                                                                      |       | 9          |       |
| ITEM 2.    |       | PROPERTIES                                                                                                         |       | 13         |       |
| ITEM  3.   |       | LEGAL  PROCEEDINGS                                                                                                 |       | 13         |       |
| ITEM 4.    |       | SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                               |       | 13         |       |
| ** ** | ** ** | **PART II**                                                                                                   | ** ** | ** ** | ** ** |
| ITEM 5.    |       | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED  STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |       | 14         |       |
| ITEM  6.   |       | SELECTED  FINANCIAL DATA                                                                                           |       | 15         |       |
| ITEM 7.    |       | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL  CONDITION AND RESULTS OF OPERATIONS                        |       | 17         |       |
| ITEM 7A.   |       | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET  RISK                                                        |       | 35         |       |
| ITEM 8.    |       | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                                        |       | 36         |       |
| ITEM 9.    |       | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND  ACCOUNTING AND FINANCIAL DISCLOSURE                             |       | 68         |       |
| ITEM 9A.   |       | CONTROLS AND PROCEDURES                                                                                            |       | 68         |       |
| ITEM  9B.  |       | OTHER  INFORMATION                                                                                                 |       | 69         |       |
| ** ** | ** ** | **PART III**                                                                                                  | ** ** | ** ** | ** ** |
| ITEM 10.   |       | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                                                 |       | 70         |       |
| ITEM 11.   |       | EXECUTIVE COMPENSATION                                                                                             |       | 72         |       |
| ITEM 12.   |       | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND  MANAGEMENT AND RELATED STOCKHOLDER MATTERS                    |       | 78         |       |
| ITEM 13.   |       | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                                                     |       | 81         |       |
| ITEM 14.   |       | PRINCIPAL ACCOUNTANT FEES AND SERVICES                                                                             |       | 81         |       |
| ** ** | ** ** | **PART IV**                                                                                                   | ** ** | ** ** | ** ** |
| ITEM 15.   |       | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES                                                                         |       | 83         |       |
| SIGNATURES |       | 89                                                                                                                 |       |

 

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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.

Evans & Sutherlandwas incorporated in the state of Utah on May 10, 1968. Our principaloffices are located at 600 Komas Drive, Salt Lake City, Utah 84108, and ourtelephone number is (801) 588-1000. Through a link on our website,www.es.com, we make available, free of charge, our annual report on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-K,and amendments to those reports filed or furnished pursuant to Section 13(a) or15(d) of the Exchange Act as soon as reasonably practicable after suchmaterial is electronically filed with or furnished to the Securities andExchange Commission (the “SEC”). We make our website content available forinformational purposes only. The information provided on our website is notincorporated by reference into this Form 10-K. The above reports andother information are also available, free of charge, at www.sec.gov. Alternatively,the public may read and copy any materials we file with the SEC at the SEC’sPublic Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Informationon the operation of the Public Reference Room may be obtained by callingthe SEC at 1-800-SEC-0330.

**Recent Events**

On February 7, 2006, Evans & Sutherlandentered into an asset purchase agreement (the “Rockwell Purchase Agreement”)with Rockwell Collins, Inc. (“Rockwell Collins”), pursuant to whichE&S will sell substantially all of the assets and certain liabilitiesprimarily related to our commercial and military simulation businesses andrelated service and support operations (the “Simulation Business”) to RockwellCollins. As part of the transaction, pursuant to a laser projection systemsagreement (the “Rockwell Laser Agreement”) to be entered into upon the closingof the transactions contemplated by the Rockwell Purchase Agreement, E&Swill provide, and grant exclusive and non-exclusive licenses to use and sell,fixed-based and motion-based laser projection systems in connection with theSimulation Business and certain related businesses of Rockwell Collins.

E&S will receive aggregate consideration of$71,500 in cash in connection with the transaction with Rockwell Collins,consisting of $66,500, subject to a potential post-closing adjustment, underthe Rockwell Purchase Agreement and $5,000 under the Rockwell Laser Agreement,subject to achieving certain milestones. At the closing, $7,000 of the $66,500purchase price under the Rockwell Purchase Agreement and $3,000 of the $5,000under the Rockwell Laser Agreement, or a total of $10,000, will be depositedinto escrow. The closing of the transaction contemplated by the RockwellPurchase Agreement is subject to~~~~approval by E&S shareholders andother customary closing conditions, including regulatory approvals. Thetransaction is currently expected to close in the second quarter of 2006.

On February 7, 2006, E&S entered into a stockpurchase agreement (the “Spitz Agreement”) with Transnational Industries, Inc.(“Transnational”) and Spitz, Inc. (“Spitz”). Under the Spitz agreement, E&Swill acquire all the issued and outstanding shares of common stock of Spitz,which specializes in planetarium theaters, projection domes, architecturaldomes and custom immersive theater attractions. As consideration for Spitz wewill issue and deliver 412,500 shares of E&S common stock subject topost-closing share adjustment depending on the average trading price of ourcommon stock for the 60-day period prior to registration of the shares issuedat closing. The closing of the Spitz transaction is subject to approval by theshareholders of Transnational and is currently expected to close in the secondquarter of 2006.

Neither the Spitztransaction nor the Rockwell Collins transaction is conditioned upon completionof the other.

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**General**

Evans & Sutherland produces high-qualityvisual systems used to rapidly and accurately display computer-generated imagesof the real world. With a 38-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 and commercialapplications, as well as for planetariums, science centers, and entertainmentvenues. We use a wide range of hardware, from desktop personal computers (PCs)to what we believe are the most advanced image generation and displaycomponents 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 50%, depending on the specific market and timeperiod. We estimate that the size of the market for simulation visual systemsis approximately $100 million annually. Many visual system providers serve thismarket, but our most significant competitors are companies that build theentire simulator. These companies sometimes choose to follow a strategy ofvertical integration by providing their own visual systems. Other competitorsinclude a number of smaller companies that generally offer components ratherthan complete visual systems. In addition, large contractors and systemintegrators build visual 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, by definition,“what you see.” Most of our visual systems are used in vehicle simulators,which are models of actual vehicles, such as aircraft cockpits. Thesesimulators are used for training operators as well as for practicing tactics orstrategy, which may require the coordinated operation of multiple simulators. Simulatorsare used in both commercial and military settings and include all types ofvehicles operating in space, air, ground, sea or undersea locations. Thesimulator itself may be built by one of many companies, often the same companythat built the actual vehicle. We also produce visual systems for digitalplanetariums, which are based on the same technology as our visual systems fortraining simulators. Our digital theaters are essentially simulators of thelarger universe, and can create simulated trips through other worlds or throughparts of our own world not accessible to existing vehicles.

A “visual system” is made of three major components: acomputer, a display system, and a visual database. E&S designs a range ofthese components at varying prices and performance levels and integrates theminto the complete visual system.

The computer portion of an E&S visual system, theimage generator, is a combination of hardware and software we design and eithermanufacture ourselves or source to a partner who assembles the hardware fromcommercially available components. Image generators create computer-generatedimages in real time and send these images to a display system.

The display portion consists of some combination ofprojectors, display screens, computer monitors and specialized optics that mayinclude options such as collimated displays, rear projection systems, onboardinstrument displays and domes offering up to 360-degree field-of-view. Theimage may be projected by different types of equipment, including multipleprojector types.

The visual databaseportion (sometimes referred to as a synthetic environment) is the “content”that the system displays. Most customers desire more content (visual databases)to enhance the richness and variety of their training and simulations. Inaddition, visual databases are finding new applications in mission planning,battle-damage assessment, intelligence, and other highly-time-sensitive defenseand homeland security initiatives. We have developed a sophisticated set oftools to make the development of visual databases more efficient and lesscostly, whether built by us or by others. We have an extensive library ofdatabases, including airports, vehicles, large geographic areas, oceans andseas with accurate wave dynamics, and special effects.

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**Description of Products**

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 orindividual components to our customers.

**Description of Markets**

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, and responsiveness tocustomer needs. In the military and commercial simulation markets weadditionally compete on service and product availability, while in the digitaltheater market we also compete on show content, access to customers, anddistribution channels. We believe our range of visual systems and services atvarious price and performance levels, our research and development investments,our responsiveness to customers, and our ability to design and manufacturevalue-added visual systems enable us to compete effectively.

***Military Simulation***

The military simulation market includes several largecompetitors such as Lockheed Martin, Thales Training and Simulation, L-3Communications and CAE, Inc. Some of these large competitors not onlyprovide visual systems, but also provide entire simulators and act as primecontractors. In such cases, these competitors provide their own visual system. Tocompete in this environment, our strategy is to provide the best performancepossible at a competitive price and to provide excellent service andresponsiveness to customer needs.

Overall, this market has declined significantly insize over the last several years. In addition, we believe the number ofmilitary contracts has also decreased. However, 2005 saw modest market growthand we expect to see additional modest market growth during 2006.

We believe our product strategy is succeeding in thismarket, as demonstrated by the success of our EPX based visual systems. Our EPXtechnology captured significant contracts during 2005. EPX offers a number ofadvantages, including high visual quality, rapid database development,flexibility to meet unique customer and program requirements, and the abilityto run across a full range of hardware platforms, using the same software anddatabases. This platform commonality offers customers the significantcapability to match hardware performance and cost while maintaining software,database and training commonality. EPX hardware platforms offered by us includethe EPX-5000, EPX-500, EPX-50, and EPX-5. In addition,we continue to market and sell other visual systems in this market based on ourolder Harmony 2 and ESIG image generators.

Following the completionof the Rockwell Collins transaction we will no longer operate our business in themilitary simulation market except for sales of our laser projectors to RockwellCollins.

***Commercial Simulation***

We are a market leader in supplying visual systems tothe world’s commercial airlines, airframe manufacturers, and independenttraining providers for commercial and corporate pilot training. While thecommercial simulation market is made up of a few large competitors, our maincompetitor is CAE. CAE expanded into training services where only theirproducts, including visual systems, are supplied to their training centers. Nevertheless,2005 was a successful year for new orders.

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The overall market for commercial simulators wasrelatively flat in 2005 as a result of a decline in new simulators forcommercial airlines. We expect demand for new and upgraded visual systems tocontinue to remain flat in 2006. However, based on our success in winning neworders in this environment we believe that our share of the available marketincreased in 2005.

In 2005, we estimate that we received well over halfof the orders available for new simulators related to “open” programs. Keyawards to E&S included multiple awards for the A380, Airbus’ newestaircraft, the award of the Alteon B787 simulator program for Boeing’s newestaircraft, and the award of the visual systems for the Eclipse program, theworld’s first Very Light Jet. The EP-1000CT visual system continued to bea technology leader in the commercial market, and we successfully installed andreceived certification of our first low cost EP-10 visual system. Wecontinued to book orders for airline visual systems that will include a widedisplay version of our E&S Laser Projector (the “ESLP”), currently underdevelopment. While not expected to be in production until 2007, customerscontinue to show substantial interest in the ESLP wide display version becauseof its many benefits, including improved performance, its ability to replacethree conventional projectors, and significant projected cost savings formaintenance and consumables.

Following the completion ofthe Rockwell Collins transaction we will no longer operate our business in thecommercial simulation market except for sales of our laser projectors toRockwell Collins.

***Digital Theater***

In the digital theatermarket our products compete with traditional optical-mechanical products anddigital display systems offered by GOTO Optical Mfg. Co., Konica-MinoltaPlanetarium Co. Ltd., Carl Zeiss Inc., Spitz, Inc. and Sky-Skan, Inc.During 2005 our share of this market remained flat due to a delay in deliveryof our ESLP projectors. As discussed under “Recent Events” above, we haveentered into an agreement to acquire Spitz which is currently one of ourcompetitors. Spitz produces traditional optical-mechanical display systems forplanetariums as well as digital systems primarily for educational markets. Spitzalso is the world leader in the design and production of dome structures. Theacquisition of Spitz will provide us with a full range of products at differentprice points, including the ability to design and build projection domestructures. We believe the acquisition of Spitz and the continued success ofour Digistar 3 Laser product will allow us to gain market share in digitaltheaters. In addition, Spitz has also been developing a business building domesand other curved structures for architectural applications not involvingplanetariums or digital theaters. We believe that this business has potentialfor growth in 2006 and future years.

***Advanced Displays***

We began work in 1997 tobuild a new generation of projection technology with specifications beyond anyother technology either available or likely in the foreseeable future. Thisgoal evolved into the production of a revolutionary projector using lasers forillumination and micro-electro-mechanical systems (MEMS) to modulate the laserlight and create an image. The result is the Evans & Sutherland LaserProjector (ESLP). The first ESLP systems were delivered late in 2005, withadditional units scheduled for delivery in 2006. The first units are being suppliedto our traditional simulation and digital theater customers who ordered systemswith the new projection technology. We believe that the ESLP also hasapplication to other markets in the future where ultra-high resolution, highefficiency, excellent image quality, and low life-cycle cost are importantconsiderations.

**Backlog**

On December 31, 2005,our backlog was $80,277 compared with $84,232 on December 31, 2004. Neitherthe 2005 nor 2004 backlog contained any unfunded government orders. We anticipatethat 

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approximately58% of the 2005 backlog will be converted to sales in 2006. As ofDecember 31, 2005, approximately 80% of the backlog was attributable tothe Simulation Business that is expected to be sold to Rockwell Collins.

**SignificantCustomers**

Worldwide customers usingour products include U.S. and international armed forces, aerospace companies,major airlines, laboratories, museums, planetariums, and science centers. Wemeasure and identify our significant customers based on direct sales.

Sales to one customerrepresented 21% of total sales during 2005. Sales to two other customersrepresented 12% and 11% of total sales during 2004. Sales to one customerrepresented 18% of total sales during 2003. Sales to no other customersrepresented 10% or more of our total sales during fiscal years 2005, 2004, or2003.

**IntellectualProperty**

We own a significantnumber of patents and trademarks and we are a licensee under several others. Ourportfolio of patents and trademarks is, as a whole, material to our business. However,no one piece of intellectual property is critical to our business, thus noindividual piece of our intellectual property is 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 86 patents, of which 59 are still active. If the transaction withRockwell Collins is completed, we will transfer certain patents and otherintellectual property rights primarily related to the Simulation Business toRockwell Collins.

**Research &Development**

We consider the timelydevelopment and improvement of our technology to be essential to maintain ourcompetitive position and to capitalize on market opportunities. We continue tofund essentially all research and development (“R&D”) efforts internally.

As planned, in 2005 wecontinued to improve the functionality and performance of the EP/EPX(Environment Processor/Environment Processor Extended) software used in ourvisual systems. Corresponding improvements were also made to the EnvironmentCreation Tool, ECTTM, which complements the software by providing the tools forthe creation of visual databases used with EP and EPX systems. We plan tocontinue enhancing our EP software technology, along with ECT, and expect theseenhancements to increase the industry leading performance and functionality ofour EP and EPX visual systems in 2006.

Also, in 2005, wesuccessfully moved our EPX-50 product line to the PCI Express baseline. Asplanned in 2005, we completed the first phase of our performance and costreduction efforts of the EP-1000CT hardware. A cost reduction of 10% wasachieved, along with a 50% increase in performance. We plan to continue to makeimprovements in the EP-1000CT hardware in 2006.

In addition, in 2005, wesubstantially completed the design of the next generation simFUSION platform. Thenew simFUSION 7000 will use commercial off-the-shelf (COTS) graphics cards invarious combinations for improved performance. The simFUSION 7000 is expected beintroduced in the second half of 2006.

Another significant focusfor our R&D in 2005 was the development of our laser projector, the ESLP.In 2005, we completed the productization efforts of the laser projector forplanetarium and rear projection 

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applications.We delivered ESLP’s in the fourth quarter of 2005 to the Air Force and begandelivery of the ESLP to planetariums in January 2006. We expect tocomplete the R&D efforts for wide display applications for the commercialsimulation market in 2006.

**Dependence onSuppliers**

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

**International Sales**

International sales arecalculated based on the location of the purchasing customer and were $38,156 in2005, $40,203 in 2004, and $45,328 in 2003. International sales accounted forapproximately 51%, 58%, and 53% of total sales in 2005, 2004, and 2003,respectively. We believe that any inherent risk that may exist in our foreignoperations is not material. For additional information on international sales andlong-lived assets, see Note 20 of Item 8 “Financial Statements andSupplementary Data” included in Part II of this annual report onForm 10-K.

**Employees**

As of December 31,2005, Evans & Sutherland and its subsidiaries employed a total of 268persons compared to 340 employees as of December 31, 2004. We believe ourrelations with our employees are good. None of our employees are subject tocollective bargaining agreements. Following completion of the Rockwell Collinstransaction, we expect to retain approximately 75 employees from our currentwork force.

**EnvironmentalStandards**

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

**StrategicRelationships**

In the normal course ofbusiness we develop and maintain various types of relationships with keycustomers and technology partners. In 2005, we entered into a limited number ofteaming agreements and product development agreements. The teaming agreementsare with industry partners and are intended to improve our overall competitiveposition. The product development agreements enhance our products by thecooperative development of new features and capabilities necessary to maintainour industry leading position. These activities will continue in 2006.

**Acquisitionsand Dispositions**

In December 2005, wesold a building that we determined was no longer needed for our operations for$6,277 in net proceeds. As part of the sale, we entered into a twenty-one monthrental guarantee with the buyer, obligating us to make certain monthly paymentsthrough September 2007 based on space available for lease in the buildingwe sold. The rental guarantee may decrease as available space is leased byothers, based on terms of the rental guarantee. As of December 31, 2005,100% of the rentable space was available. Further information concerning thesale of this building and the related rental guarantee is provided in Note 23of Item 8 “Financial Statements and Supplementary Data” and in Item 7“Management’s Discussion and Analysis of Financial Position and Results ofOperations” included in Part II of this annual report on Form 10-K.

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**BusinessSubject to Government Contract Renegotiation**

A significant portion ofthe visual simulation business is dependent on contracts and subcontractsassociated with government business. The U.S. government and other governmentsmay terminate any of our government contracts and, in general, subcontracts, attheir convenience as well as for default based on lack of performance. If anyof our government contracts were terminated for convenience, we generally wouldbe able to recover our costs, receive allowable termination or cancellationcosts, and receive a negotiated profit for work performed. Depending on thecontract, if such an event were to occur, it could materially affect our sales,profits, and cash flow. Historically, our experience indicates that terminationfor convenience is an extremely rare occurrence. In 2005, we had no contractsor subcontracts terminated.

U.S. government contractsalso are conditioned upon continuing congressional approval of appropriations. Long-termgovernment contracts and related orders are subject to cancellation orrestructuring if appropriations for subsequent performance periods are notapproved or are reduced from planned levels. As of December 31, 2005 allcontracts subject to this continuing appropriation of funds were fully fundedfor their option year.

**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 Item 7 “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”included in Part II of this annual report on Form 10-K for alist of some of the forward-looking statements included in this Form 10-K.See Item 1A “Risk Factors” below for factors that may affect theseforward-looking statements.

**ITEM 1A.**     RISKFACTORS

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 prospects, the following discussion highlights some risksand uncertainties that should be considered in evaluating our growth outlook.

***Our Business Model Is Changing and May Not ProduceConsistent Earnings Which Could Adversely Affect Our Business***

Our success depends on ourability to compete in an industry that is highly competitive, with rapidtechnological advances and products that require constant improvement in bothprice and performance. In most of our markets we are experiencing increasedcompetition, and we expect this trend to continue. If our competitors are moresuccessful than we are in developing technology and products, then our revenuesand growth rates could decline.

When new systems areordered, prices are usually below our comparable, last generation systems. Successin this environment requires a business model that emphasizes smaller systemsand 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.

In addition, if wesuccessfully sell our Simulation Business to Rockwell Collins and successfullyacquire Spitz, Inc., then our business model will significantly changeduring 2006. Our business will be based on digital theaters and laserprojectors. A significant portion of our future success will depend oncompleting and selling our laser projector, an unproven product, and futureproducts based on this 

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technology.There is no guarantee that the laser projector or any future products based onthis same technology will be successful in the market or that we can developthem. If we are unable to develop our laser projector, our business may beadversely affected.

***Competitors orThird Parties May Infringe E&S Intellectual Property***

Throughout its historyE&S has been awarded numerous patents. While competitors or third partieshave not materially infringed our patents, we are entering the production stageof a new product, the ESLP. We have a number of patents either issued orpending 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 which could adversely affect ourbusiness.

***Migration to PC’sin the Commercial Simulation Market May Negatively Impact 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 ContinueBringing Work In-house, Decreasing Demand for E&S Products***

Large prime contractors inthe defense and aerospace industry have encountered the same competitivepressures described earlier for simulation and training revenue. To protecttheir own revenue and margins, most have responded by putting pressure onsmaller suppliers, as well as bringing work in-house to protect establishedengineering organizations wherever possible.

This trend has, in effect,created new competitors for our traditional business. These in-houseengineering groups attempt to do only the most profitable work, such assoftware and databases, and leave less profitable hardware development toothers. Often the costs of these efforts are not visible to the end customerbecause they are part of a much larger contract.

If these trends continueand the end customers accept the results, they could reduce demand for oursoftware and databases, which would adversely affect our financial performance.

***Delays in NewProduct Introductions Could Negatively Affect Financial Performance***

During 2006, we intend tointroduce several important new products, including the simFUSION 7000 and theESLP. Delays in introducing and delivering these products could reduce plannedsales and profit contribution.

***Changes inGovernment Priorities May Further Impact 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 andcause further declines in our revenue from this market.

***We Depend on Several Significant Customers and ourBusiness, Financial Condition and Results of Operations Could Suffer if TheirPurchases Decline***

We currently derive asignificant portion of our sales from a limited number of non-U.S. governmentcustomers. The loss of any one or more of these customers could have a materialadverse effect on our business, financial condition and results of operations.We were dependent on four of our non-U.S. government customers forapproximately 21% of our consolidated sales in 2005. We expect that sales to alimited number of customers will continue to account for a substantial portionof our sales in the 

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foreseeablefuture. We have no assurance that sales from this limited number of customerswill continue to reach or exceed historical levels in the future. We do nothave supply contracts with any of our significant customers.

***Our Sales Could Decline Substantially as a Result ofTerrorist Attacks and Other Activities that Make Air Travel Difficult or Reducethe Willingness of Our Commercial Airline Customers to Purchase Our SimulationProducts***

During 2005, approximately26% of our total sales were derived from sales of our visual systems to commercialairline companies and other third parties in the commercial airline industry. Thedemand for our various commercial simulation products and services is heavilydependent upon new orders from these commercial airline customers. In the eventterrorist attacks or other activities make air travel difficult or reduce thedemand or willingness of our customers to purchase our commercial simulationproducts, our revenue may decline substantially.

***Our Shareholders May NotRealize Certain Opportunities 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.

***Following the Sale of Our Simulation Business toRockwell Collins, Your Ability to Sell Your Stock May be Substantially Limited***

Our common stock iscurrently traded on the Nasdaq National Market under the symbol “ESCC.” Followingthe completion of the proposed sale of our Simulation Business, we expect to continueto trade as a public company on the Nasdaq National Market. However, it is notpossible to predict the trading price of our common stock following the closingof the sale to Rockwell Collins. If we fail to meet any of the continuedlisting standards of the Nasdaq National Market, our common stock may bedelisted from the Nasdaq National Market. If we are delisted from the NasdaqNational Market, we expect our common stock will be traded on the NasdaqCapital Market if we meet the listing standards of that market or we willattempt to be traded on the OTC Bulletin Board or “pink sheets” maintained bythe National Quotation Bureau, Inc. The OTC Bulletin Board and pink sheets aregenerally considered less efficient markets than the Nasdaq National Market andthe Nasdaq Capital Market.

***We May NotComplete the Transaction to Sell the Assets of our Simulation Business toRockwell Collins Which Could Adversely Affect our Level of Expenses andOperating Results***

Even though we haveentered into the Rockwell Purchase Agreement concerning the sale of our SimulationBusiness, this transaction may not be completed. In order for the sale to becompleted certain pre-closing requirements must be met. If these pre-closingrequirements are not met or if not waived as a requirement to closing, thenthis transaction will not occur, which could adversely affect our operatingresults.

***We May notReceive the $10 Million in Escrow Related to the Sale of Assets to RockwellCollins and the Laser Projector Agreement***

Aspart of the Rockwell Purchase Agreement and Laser Agreement, a total $10.0million is being held in an escrow account to secure any post-closing reductionin the purchase price based on the net asset value of the Simulation Businessat closing, our indemnification obligations under the Rockwell PurchaseAgreement and our delivery obligations under the Rockwell Laser Agreement. Inthe event that Rockwell Collins becomes entitled to any such purchase pricereduction under the Rockwell Purchase Agreement, 

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penalty under the Rockwell Laser Agreement orindemnification under the Rockwell Purchase Agreement, we may forfeit some orall of the $10.0 million deposited in escrow, which will reduce the amount ofcash we have available in the future. Accordingly, there is no guarantee thatwe will receive these funds. Accordingly, there is no guarantee that we willreceive these funds.

If we do not deliver amotion-based ESLP to Rockwell Collins by a specified time, Rockwell Collins hasthe right to withdraw up to $3.0 million from the escrow account under theterms of the Rockwell Purchase Agreement and the related escrow agreement.

***Our Business will be Harmed if the Proposed Sale ofOur Simulation Business to Rockwell Collins Disrupts Our Business Operations andPrevents Us From Realizing its Intended Benefits***

Prior to theclosing of the sale of our Simulation Business to Rockwell Collins, ourbusiness operations may be disrupted due to a number of factors, any of whichcould harm our business or ability to complete the proposed sale. These factorsinclude:

·       lossof key employees, sales representatives, vendors, or customers;

·       expensesincurred in connection with the proposed sale; and

·       the diversion ofmanagement’s attention from our day-to-day business.

***We May Not BeAble to Integrate the Spitz Acquisition into Our Operations Successfully***

If we successfully acquireSpitz from Transnational Inc. we may experience difficulties integrating theirbusiness with ours. This could result in additional costs and loss ofproductivity that could materially affect our operations and financial results.

***We May FaceRisks Related to an SEC Investigation and Securities Litigation in Connectionwith the Restatement of our Financial Statements***

We are not aware that theSEC has begun any formal or informal investigation in connection withaccounting errors requiring restatement of 2003 and 2004 financial statementsand 2004 and 2005 quarterly financial statements, or that any laws have beenviolated. However, if the SEC makes a determination that the Company hasviolated Federal securities laws, the Company may face sanctions, including,but not limited to, monetary penalties and injunctive relief, which couldadversely affect our business. In addition, the Company or its officers anddirectors could be named defendants in civil proceedings arising from therestatement. We are unable to estimate what our liability in either event mightbe.

***If we are unable toretain certain key personnel and hire new highly skilled personnel, we may notbe able to execute our business plan.***

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

**ITEM1B.**    UNRESOLVED STAFF COMMENTS

None.

**ITEM 2.**             PROPERTIES

Our principal executive,engineering, manufacturing and operations facilities are located in theUniversity of Utah Research Park in Salt Lake City, Utah, where we own threebuildings totaling 

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approximately176,000 square feet. The buildings are located on land leased from theUniversity of Utah with an initial term of 40 years or longer.

We hold leases on severalsales, operations, service and production facilities located throughout theUnited States, Europe, and Asia. None of these are material to ourmanufacturing, engineering or operating facilities. We believe that theseproperties are suitable for our immediate needs and we do not currently plan toexpand our facilities or relocate to other facilities.

Following the completionof the Rockwell Collins transaction we will no longer own one of the threebuildings located in the University of Utah Research Park in Salt Lake City,Utah, and several leases on facilities in the United States and Europe will beassumed by Rockwell Collins.

**ITEM 3.**                LEGALPROCEEDINGS

In December 2005, we settleda lawsuit previously filed by us against an insurance company with respect toan insurance claim made by us for losses incurred due to the cancellation of asignificant contract by a customer. Under the terms of the settlement, wereceived a payment of $8,000 and agreed to dismiss the lawsuit and to provide arelease of claims against the insurance company.

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

**ITEM4.**                SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submittedto a vote of security holders during the fourth quarter of fiscal year 2005.

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**PART II**

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

Our common stock trades on the Nasdaq Stock Marketunder the symbol “ESCC.” On March 24, 2006, there were 540 holders of recordof our common stock. Because brokers and other institutions hold many of ourshares on behalf of shareholders, we are unable to estimate the total number ofshareholders represented by these record holders.

We have never paid a cash dividend on our common stockand have used retained earnings for the operation and expansion of our business.Currently we have an accumulated deficit. For the foreseeable future, we intendto follow our policy of retaining any future earnings to finance thedevelopment and growth of our business. Following the completion of thetransaction contemplated by the Rockwell Purchase Agreement, depending on ourcash requirements and market conditions at the time, we plan to consider usinga portion of the proceeds from the transaction with Rockwell Collins for apossible share buy-back or special dividend. However, our board of directorshas not determined to take any such activity at this time and there can be noassurance as to whether or when we might do so.

Additional informationrequired by this item is incorporated by reference to the table captioned *Quarterly Financial Data (Unaudited)* in Item 6 “SelectedFinancial Data” and the table captioned *Securities Authorized forIssuance Under Equity Compensation Plans as of December 31, 2005*in Item 12 “Security Ownership of Certain Beneficial Owners and Management andRelated Stockholder Matters” of Part III of this annual report on Form 10-K.

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**ITEM 6.**                SELECTEDFINANCIAL DATA

The following selectedconsolidated financial data for the most recent five fiscal years endedDecember 31, 2005, have been derived from our consolidated financialstatements. The financial information shown as of December 31, 2005 and 2004,and for the years ended December 31, 2005, 2004 and 2003, has been derived fromour audited consolidated financial statements as of such dates and for suchyears. As discussed in the notes to our consolidated financial statements, ourconsolidated financial statements as of December 31, 2004 and for the yearsended December 31, 2004 and 2003, were restated. The financial informationshown as of December 31, 2003, 2002 and 2001, and for the years ended December31, 2002 and 2001, has not been audited and reflects our previously issuedfinancial information restated for the effects on such periods, as applicable,of the issues giving rise to the restatements discussed in the notes to ourconsolidated financial statements. The data presented below should be read inconjunction with Item 7 “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” and Note 3 “Restatement of FinancialStatements” of Item 8 “Financial Statements and Supplementary Data” of thisannual report on Form 10-K.

| ** **                                             | ** ** | **2005**                                                              | ** ** | **2004**       | ** ** | **2003**       | ** ** | **2002**        | ** ** | **2001**        | ** ** |
|--------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------------|------------|----------------|------------|-----------------|------------|-----------------|------------|
| ** **                                             | ** ** | ** **                                                            | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)**  | ** ** | **(Restated)**  | ** ** |
| ** **                                             | ** ** | ** **                                                            | ** ** | ** **     | ** ** | ** **     | ** ** | **(Unaudited)** | ** ** | **(Unaudited)** | ** ** |
| ** **                                             | ** ** | **(in thousands, except per share amounts)** | ** ** |
| Sales                                                  |       | $                                                                     | 73,567     |           |       | $              | 67,859     |            |       | $               | 83,837     |   |   | $ | 122,584 |   |   |   | $ | 145,287 |   |   |
| Cost of sales                                          |       | 46,288                                                                |       |           | 43,215     |           |       | 52,152          |       |            | 78,134     |   |   |   | 115,915 |   |   |
| Inventory  impairment                                  |       | —                                                                |       |           | —     |           |       | 14,566          |       |            | 1,392      |   |   |   | — |   |   |
| Gross profit                                           |       | 27,279                                                                |       |           | 24,644     |           |       | 17,119          |       |            | 43,058     |   |   |   | 29,372 |   |   |
| Expenses:                                              |       |                                                                  |       |           |       |           |       |            |       |            |       |   |   |   |   |   |   |
| Selling, general  and administrative                   |       | 20,172                                                                |       |           | 24,022     |           |       | 26,999          |       |            | 27,253     |   |   |   | 31,423 |   |   |
| Research and  development                              |       | 16,878                                                                |       |           | 16,734     |           |       | 21,827          |       |            | 26,114     |   |   |   | 32,993 |   |   |
| Restructuring  charges (recoveries)                    |       | 1,759                                                                 |       |           | (491       | )              |       | 3,416           |       |            | 4,492      |   |   |   | 2,843 |   |   |
| Gain on insurance  settlement                          |       | (8,000                                                                | )          |           | —     |           |       | —          |       |            | —     |   |   |   | — |   |   |
| Impairment loss                                        |       | —                                                                |       |           | —     |           |       | 1,151           |       |            | 311        |   |   |   | 220 |   |   |
| Operating expenses                                     |       | 30,809                                                                |       |           | 40,265     |           |       | 53,393          |       |            | 58,170     |   |   |   | 67,479 |   |   |
| Gain on sale of  assets held for sale                  |       | 2,745                                                                 |       |           | 4,298      |           |       | 1,926           |       |            | 1,212      |   |   |   | 9,000 |   |   |
| Gain on sale of  assets                                |       | —                                                                |       |           | 3,817      |           |       | —          |       |            | 253        |   |   |   | — |   |   |
| Gain on sale of  business unit                         |       | —                                                                |       |           | —     |           |       | —          |       |            | —     |   |   |   | 774 |   |   |
| Gain on  curtailment of pension plan                   |       | —                                                                |       |           | —     |           |       | —          |       |            | 3,575      |   |   |   | — |   |   |
| Operating loss                                         |       | (785                                                                  | )          |           | (7,506     | )              |       | (34,348         | )          |            | (10,072    | ) |   |   | (28,333 | ) |   |
| Other income  (expense), net                           |       | (779                                                                  | )          |           | (1,111     | )              |       | (1,960          | )          |            | (2,441     | ) |   |   | (2,507 | ) |   |
| Loss before income taxes                               |       | (1,564                                                                | )          |           | (8,617     | )              |       | (36,308         | )          |            | (12,513    | ) |   |   | (30,840 | ) |   |
| Income tax  expense (benefit)                          |       | (430                                                                  | )          |           | 112        |           |       | (971            | )          |            | (463       | ) |   |   | (3,172 | ) |   |
| Net loss applicable to common stock                    |       | $                                                                     | (1,134     | )              |       | $              | (8,729     | )               |       | $               | (35,337    | ) |   | $ | (12,050 | ) |   |   | $ | (27,668 | ) |   |
| Net loss per common  share:                            |       |                                                                  |       |           |       |           |       |            |       |            |       |   |   |   |   |   |   |
| Basic and diluted                                      |       | $                                                                     | (0.11      | )              |       | $              | (0.83      | )               |       | $               | (3.37      | ) |   | $ | (1.16 | ) |   |   | $ | (2.72 | ) |   |
| Average weighted number  of common shares outstanding: |       |                                                                  |       |           |       |           |       |            |       |            |       |   |   |   |   |   |   |
| Basic and diluted                                      |       | 10,523                                                                |       |           | 10,498     |           |       | 10,471          |       |            | 10,422     |   |   |   | 10,169 |   |   |

 

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| ** **                            | ** ** | **2005**                | ** ** | **2004**       | ** ** | **2003**       | ** ** | **2002**        | ** ** | **2001**        | ** ** |
|---------------------------------------|------------|-------------------------|------------|----------------|------------|----------------|------------|-----------------|------------|-----------------|------------|
| ** **                            | ** ** | ** **              | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)**  | ** ** | **(Restated)**  | ** ** |
| **As of December 31,** | ** ** | ** **              | ** ** | ** **     | ** ** | ** **     | ** ** | **(Unaudited)** | ** ** | **(Unaudited)** | ** ** | **(Unaudited)** | ** ** |
| ** **                            | ** ** | **(in thousands)** | ** ** |
| Cash                                  |       | $                       | 14,606     |           |       | $              | 10,147     |            |       |            | $          | 9,714 |   |   |   | $ | 7,375 |   |   |   | $ | 8,717 |   |   |
| Total assets                          |       | 68,050                  |       |           | 73,615     |           |       |            | 94,824     |            |       |   | 127,509 |   |   |   | 177,353 |   |   |
| Long-term debt,  less current portion |       | 18,015                  |       |           | 18,015     |           |       |            | 18,015     |            |       |   | 20,685 |   |   |   | 18,086 |   |   |
| Stockholders’ equity  (deficit)  |       | (6,455                  | )          |           | (948       | )              |       |            | 10,717     |            |       |   | 47,863 |   |   |   | 59,488 |   |   |
|                                       |            |                         |            |                |            |                |            |                 |            |                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Quarterly Financial Data (Unaudited)**

(Inthousands, except per share information)

| **2005**                                      | ** ** | **Quarter Ended** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|
| ** **                                    | ** ** | **April 1**       | ** ** | **July 1** | ** ** | **Sep. 30** | ** ** | **Dec. 31** | ** ** |
| ** **                                    | ** ** | **(Restated)**         | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | ** ** | ** ** |
| Sales                                         |       |                   | $          | 13,280 |   |   |   | $ | 20,277 |   |   |   | $ | 21,148 |   |   |   | $ | 18,862 |   |   |
| Gross profit                                  |       |                   | 4,628      |   |   |   | 7,884 |   |   |   | 7,502 |   |   |   | 7,265 |   |   |
| Net income (loss)  before income taxes(4)     |       |                   | (6,389     | ) |   |   | (1,468 | ) |   |   | (1,226 | ) |   |   | 7,519 |   |   |
| Net income (loss)  applicable to common stock |       |                   | (5,978     | ) |   |   | (1,494 | ) |   |   | (1,238 | ) |   |   | 7,576 |   |   |
| Basic and diluted  income (loss) per share(1) |       |                   | (0.57      | ) |   |   | (0.14 | ) |   |   | (0.12 | ) |   |   | 0.72 |   |   |
| Common stock price range(2)                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| High                                          |       |                   | 7.99       |   |   |   | 6.88 |   |   |   | 6.22 |   |   |   | 6.25 |   |   |
| Low                                           |       |                   | 5.50       |   |   |   | 4.38 |   |   |   | 4.50 |   |   |   | 4.57 |   |   |

 

| **2004**                                      | ** ** | **Quarter Ended** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|
| ** **                                    | ** ** | **April 2**       | ** ** | **July 2** | ** ** | **Oct. 1** | ** ** | **Dec. 31(3)** | ** ** |
| ** **                                    | ** ** | **(Restated)**         | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Sales                                         |       |                   | $          | 17,807 |   |   |   | $ | 16,869 |   |   |   | $ | 15,832 |   |   |   | $ | 17,351 |   |   |
| Gross profit                                  |       |                   | 7,056      |   |   |   | 5,895 |   |   |   | 5,135 |   |   |   | 6,558 |   |   |
| Net income (loss)  before income taxes        |       |                   | (3,030     | ) |   |   | (1,298 | ) |   |   | (4,854 | ) |   |   | 565 |   |   |
| Net income (loss)  applicable to common stock |       |                   | (3,068     | ) |   |   | (1,356 | ) |   |   | (4,892 | ) |   |   | 587 |   |   |
| Basic and diluted  income (loss) per share(1) |       |                   | (0.29      | ) |   |   | (0.13 | ) |   |   | (0.47 | ) |   |   | 0.06 |   |   |
| Common stock price range(2)                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| High                                          |       |                   | 6.25       |   |   |   | 5.49 |   |   |   | 5.49 |   |   |   | 7.74 |   |   |
| Low                                           |       |                   | 4.08       |   |   |   | 4.25 |   |   |   | 4.00 |   |   |   | 5.00 |   |   |

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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 reflect inter-dealerprices, without mark-up, mark-down or commission and may not necessarilyreflect 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, including ESCP and TargetView. Thistransaction required that we transfer all assets related to the development andmanufacture of these products. We continue to sell and support these displaysystems.

(4)          Inthe fourth quarter of 2005, we recorded a gain of $8,000 on an insurancesettlement and a gain of $2,745 on the sale of a building.

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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 “FinancialStatements and Supplementary Data” of this annual report on Form 10-K.Information set forth in “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” includes forward-looking statements thatinvolve risks and uncertainties. Many factors could cause actual results todiffer materially from those contained in the forward-looking statements. See “Forward-LookingStatements” below and Item 1A “Risk Factors” in Part I of this annualreport on Form 10-K for additional information concerning theseitems. All dollar amounts are in thousands unless otherwise indicated.

**Executive Summary**

2005 was an exceptionally important year in the lifeof Evans & Sutherland, both for our operations and for our structureas a company. In our operations, we continued to make progress toward adaptingthe Company to the fundamental changes that have occurred in our markets overthe last five years. The size of the market for simulation visual systems has decreasedby two thirds since 2001, and simultaneously the technology has shifted tolower-cost hardware including PC-based systems. We have aggressively adjustedboth the size and technology of the Company, moving from more than 1,000employees to 270, introducing the industry-leading EP software, andbecoming the leading producer of PC-based visual systems in addition to ourtraditional high-end systems. We have also sold assets no longer needed in thebusiness, including several buildings. As a result of these actions we reducedour net loss per share from $3.37 in 2003 to $0.83 in 2004 and $0.11 in 2005.We expect further improvement in 2006.

In addition, we announcedin February an agreement to sell the assets of our Simulation Business toRockwell Collins and also announced that we would acquire Spitz, one of ourcompetitors in the digital theater market. These transactions move E&S awayfrom our traditional simulation visual systems business and position us tofocus on our digital theater and new laser projector businesses. We believethat the dynamics of the Simulation Business makes it better suited to be partof a larger, more integrated company, while the remaining businesses of E&Shave the potential for higher growth in the future.

**Restatement**

During the fiscal 2005 year-end closing process, wereviewed our accounting practices with respect to leasing transactions anddetermined that our then-current method of accounting for rent expense forleased real property was not in compliance with Financial Accounting StandardsBoard Technical Bulletin No. 85-3, *Accountingfor Operating Leases with Scheduled Rent Increases*(“FTB 85-3”).After discussion with our Audit Committee and our independent registered publicaccounting firm, we concluded that a restatement of our previously issuedconsolidated balance sheet as of December 31, 2004 and consolidated statementsof operations and stockholders’ equity (deficit) and comprehensive loss foreach of the years ended December 31, 2004 and 2003, and for the interimquarterly periods in 2005 and 2004 was needed to correct our accounting forannual rental rate escalations under our real property leases. FTB 85-3indicates that the lessee should recognize scheduled rent increases on astraight-line basis over the lease term, which may include optional leaserenewal terms, and deferred rent expense should be recognized to reflect thedifference between the rent paid in the current period and the calculatedstraight-line amount. By not accounting for the future annual increases on a straight-linebasis, we understated rent expense by $211 and $245 in 2004 and 2003,respectively, and understated the deferred rent obligation by $4,482, $5,081and $5,500 in 2004, 2003 and 2002, respectively. In addition, we understatedthe gain on sale of assets held for 

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sale related to realproperty leases that were assumed by the purchasers of certain of our buildingfacilities in prior fiscal years in the amount of $810 and $520 for 2004 and2003, respectively.

We have elected to correct other previously identifiederrors which were considered immaterial individually and in the aggregate by usat the time these errors were first identified. These other previouslyidentified errors included corrections of i) the useful lives of leaseholdimprovements; ii) the recognition of revenue; iii) foreign exchange gains andlosses; iv) the recognition of a contingent loss accrual; and v) the timing ofa gain on disposal of fixed assets. In addition to these adjustments, we adjustedsales and cost of sales related to one contract to research and developmentexpense, because the contract was determined to be a research and developmentarrangement. The effect of this reclassification was to decrease sales and costof sales by $981 and $1,204 for the years ended December 31, 2004 and 2003,respectively.

The cumulative effect of these restatement amounts onprior years resulted in a decrease in retained earnings of approximately $5,500as of December 31, 2002 and a decrease in net loss of approximately $138 and$651 for the fiscal years ended December 31, 2004 and 2003, respectively. See Note 3: “Restatement of FinancialStatements” in Item 8 “Financial Statements and Supplementary Data” of this annualreport on Form 10-K for further information, including the effect of thechanges on our consolidated financial statements for the affected periods.

The following discussionin this section reflects the effects of this restatement where applicable.

**Subsequent Events**

On February 7, 2006, we entered into the RockwellPurchase Agreement, pursuant to which we will sell substantially all of theassets and certain liabilities primarily related to our Simulation Businesses toRockwell Collins. As part of the transaction, pursuant to the Rockwell LaserAgreement to be entered into upon the closing of the asset sale, E&S willprovide, and grant exclusive and non-exclusive licenses to use and sell,fixed-based and motion-based laser projection systems in connection with theSimulation Business and certain related businesses of Rockwell Collins.

We will receive aggregate consideration of $71,500 incash in connection with the transaction with Rockwell Collins, consisting of$66,500, subject to a potential post-closing adjustment, under the RockwellPurchase Agreement and $5,000 under the Rockwell Laser Agreement, subject to achievingcertain milestones. At the closing, $7,000 of the $66,500 purchase price underthe Rockwell Purchase Agreement and $3,000 of the $5,000 under the RockwellLaser Agreement, or a total of $10,000, will be deposited into escrow. Theclosing of the transaction contemplated by the Rockwell Purchase Agreement issubject to~~~~approval by E&S shareholders and other customary closingconditions, including regulatory approvals. The transaction is currentlyexpected to close in the second quarter of 2006.

On February 7, 2006, we entered into theSpitz Agreement with Transnational and Spitz. Under the terms of the SpitzAgreement, we will acquire all of the issued and outstanding shares of commonstock of Spitz, which specializes in planetarium theaters, projection domes,architectural domes and custom immersive theater attractions. As considerationfor Spitz we will issue and deliver 412,500 shares of E&S commonstock, subject to a post-closing share adjustment dependingon the average trading price of our common stock forthe 60-day period prior to registration of the shares issued atclosing. The closing of the Spitz transaction is subject to approval by theshareholders of Transnational and is currently expected to close in the secondquarter of 2006.

Neither the Spitztransaction nor the Rockwell Collins transaction is conditioned upon completionof the other.

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**MajorFactors in Historical Performance (2003—2004)**

The three major factors affecting performance of theCompany in 2003 and 2004 were declines in our markets 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 military customers.

Following September 11, we received few ordersfrom major North American airlines which were formerly large customers of ourcommercial simulation products. This part of the commercial market has not yetfully recovered, but has been partially offset by gains in other commercialmarket areas. Additionally, military events following that time have alsoaffected U.S. military markets, primarily because a number of large weaponsprograms were either cancelled or delayed, causing reductions in the number ofnew military simulators needing visual 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 some of these programs. Wehad reserve balances of $562 in 2004 and $1,734 in 2003 to cover thesepotential costs. In 2003, we settled with one customer for approximately $1,200in goods and services which were fully delivered in 2004.

At the end of 2003, cost and estimated earnings inexcess of billings on uncompleted contracts relating to the Big Six programswas $2,100. Our collections in 2004 were $3,200. At the end of 2004, there wereno costs and estimated earnings in excess of billings on uncompleted contractsrelating to the Big Six programs. Related accounts receivable at the end of2004 totaled $2,700. At the end of 2005, costs and earnings in excess ofbillings on uncompleted contracts relating to the Big Six programs was $384 andaccounts receivable was $21.

We received acceptance on the remaining two Big Sixprograms during 2004. A few minor requirements remain to complete in 2006 andtheir impact on our 2006 financial results is expected to be immaterial. Weexpect to meet all remaining requirements in 2006.

We have historicallyproduced visual systems required by military customers with proprietaryhardware. In the past few years, some military customers have been drivingproducers of visual systems to reduce costs by delivering systems with similarcapabilities but using commercial off-the-shelf (COTS) PC hardware. As aresult, visual systems prices have in some cases declined significantly. Wehave been successful in this product transition and have become the leadingsupplier of both high-end and PC-based systems. While the total number ofvisual channels has increased in this transition, the revenue produced hasdeclined. We believe the trend toward more systems at lower prices willcontinue, though we do not believe that total revenue will decline further.

**Results of Operations**

Our 2005 sales increased by 8% primarily from anincrease in sales to our military and digital theater markets. Strong orders in2004 contributed to a $19,548 increase in our 2004 year-ending backlog whichallowed us to increase sales in 2005. We continued to lower our costs byreducing headcount and labor costs, which is our largest cost category. However,these savings were partly offset by additional research and developmentrequired for our laser projector. Lastly, we recognized gains on the sale of abuilding and an insurance settlement of $2,745 and $8,000, respectively.

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Moredetailed explanations of our 2005 results are provided below.

***Consolidated Sales***

Thefollowing table summarizes our consolidated sales for fiscal year:

| ** ** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------|------------|----------|------------|----------|------------|----------|------------|
| Sales      |       | $        | 73,567     |     | $          | 67,859   |       | $ | 83,837 |   |
|            |            |          |            |          |            |          |            |  |  |  |

 

*Fiscal 2005 vs.2004*

The primary reason for the 8.4% increase in 2005 saleswas improvement in sales in the military and digital theater markets. Militarysales increased $6,778, while sales in the planetarium market increased $5,697.These increases were offset by reduced sales in the commercial airlines marketand in service and support. Sales in the commercial airline market decreased$5,013 and service and support sales decreased $1,935.

Military markets improved due to an increase inmilitary training requirements. We believe we will see continued improvement in2006 orders and sales from these customers. A few large prime contractors thatare both customers and competitors continue to move toward providing their ownvisual systems. We also continue to believe that there has been an increase inmilitary contracts awarded directly to incumbents and a corresponding reductionin contracts being placed for open bid. To compete against these trends, westrive to offer superior visual systems at competitive prices and to be moreresponsive in meeting and supporting customer needs.

Domestic airlines continue to be under financialpressure, resulting in a decrease in the number of new simulators purchased inthis market. However, since many international airlines are upgrading theircurrent simulators, we have attempted to offset domestic market trends byupgrading our large installed visual system base using the EP-1000CTproduct. Orders and sales were nevertheless below 2004 levels, but we expecthigher orders and sales in 2006.

While our overall salesincreased in 2005, new orders were slightly down during the year. As a result,backlog decreased by 5% from $84,232 to $80,277. We believe this decrease inbacklog will not result in lower sales in 2006 and expect the backlog to remainflat at year end 2006.

*Fiscal 2004 vs.2003*

Sales in 2004 declined 19.1% from $83,837 in 2003. Thiswas primarily the result of a $15,071 reduction in sales to military customersdue to constraints on military training programs. Service and support salesdeclined $2,510 also resulting from military constraints. Commercial airlinessales remained consistent with 2003 levels, and sales to planetarium customersincreased $2,197 as a result of the success of our Digistar 3 visual systemtechnology.

While sales decreased in2004, backlog increased over 2003 from $64,684 to $84,232.

***Gross Margin***

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

| ** **              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------|------------|----------|------------|----------|------------|----------|------------|
| Gross margin            |       | $        | 27,279     |     | $          | 24,644   |       | $ | 17,119 |   |
| Gross margin percentage |       | 37.1     | %          | 36.3     | %          | 20.4     | %          |
|                         |            |          |            |          |            |          |            |  |  |  |

 

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*Fiscal 2005 vs.2004*

Our gross marginpercentage improved to 37.1% in 2005, compared with 36.3% in 2004. In 2005, ourgross margin from sales to military customers improved 4.9% as a result ofbetter product mix. There were fewer deliveries with high pass-through content,resulting in higher internal value-added and improved gross margins. Grossmargins to planetarium customers improved 1.3% as Digistar 3 continued tomature as a product. Commercial airline margins decreased 1.1%, while serviceand support margins decreased by 8.0%. Service and support margins havedeclined as the mix of equipment shifted to more PC-based products and as aresult of high margin chip sales which occurred in 2004, and were fullyimpaired, but not in 2005.

*Fiscal 2004 vs.2003*

Our gross margin percentage improved to 36.3% in 2004,compared with 20.4% in 2003. Our 2003 gross margins were depressed by a $14,566inventory impairment loss. In 2004, gross margins from sales to our militarycustomers decreased 7.5% due to a change in product mix. Significant deliverieswere made in 2004 on large military contracts with a high proportion ofsubcontract pass-through sales resulting in lower gross margins. Gross marginsfrom sales to our planetarium customers decreased 6.3% and our service andsupport gross margins decreased 6.1% in 2004. Both decreases were a result ofunique, high-margin deliveries during 2003 which were not repeated in 2004. Weachieved a 1.7% gross margin increase in sales to commercial customers as a resultof improved cost performance and a 1.7% gross margin increase due to reductionsin warranty expense as we improved product reliability.

***Operating Expenses***

Thefollowing table summarizes our operating expenses during fiscal year:

| ** **                                                  | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Selling, general  and administrative (“SG&A”) |       | $        | 20,172     |     | $24,022    |     | $          | 26,999 |   |
| Research and  development (“R&D”)             |       | 16,878   |       | 16,734   |       | 21,827   |       |
| Restructuring  charges (recoveries)                         |       | 1,759    |       | (491     | )          | 3,416    |       |
| Gain on insurance  settlement                               |       | (8.000   | )          | —   |       | —   |       |
| Impairment loss                                             |       | —   |       | —   |       | 1,151    |       |
| Operating expenses                                          |       | $        | 30,809     |     | $          | 40,265   |       | $ | 53,393 |   |
|                                                             |            |          |            |          |            |          |            |  |  |  |

 

***SG&A Expenses***

*Fiscal 2005 vs.2004*

SG&A expensesdecreased 16.0% during 2005 mainly because of lower labor costs. In addition,our bad debt expense was $822 lower in part due to a collection on a $435receivable we had previously reserved. Depreciation and amortization were alsodown from 2004 by $651 due to prior year building sales. These decreases wereoffset by increased legal expenses of $1,774 associated with the insurancesettlement that occurred at the end of 2005 and associated with the RockwellCollins transaction. We expect SG&A to remain at this level or slightlyhigher as a result of transaction costs related to the sale of assets toRockwell Collins.

*Fiscal 2004 vs.2003*

SG&A expensesdecreased 11.0% during 2004. We achieved $2,534 in SG&A expense reductionsfrom reduced headcount, $543 in reduced equipment costs and the remainder from variouscost reductions.

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***R&D Expenses***

*Fiscal 2005 vs.2004*

R&D expenses increased0.9% during 2005. We achieved reductions during 2005 of $899 in labor andassociated overheads, and $824 in our use of outside consultants andmanufacturing services. These reductions were offset by a $433 increase inpurchases related to the development of the ESLP and $1,320 for the delivery offour prototype ESLP systems to the U.S. Air Force under a cost sharing contract.We expect R&D expenses in 2006 to be slightly less than in 2005 as wecomplete development efforts on the first generation of our laser projector.

*Fiscal 2004 vs.2003*

R&D expenses decreased23.3% during 2004. We achieved reductions during 2004 of $3,800 in labor andassociated overheads, $709 in development expenses, and $600 in software andmiscellaneous expenses.

***Restructuring Charges (Recoveries)***

*Fiscal 2005 vs.2004*

In order to improve ourprofitability and cash flow in 2005, we initiated a restructuring plan in March 2005.The largest cost element of our business is our labor and labor-related costs. Therestructuring reduced our aggregate labor force by approximately 60 full-timeequivalent employees at an expected cost of $1,625 in severance benefits to bepaid out over two years. We expect this action to reduce our labor andlabor-related costs approximately $5,140 per year, which was partially achievedin 2005. During the first quarter of 2005, we recorded a restructuring chargeof $1,891. We incurred an additional $35 in the second quarter relative to thisaction. In the fourth quarter, we reduced this restructuring charge by $168 asthe actual cost of the plan was finalized and was less than our initialestimate.

*Fiscal 2004 vs.2003*

We did not record anyrestructuring charges in 2004. Due to declines in our two primary markets weimplemented a restructuring plan in 2003 to reduce our labor costs and werecorded restructuring charges of $3,416 related to headcount reductions ofapproximately 120 full-time equivalent employees. Our labor reductions wereexecuted throughout the Company. This restructuring resulted in a reduction ofapproximately $7,500 per year in our labor costs, which was partially achievedin 2003 and entirely in 2004, through reductions in cost of sales and operatingexpenses.

***Gain on Insurance Settlement***

*Fiscal 2005 vs.2004*

In December 2005, wesettled a lawsuit previously filed by us against an insurance company withrespect to an insurance claim made by us for losses incurred due to acancellation of a significant contract by a customer in 2000. Under thesettlement terms we received $8,000 and agreed to dismiss the lawsuit and toprovide release of claims against the insurance company.

*Fiscal 2004 vs.2003*

During 2004 and 2003 therewere no similar insurance settlements.

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***Impairment Loss***

*Fiscal 2005 vs.2004*

During 2005, we did notincur any impairment charges.

*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.

***Gains***

Thefollowing table summarizes our gains during fiscal year:

| ** **                    | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Gain on sale of  assets       |       | $        | —     |     | $          | 3,817    |       | $ | — |   |
| Gain on assets held for  sale |       | 2,745    |       | 4,298    |       | 1,926    |       |
|                               |            |          |            |          |            |          |            |  |  |  |

 

In 2005, we recognized a gain on a building held forsale of $2,745.

In 2004, we recognized gains on the sale of two assetstotaling $8,115. A building held for sale was sold resulting in a gain of$4,298. We sold our CRT based projector assets to Video Display Corporationrecognizing a gain of $3,662 as we shifted our focus to our new laserprojector.

In 2003, we recognized again on a building held for sale of $1,926.

***Other Income and Expense***

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

| ** **                   | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Other income  (expense), net |       | $        | (779       | )        | $          | (1,111   | )          | $ | (1,960 | ) |
|                              |            |          |            |          |            |          |            |  |  |  |

 

We reduced our otherexpenses in 2005 29.9%. Bank fees decreased $268 due to allowing our line ofcredit to expire at the end of 2004, earnings from our unconsolidatedsubsidiary increased $270, interest income increased $234, and we had a gain onthe sale of an investment of $654. These were offset by increased realized andunrealized foreign currency losses of $932. We reduced our other expenses in2004 by 43.3% due to the absence of a $500 loss recorded in 2003 for thewrite-off of an investment and a $81 reduction in interest expense due toreduced debt levels.

***Income Taxes***

Thefollowing table summarizes our income taxes during fiscal year:

| ** **                    | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Income tax  expense (benefit) |       | $        | (430)      |     | $          | 112      |       | $ | (971 | ) |
|                               |            |          |            |          |            |          |            |  |  |  |

 

The income tax benefit in2005 is attributable to adjustments to prior years’ tax provisions as a resultof favorable resolution of certain international income tax contingencies andbenefit from foreign income taxes. The income tax expense in 2004 was primarilyattributable to foreign income taxes. The income tax benefit in 2003 wasprimarily due to the favorable resolution of certain worldwide income taxcontingencies. Deferred tax assets arising from net operating losscarryforwards are fully reserved through a valuation allowance because it ismore likely than not that the net deferred income tax assets will not be realized.

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***Subsequent Events Potential Impact on Future Resultsof Operations***

As neither the sale of our assets primarily related tothe Simulation Business under the Rockwell Collins Agreement nor theacquisition of Spitz under the Spitz Agreement has been completed, thepotential impact of these two transactions on our results of operations are notdiscussed above. The completion of either or both of these transactions willmaterially impact our future results of operations. Below is a summarydiscussion of their expected impact.

Following the completionof the Rockwell Collins transaction we will no longer operate our business inthe military and commercial visual simulation markets, except for sales of ourlaser projectors to Rockwell Collins. This will result in significantly lowersales and related operating costs. The remaining business will be focused onsales to the digital theater market and the expansion of products based on ourlaser technology. In order to increase our market share and sales in thedigital theater market we agreed to acquire Spitz, one of our competitors inthis market. With this acquisition we expect to have a more robust range ofproducts for this market, including the ability to design and build domes. Inaddition to increasing sales in our digital theater market, the acquisition ofSpitz, which will add approximately 60 employees and their operations facilityin Pennsylvania, will also increase our operating costs. Currently, the ESLPhas been developed or is in development for the digital theater, commercial andmilitary simulation markets. As a result of these transactions we expect theoverall cost structure of our Company to decrease significantly, though R&Dis expected to remain at a high percentage of sales as we continue to developour laser projector products. Our SG&A is also expected to remain initiallyat a high level due to additional costs related to the transactions.

**Liquidity and Capital Resources**

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

| ** **                 | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|
| Cash and cash  equivalents |       | $        | 14,606     |     | $          | 10,147 |   |
| Restricted cash            |       | 1,099    |       | 3,414    |       |
| Lines of credit            |       | —   |       | —   |       |
| Net short term  cash       |       | 15,705   |       | 13,561   |       |
| Long-term debt             |       | (18,015  | )          | (18,015  | )          |
| Net cash  (indebtedness)   |       | $        | (2,310     | )        | $          | (4,454 | ) |
| Stockholders’ deficit |       | $        | (6,455     | )        | $          | (948 | ) |

 

In 2005, we continued toimprove our overall liquidity and maintain our ability to issue letters ofcredit. This was mainly due to selling an office building and reaching a cashsettlement in a lawsuit. In addition we believe our products are performingwell and we expect to meet our delivery requirements. As a result, we do notforesee any liquidated damages or late delivery penalties in 2006.

***Outlook***

In 2006, we expect to complete the sale of our assetsprimarily related to the Simulation Business to Rockwell Collins. We expectthis to result in approximately $18,737, net of projected uses of cash andamounts required to be held in escrow. See “Subsequent Events” above forfurther information concerning this transaction. We expect the net cash fromthis transaction along with cash from operations to fund our requirements in2006 and beyond. However, there is no guarantee we can complete the transactionwith Rockwell Collins and failure to do so will impact our financial positionand liquidity. Circumstances that could materially affect liquidity in 2006include, but are not limited to: (i) completing the asset sale to RockwellCollins (ii) successfully delivering new technologies and products, (iii) meeting2006 forecasted sales levels, and (iv) continuing to reduce costs andexpenses.

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For years after 2006, weexpect cash from operations and net cash from the sale to Rockwell Collins tofund our planned needs in the short term as we invest in research anddevelopment related to our laser projector products. For the long term, webelieve that our cash from operations will fund our planned needs. However, weoperate in a rapidly evolving and often unpredictable business environment thatmay change the timing or amount of expected future cash receipts andexpenditures. Accordingly, there can be no assurance that our sources of fundswill be sufficient to meet our liquidity needs or that we will not be requiredto raise additional funds to meet those needs, including future businessexpansion, through the sale of equity or debt securities or from creditfacilities with lending institutions.

***Cash Flow***

| ** **                             | ** ** | **Year ended December 31** | ** ** |
|----------------------------------------|------------|-------------------------------------------|------------|
| ** **                             | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net cash provided  by (used in):       | ** ** | ** **                                |       | ** ** | ** ** | ** ** |   |
| Operating activities                   |       | $                                         | (2,782     | ) | $ | (484 | ) | $ | (771 | ) |
| Investing activities                   |       | 4,830                                     |       | 11,536 |   | 997 |   |
| Financing activities                   |       | 2,411                                     |       | (10,619 | ) | 2,113 |   |
| Increase in cash and  cash equivalents |       | $                                         | 4,459      |   | $ | 433 |   | $ | 2,339 |   |

 

Cash and cash equivalents increased $4,459 to $14,606during fiscal year 2005, primarily as a result of cash provided by investingand financing activities. During 2005, we sold a building which was held forsale, received an insurance settlement and released additional cash that wasrestricted at the end of 2004.

*OperatingActivities*

Operating activities used $2,782 of cash during 2005.This resulted primarily from a decrease in working capital of $5,909 offset bynet income of $3,077 (adjusted for non-cash items of $4,211). Accountsreceivable decreased due to improved collections. Inventories increased due topurchases related to our ESLP for deliveries to our digital theater customersstarting in the first quarter of 2006. Net costs and estimated earnings inexcess of billings on uncompleted contracts decreased due to increased revenuerecognition on percent complete contracts compared to billings on percentcomplete contracts. Prepaid expenses and deposits decreased due to a reductionof prepaid software licenses. The decrease in our liabilities used $4,219.Customer deposits increased due to the excess of cash received on completedcontracts compared to revenue recognized during the period.

Operating activities used $484 of cash during 2004.This resulted primarily from a net loss of $8,729 (adjusted for non-cash itemsof $168) offset by changes in working capital. Changes in working capitalprovided $8,006 of cash during 2004. Our accounts receivable decrease wasmainly due to collections on several large contracts. Our inventory decreasewas mainly due to the sale of $1,090 of CRT based projector inventory in thesale to Video Display Corporation, and to improved inventory management. Ournet costs and estimated earnings in excess of billings on uncompleted contractsdecrease was primarily due to the completion of the remaining two Big Sixprograms. Our accounts payable decrease was a result of our continued focus onreducing our outstanding trade payables and our improved liquidity. Our accruedexpense decrease used $5,582 and our deferred rent increase provided $230.During 2004, we met the requirements of a settlement agreement we entered intoat the end of 2003 with one of our customers concerning the delivery of Harmony1 based visual systems. We had accrued $1,200 and our settlement costs wereapproximately $1,200. In addition we charged $1,007 against our warrantyreserve, and our payments for severance benefits during 2004 related to prioryears’ restructure plans was approximately $1,066.

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Operating activities used$771 of cash during 2003. This resulted primarily from a net loss of $5,936(adjusted for non-cash items of $28,412) offset by changes in working capital. Changesin working capital provided $6,102 of cash during 2003. Our net costs andestimated earnings in excess of billings on uncompleted contracts decreaseprovided $11,346 due to the completion and billing of all but two of the BigSix programs. The decrease in our accounts payables used $1,225 as a result ofimproved liquidity in 2003 as well as due to a shrinkage of our business. Thedecrease in our accrued expenses used $5,311as a result of warranty claims of$1,952 and compensation and benefits accruals decreasing $1,816. Compensationand benefits accruals decreased partially, due to reduced headcounts in 2003and 2002 as a result of restructurings implemented during that time. Also, ouraccrued liquidated damages and late penalties increased due to reaching a$1,200 settlement with one of our Big Six program customers. In addition, wehad a net decrease of $414 in restructure charges, with approximately $3,830 inseverance benefits paid.

*InvestingActivities*

Investing activities provided $4,830 of cash during2005. This resulted primarily from the sale of one of our office buildings thatwas no longer in use for $6,277 in cash. This was partly offset by property,plant and equipment purchases of $2,434.

Investing activities provided $11,536 of cash during2004. This resulted primarily 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 partly offset bythe use of $1,869 of cash for the purchase of property, plant and equipment andthe use of $871 of cash for a deposit. The deposit was required in relation tothe sale of our office building and the rental guarantee we entered into withthe buyer.

Investing activitiesprovided $997 of cash during 2003. This resulted primarily from the sale of oneof our office buildings that was no longer in use for $4,760 in cash. This wasoffset by the use of $3,767 of cash for the purchase of investments inproperty, plant and equipment.

*FinancingActivities*

Financing activities provided $2,411 of cash during2005 primarily as a result of a reduction in our restricted cash requirementsrelated to the issuance of letters of credit.

Financing activities used $10,619 of cash during 2004primarily due to the pay down of our lines of credit during 2004 and due to anincrease in restricted cash requirements related to the issuance of letters ofcredit.

Financing activitiesprovided $2,113 of cash during 2003 primarily as a result of a restricted cashrequirement under our line of credit agreements.

***Credit Ratings***

On July 12, 2005,Moody’s Investor Services (“Moody’s) withdrew all debt ratings assigned toEvans and Sutherland for “business reasons”. The ratings withdrawn were thecorporate family rating previously rated B3; and the rating on the 6%Convertible Subordinated Debentures (the “6% Debentures”) previously rated Caa2.*Moody’s Guidelines for the Withdrawal of Ratings*provides that “business reasons” for the withdrawal of a rating indicates thatunder certain circumstances, Moody’s will withdraw a rating for an issuer or anobligation for reasons unrelated to the adequacy of information, bankruptcy orreorganization status of the credit. When this occurs, Moody’s will balance themarket need for a rating against the costs to maintain and monitor a rating.

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***Credit Facilities***

The ability to issue letters of credit and bankguarantees is important to our business because sales outside North America andWestern Europe have increased. Letters of credit and bank guarantees in manycountries are required as part of any final contract. Letters of credit andbank guarantees are issued to ensure our performance to customers in thosecountries. We also obtain letters of credit in our favor from such countries toensure payment for equipment and services delivered to customers in thosecountries.

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 31,2005, our outstanding letters of credit totaled $1,384. Letters of credit thatexpire in 2006 total $988 and those that expire in 2007-2010 total $396.

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

As of December 31,2005, we had approximately $18,015 of the 6% Debentures outstanding that aredue in 2012. The 6% Debentures are unsecured and are convertible at eachbondholder’s option into shares of our common stock at a conversion price of$42.10 per share for an aggregate of 428,000 shares of our common stock if alloutstanding 6% Debentures are converted, subject to adjustment. The 6%Debentures are redeemable at our option, in whole or in part, at par. Theindenture pursuant to which the 6% Debentures were issued prohibits theconveyance or transfer of our assets substantially as an entirety to any personunless such person expressly assumes all of the obligations and liabilities ofthe 6% Debentures. Accordingly, under the terms of the Rockwell PurchaseAgreement, we agreed to satisfy and discharge our obligations under the 6%Debenture and the indenture upon the closing of the transaction with RockwellCollins. Specifically, we will issue a notice of redemption with respect to the6% Debentures immediately prior to the closing of the Rockwell Collinstransaction and deposit with the indenture trustee sufficient funds to satisfythe redemption payments.

***Rental Guarantees***

During 2005, we entered into a 21 month buildingrental guarantee with the buyer of a building that was available for sale. Underthe terms of the rental guarantee, our maximum obligation will be reduced asthe buyer leases space in the building. As of December 31, 2005, we hadaccrued $1,197 for this obligation and 100% of the leasable space in thisbuilding was available.

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 maximum obligationwill be reduced as the buyer leases space in this building. As of December 31,2005, we had accrued $447 for this obligation and approximately 57% of theleasable space in this building was available.

***Legal Settlement***

In December 2005, weentered a settlement agreement with an insurance company and received a paymentof $8,000 in exchange for dismissing a lawsuit filed by E&S against theinsurance company and 

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releasingthe insurance company from all existing claims under insurance polices writtenby that insurance company in favor of E&S.

***Other***

In 2006, we expect capital expenditures to be similarto 2005, or approximately $2,000 to $3,000. There were no material capitalexpenditure commitments at the end of 2005, 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 March 31, 2005, 463,500shares remained available for repurchase under the plans approved by the Boardof Directors. No shares were repurchased during 2005, 2004, or 2003. 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, 2005, our totalindebtedness was $18,015 consisting of long-term debt. Our cash and restrictedcash, subject to various restrictions set forth in this annual report on Form 10-K,are available for working capital needs, capital expenditures, strategicinvestments, mergers and acquisitions, stock repurchases and other potentialcash needs as they may arise.

***Effects of Inflation***

The effects of inflationwere not considered material during fiscal years 2005, 2004, or 2003, and arenot expected to be material for fiscal year 2006.

**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 to provide E-3D Sentry Aircrew Training Services. Wehave a 50% interest in Quest which is accounted for as an investment under theequity method and therefore is not consolidated in our financial statements. SeeNote 9 in Item 8 “Financial Statements and Supplementary Data of this annualreport on Form 10-K for Quest summary financial information.

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, 2005, wehad four guarantees outstanding related to Quest. Pursuant to the firstguarantee, we have guaranteed, jointly and severally with Quadrant, 

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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 $1,721), 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 aresatisfied or the date on which the loan agreement is otherwise terminated. Inthe event of default on this loan agreement, the lending institution canrequest that the trustee holding such equity shares surrender them to thelending institution in order to satisfy all amounts then outstanding under theloan agreement. As of December 31, 2005, the outstanding loan balance was£4,889 (approximately $8,077). Quadrant has made identical guarantees for thisobligation of Quest. Pursuant to the fourth guarantee, we have guaranteedpayment, up to a maximum of £125 (approximately $215), in the event that Questhas a default event, as defined by its loan agreement. This guarantee is inplace until 2020. Quadrant has made identical guarantees for this obligation ofQuest. As of December 31, 2005, no amounts have been accrued for anyestimated losses under these guarantees because we believe that Quest will meetall of its performance and financial obligations in relation to its contractwith the U.K. MOD. However, if we are required to perform under any or all ofthe four guarantees, it could have a material adverse impact on our operatingresults and liquidity.

Upon completion of theasset sale contemplated by the Rockwell Purchase Agreement, Rockwell Collinswill acquire our entire interest in Quest and will assume our obligations underthe guarantees related to Quest.

**ContractualObligations**

The impact that ourcontractual obligations as of December 31, 2005 are expected to have onour liquidity and cash flow in future periods is as follows:

| ** **                                       | ** ** | **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)    |       | $                                         | 25,581     |   |   | $ | 1,081 |   |   |   | $ | 2,162 |   |   |   | $ | 2,162 |   |   |   | $ | 20,176 |   |   |
| Operating lease  obligations(2)                  |       | 16,726                                    |       |   | 1,889 |   |   |   | 2,233 |   |   |   | 1,394 |   |   |   | 11,210 |   |   |
| Purchase  obligations(3)                         |       | 7,182                                     |       |   | 5,364 |   |   |   | 1,818 |   |   |   | — |   |   |   | — |   |   |
| Pension and post  retirement plan obligations(4) |       | 520                                       |       |   | 520 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Total(5)                                         |       | $                                         | 50,009     |   |   | $ | 8,854 |   |   |   | $ | 6,213 |   |   |   | $ | 3,556 |   |   |   | $ | 31,386 |   |   |

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(1)          Amountsrepresent the expected cash payments on our long-term debt, including interestpayments, and do not include any fair value adjustments or bond premiums ordiscounts. In accordance with the terms of the Rockwell Purchase Agreement, weagreed to satisfy and discharge our obligations under the 6% Debenture and theindenture upon the closing of the transaction with Rockwell Collins.

(2)          Themajority of the operating lease obligations are land leases for periods up to40 years on the land underlying our buildings. Our maximum rental guaranteepayments are included in operating lease obligations. Upon the closing of theRockwell Collins transaction, certain of our operating lease obligations willbe assumed by Rockwell Collins.

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(3)          Purchaseobligations include agreements to purchase goods or services that areenforceable and legally binding on E&S and that specify all significantterms, including fixed or minimum quantities to be purchased and theapproximate timing of the transaction. Purchase obligations exclude agreementsthat are cancelable without penalty. Our maximum rental guarantee payments areincluded in purchase obligations. Upon the closing of the Rockwell Collinstransaction, certain of our purchase obligations will be assumed by RockwellCollins.

(4)          Ourpolicy is to make contributions to pension and post-retirement plans only ifrequired to by statutory funding requirements. We currently intend to use aportion of the proceeds from the Rockwell Collins transaction to fund 90% ofour existing obligations under our pension plan, our Executive Savings Plan andour Supplemental Executive Retirement Plan.

(5)          Thetable does not reflect the impact of the Rockwell Collins transaction on ourexpected liquidity cash flow in future periods. In addition, not included inthe table above are our guarantees related to Quest. See “Off Balance SheetArrangements” for further information on these guarantees. Upon the closing ofthe Rockwell Collins transaction, these guarantees will be assumed by RockwellCollins.

**Applicationof Critical Accounting Estimates**

The application of theaccounting estimates discussed below are considered by management to becritical to an understanding of our financial statements. Their applicationplaces significant demands on management’s judgment, with financial reportingresults relying on estimates about the effect of matters that are inherentlyuncertain. Specific risks for these critical accounting estimates are describedin the following paragraphs. A summary of significant accounting policies canbe found in Note 2 “Summary of Significant Accounting Policies” of Item 8 “FinancialStatements and Supplementary Data” in this annual report on Form 10-K.For all of these policies, management cautions that future results rarelydevelop exactly as forecast, and the best estimates routinely requireadjustment.

***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 lowerthan management’s anticipated total costs, then an adjustment is required toincrease the previously recognized revenue as the ratio of costs incurred tomanagement’s estimate is understated. Adjustments for revisions of previousestimates are made in the period they become known.

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

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

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***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 theseitems. Reserve adequacy is based on estimates of future sales, product pricing,and requirements to complete projects. Revisions of these estimates wouldresult in adjustments to our operating results.

***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 ofDecember 31, 2005. These liquidated damages are based primarily onestimates of project completion dates. To the extent completion dates are notconsistent with our estimates, these damage and penalty accruals may requireadditional adjustments.

***Allowance for Doubtful Accounts***

We specifically analyzeaccounts receivable 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 of preparing our consolidatedfinancial statements we are required to estimate our actual income taxes ineach of the jurisdictions in which we operate. This involves estimating ouractual current tax exposure together with assessing temporary differencesresulting from differing treatments of items, such as accrued liabilities, fortax and accounting purposes. These differences result in deferred income taxassets and liabilities, which are included in our consolidated balance sheets.We must then assess the likelihood that our deferred income tax assets will berecovered from future taxable income and, to the extent we believe thatrecovery is not likely, we must establish a valuation allowance. To the extentwe establish a valuation allowance or increase or decrease this allowance in aperiod, we must include a corresponding adjustment within the income taxprovision in the statement of operations. Significant judgment by management isrequired to determine our provision for income taxes, our deferred income taxassets and liabilities and any valuation allowance recorded against our netdeferred 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 

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than amounts for severanceand benefits, can be recorded when a detailed restructuring plan to exitspecific activities has been approved by management prior to the financialreporting date and the Company has the ability to reasonably estimate costs. Estimatedamounts for severance and benefits are accrued once the potentially affectedemployees have been notified of the termination and severance benefits havebeen communicated. The communication must include, at a minimum, the number ofimpacted employees, the job functions and the locations that are affected. Ifactual costs differ from the estimated costs, adjustments to the restructuringcharges are required.

Restructuring charges thatoccurred after December 31, 2002 were recorded under SFAS No. 112“Employers’ Accounting for Postemployment Benefits—an Amendment of FASBNo. 5 and 43.” As a result, a liability for the estimated costs associatedwith an exit or disposal activity is recognized when the liability is incurred.Thus estimated amounts for severance and benefits are accrued once they are probableand estimable; for contract terminations costs are accrued once the contract isterminated or the Company ceases receiving any benefit from the contract; andfor leased property costs are accrued once the Company has exited the facilityand is no longer receiving any benefit from the lease. If actual costs differfrom the estimated costs, adjustments to the restructuring charges are required.

***Straight Line Rent and Contingent Obligation***

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

**Recent Accounting Pronouncements**

In May 2005, the FASB issued SFAS No. 154, “AccountingChanges and Error Corrections”, a replacement of Accounting Principles Board (“APB”)Opinion No. 20 and FASB Statement No. 3. SFAS No. 154 requiresretrospective application to prior period’s financial statements of a voluntarychange in accounting principle unless it is impracticable. APB Opinion No. 20,“Accounting Changes,” previously required that most voluntary changes inaccounting principle be recognized by including in net income of the period ofthe change the cumulative effect of changing to the new accounting principle.SFAS No. 154 became effective for our Company on January 1, 2006. Webelieve that the adoption of SFAS No. 154 will not have a material impacton our consolidated financial statements.

In December 2004,FASB issued Statement of Financial Accounting Standards No. 123R, “Share-BasedPayment” (“SFAS 123R”). SFAS 123R is a revision of SFAS 123 and it was to beeffective for us as of the beginning of the first interim or annual reportingperiod that began after June 15, 2005. However, the Securities andExchange Commission has permitted companies subject to its oversight to delayimplementing SFAS 123R until the beginning of their next fiscal year. Accordingly,we will implement the guidance of SFAS 123R at the beginning of our next fiscalyear that starts January 1, 2006. We do not expect the adoption of SFAS123R to have a material impact on our financial position or cash flows; howeverit will have a material impact on our results of operations as we are requiredto recognize stock-based compensation to our employees as compensation expenseunder the fair value method over 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 Securities Exchange Act of 1934, asamended, including among others, those statements preceded by, followed by orincluding the words “estimates,” “believes,” “expects,” “plans,” “projects,”and similar expressions.

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

·       Ourbelief that we will complete the Rockwell Collins transaction in the secondfiscal quarter of 2006 and receive consideration of $66,500 subject topost-closing adjustments, that we will enter into the Rockwell Laser Agreement,and that the amounts held in escrow totaling $10,000 related to the RockwellAsset Purchase and Rockwell Laser Agreement will be released in full to us inthe future.

·       Ourbelief that following the completion of the Rockwell Collins transaction wewill no longer operate our business in the military simulation markets and thecommercial simulation markets except for sales of our laser projectors toRockwell Collins.

·       Ourbelief that we will complete the transaction with Transnational for thepurchase of Spitz in the second fiscal quarter of 2006.

·       Ourbelief that the acquisition of Spitz and the continued success of our Digistar3 Laser product will allow us to gain market share in digital theaters and thatwe may be able to grow the Spitz dome building business in 2006 and futureyears.

·       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.

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

·       Ourbelief that our products are performing well, that we will meet all ourdelivery requirements, and as a result we will incur no liquidated damages orlate delivery penalties in 2006.

·       Ourbelief that capital expenditures during 2006 will be similar to the capitalexpenditures incurred during 2005.

·       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 2006 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 2006.

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

·       Ourbelief that approximately 58% of our backlog will be converted to sales in 2006.

·       Ourbelief that the impact of the Big Six programs will be immaterial to ourfinancial condition in 2006 and that we will complete all our requirementsrelated to these programs in 2006.

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·       Ourbelief that we will see improvements in our 2006 orders and sales from themilitary and commercial simulation markets even though we expect modestimprovements in the military simulation market and and expect the commercialsimulation market to remain flat.

·       Ourbelief that our SG&A expenses could remain at their 2005 levels or higherdue to additional costs related to the Rockwell Collins and Sptiz transactions.

·       Ourbelief that the Rockwell Collins transaction and the Spitz transactions onceconsummated will materially affect our future financial performance andposition as we will have sold a significant percentage of operational assetsrelated to the Simulation Business and acquired additional operational assetsrelated to the digital theater simulation group.

·       Ourbelief that the net cash from the Rockwell Collins transaction along with cashfrom operations will fund our requirements in 2006.

·       Ourbelief that for years beyond 2006 cash from operations and net cash from thesale to Rockwell Collins will fund our planned needs in the short term as weinvest in research and development related to our laser projector products andour belief that for the long term, cash from operations will fund our plannedneeds.

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

·       Ourbelief that we will continue to improve the performance of the EP and ECTsoftware technology and that these improvements will increase the performanceand functionality of our EP and EPX visual systems in 2006 and that we willcomplete the R&D efforts for wide display applications for the commercialsimulation market in 2006.

·       Ourbelief that while visual system prices have decreased significantly in themilitary simulation market due to a push to use commercial off-the-shelf (COTS)PC hardware, revenues will not decline as a result of this trend.

·       Ourbelief that our prior changes in strategy will continue to result inimprovements to our net loss per share.

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 inItem 1A “Risk Factors” in Part I of this annual report on Form 10-K,important factors to consider in evaluating such forward-looking statementsinclude risks of product demand, market acceptance, economic conditions,competitive products and pricing, difficulties in product development, andproduct delays. In light of these risks and uncertainties, there can be noassurance that the events contemplated by the forward-looking statementscontained in this annual report will, in fact, occur.

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

The principal market risks to which we are exposed arechanges in foreign currency exchange rates and changes in interest rates. Ourinternational sales, which in fiscal years 2005, 2004, and 2003 accounted forapproximately 51%, 58%, and 53% of our totals sales, respectively, areconcentrated in the United Kingdom, continental Europe, and Asia. In general,we enter into sale agreements with our international customers denominated inU.S. dollars. Foreign currency purchase and sale contracts may be entered intofor periods consistent with related underlying exposures and do not constitutepositions independent of those exposures. We do not enter into foreign currencycontracts for trading purposes and do not use leveraged contracts. As of December 31,2005, we had sales contracts in Euros with approximately €2,361remaining to collect, sales contracts in GBP with approximately £315 remainingcollect.

We reduce our exposure to changes in interest rates bymaintaining a high proportion of our debt in fixed-rate instruments. As of December 31,2005, our fixed-rate instruments consisted 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 $11,530 as of December 31,2005.

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**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

**CONSOLIDATEDBALANCE SHEETS***(In thousands, exceptshare data)*

| ** **                                                                                                          | ** ** | **December 31** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                                                          | ** ** | **2005**             | ** ** | **2004 ** | ** ** |
| ** **                                                                                                          | ** ** | ** **           | ** ** | **(Restated)** | ** ** |
| **ASSETS**                                                                                                          | ** ** | ** **           | ** ** | ** ** | ** ** |
| Current assets:                                                                                                     |       |                 |       |   |   |
| Cash                                                                                                                |       | $                    | 14,606     |   | $ | 10,147 |   |
| Restricted cash                                                                                                     |       | 1,099                |       | 3,414 |   |
| Accounts receivable, net                                                                                            |       | 10,770               |       | 15,102 |   |
| Costs and estimated earnings in excess of billings  on uncompleted contracts                                        |       | 9,509                |       | 5,616 |   |
| Inventories, net                                                                                                    |       | 11,186               |       | 10,802 |   |
| Prepaid expenses and deposits                                                                                       |       | 3,768                |       | 4,655 |   |
| Total current assets                                                                                                |       | 50,938               |       | 49,736 |   |
| Property, plant  and equipment, net                                                                                 |       | 14,894               |       | 20,597 |   |
| Investments                                                                                                         |       | 1,224                |       | 1,933 |   |
| Other assets                                                                                                        |       | 994                  |       | 1,349 |   |
| Total assets                                                                                                        |       | $                    | 68,050     |   | $ | 73,615 |   |
| **LIABILITIES AND STOCKHOLDERS’ DEFICIT**                                                                      |       |                 |       |   |   |
| Current liabilities:                                                                                                |       |                 |       |   |   |
| Accounts payable                                                                                                    |       | $                    | 7,589      |   | $ | 6,454 |   |
| Accrued liabilities                                                                                                 |       | 9,331                |       | 11,032 |   |
| Billings in excess of costs and estimated earnings  on uncompleted contracts                                        |       | 6,022                |       | 11,776 |   |
| Customer deposits                                                                                                   |       | 5,274                |       | 2,968 |   |
| Total current liabilities                                                                                           |       | 28,216               |       | 32,230 |   |
| Deferred rent  obligation                                                                                           |       | 3,678                |       | 4,482 |   |
| Convertible  subordinated notes                                                                                     |       | 18,015               |       | 18,015 |   |
| Pension and  retirement obligations                                                                                 |       | 24,596               |       | 19,836 |   |
| Total liabilities                                                                                                   |       | 74,505               |       | 74,563 |   |
| Stockholders’ deficit:                                                                                         |       |                 |       |   |   |
| Preferred stock, no par value: 10,000,000 shares  authorized; no shares issued and outstanding                      |       | —               |       | — |   |
| Common stock, $0.20 par value: 30,000,000 shares  authorized; 10,884,848 and 10,864,042 shares issued, respectively |       | 2,177                |       | 2,173 |   |
| Additional paid-in-capital                                                                                          |       | 49,814               |       | 49,707 |   |
| Common stock in treasury, at cost 352,500 shares                                                                    |       | (4,709               | )          | (4,709 | ) |
| Accumulated deficit                                                                                                 |       | (43,860              | )          | (42,726 | ) |
| Accumulated other comprehensive loss                                                                                |       | (9,877               | )          | (5,393 | ) |
| Total stockholders’ deficit                                                                                    |       | (6,455               | )          | (948 | ) |
| Total liabilities  and stockholders’ deficit                                                                   |       | $                    | 68,050     |   | $ | 73,615 |   |

 

See notes to consolidated financial statements.

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**CONSOLIDATED STATEMENTS OF OPERATIONS***(In thousands, except pershare data)*

| ** **                                                    | ** ** | **Year ended December 31** | ** ** |
|---------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                    | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                    | ** ** | ** **                                | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Sales                                                         |       | $                                         | 73,567     |   |   | $ | 67,859 |   |   | $ | 83,837 |   |
| Cost of sales                                                 |       | 46,288                                    |       |   | 43,215 |   |   | 52,152 |   |
| Inventory  impairment                                         |       | —                                    |       |   | — |   |   | 14,566 |   |
| Gross profit                                                  |       | 27,279                                    |       |   | 24,644 |   |   | 17,119 |   |
| Expenses:                                                     |       |                                      |       |   |   |   |   |   |   |
| Selling, general and administrative                           |       | 20,172                                    |       |   | 24,022 |   |   | 26,999 |   |
| Research and development                                      |       | 16,878                                    |       |   | 16,734 |   |   | 21,827 |   |
| Restructuring charges (recoveries)                            |       | 1,759                                     |       |   | (491 | ) |   | 3,416 |   |
| Gain on insurance settlement                                  |       | (8,000                                    | )          |   | — |   |   | — |   |
| Impairment loss                                               |       | —                                    |       |   | — |   |   | 1,151 |   |
| Operating expenses                                            |       | 30,809                                    |       |   | 40,265 |   |   | 53,393 |   |
| Gain on sale of  assets                                       |       | —                                    |       |   | 3,817 |   |   | — |   |
| Gain on sale of  assets held for sale                         |       | 2,745                                     |       |   | 4,298 |   |   | 1,926 |   |
| Operating loss                                                |       | (785                                      | )          |   | (7,506 | ) |   | (34,348 | ) |
| Other income (expense):                                       |       |                                      |       |   |   |   |   |   |   |
| Interest income                                               |       | 325                                       |       |   | 90 |   |   | 412 |   |
| Interest expense                                              |       | (1,227                                    | )          |   | (1,296 | ) |   | (1,376 | ) |
| Impairment of investment securities                           |       | —                                    |       |   | — |   |   | (500 | ) |
| Gain on sale of investment securities                         |       | 654                                       |       |   | 133 |   |   | — |   |
| Equity in income of investee                                  |       | 425                                       |       |   | 156 |   |   | 64 |   |
| Other                                                         |       | (956                                      | )          |   | (194 | ) |   | (560 | ) |
| Total other income (expense), net                             |       | (779                                      | )          |   | (1,111 | ) |   | (1,960 | ) |
| Loss before  income taxes                                     |       | (1,564                                    | )          |   | (8,617 | ) |   | (36,308 | ) |
| Income tax  expense (benefit)                                 |       | (430                                      | )          |   | 112 |   |   | (971 | ) |
| Net loss                                                      |       | $                                         | (1,134     | ) |   | $ | (8,729 | ) |   | $ | (35,337 | ) |
| Basic and diluted  net loss per common share                  |       | $                                         | (0.11      | ) |   | $ | (0.83 | ) |   | $ | (3.37 | ) |
| Basic and diluted  weighted average common shares outstanding |       | 10,523                                    |       |   | 10,498 |   |   | 10,471 |   |

 

See notes to consolidated financial statements.

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**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’EQUITY (DEFICIT) AND COMPREHENSIVE LOSS***(In thousands)*

| ** **                                                 | ** ** | ** **            | ** ** | ** **  | ** ** | ** **     | ** ** | ** **       | ** ** | **Retained**      | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|----------------|------------|------------------|------------|-------------------|------------|-----------------|------------|------------|------------|
| ** **                                                 | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional** | ** ** | ** **       | ** ** | **Earnings**      | ** ** | **Other**       | ** ** | ** ** | ** ** |
| ** **                                                 | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Treasury**   | ** ** | **(Accumulated** | ** ** | **Comprehensive** | ** ** | ** **      | ** ** |
| ** **                                                 | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **Stock**        | ** ** | **Deficit)**      | ** ** | **Loss**        | ** ** | **Total**  | ** ** |
| Balance at December 31, 2002, as previously  reported |       | 10,806                |       |        | $          | 2,161          |       |             |       | $                 | 49,413     |            |       |       | $          | (4,709 | ) |   |   | $ | 6,840 |   |   |   | $ | (342 | ) |   | $ | 53,363 |   |
| Restatement adjustment (Note 3)                       |       | —                |       |        | —     |           |       |             | —     |              |       |            | —     |       |       |   | (5,500 | ) |   |   | — |   |   | (5,500 | ) |
| Balance at December 31, 2002, as restated             |       | 10,806                |       |        | 2,161      |           |       |             | 49,413     |              |       |            | (4,709     | )          |       |   | 1,340 |   |   |   | (342 | ) |   | 47,863 |   |
| Components of  comprehensive loss:                         |       |                  |       |        |       |           |       |             |       |              |       |            |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Net loss, as restated                                      |       | —                |       |        | —     |           |       |             | —     |              |       |            | —     |       |       |   | (35,337 | ) |   |   | — |   |   | (35,337 | ) |
| Unrealized gains on marketable securities                  |       | —                |       |        | —     |           |       |             | —     |              |       |            | —     |       |       |   | — |   |   |   | 444 |   |   | 444 |   |
| Additional minimum pension liability                       |       | —                |       |        | —     |           |       |             | —     |              |       |            | —     |       |       |   | — |   |   |   | (2,421 | ) |   | (2,421 | ) |
| Total comprehensive loss, as restated                      |       |                  |       |        |       |           |       |             |       |              |       |            |       |       |       |   |   |   |   |   |   |   |   | (37,314 | ) |
| Issuance of common stock                                   |       | 30                    |       |        | 6          |           |       |             | 162        |              |       |            | —     |       |       |   | — |   |   |   | — |   |   | 168 |   |
| Balance at December 31, 2003, as restated             |       | 10,836                |       |        | 2,167      |           |       |             | 49,575     |              |       |            | (4,709     | )          |       |   | (33,997 | ) |   |   | (2,319 | ) |   | 10,717 |   |
| Components of  comprehensive loss:                         |       |                  |       |        |       |           |       |             |       |              |       |            |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Net loss, as restated                                      |       | —                |       |        | —     |           |       |             | —     |              |       |            | —     |       |       |   | (8,729 | ) |   |   | — |   |   | (8,729 | ) |
| Unrealized gains on marketable securities                  |       | —                |       |        | —     |           |       |             | —     |              |       |            | —     |       |       |   | — |   |   |   | 99 |   |   | 99 |   |
| Foreign currency translation                               |       | —                |       |        | —     |           |       |             | —     |              |       |            | —     |       |       |   | — |   |   |   | 244 |   |   | 244 |   |
| Additional minimum pension liability                       |       | —                |       |        | —     |           |       |             | —     |              |       |            | —     |       |       |   | — |   |   |   | (3,417 | ) |   | (3,417 | ) |
| Total comprehensive loss, as restated                      |       |                  |       |        |       |           |       |             |       |              |       |            |       |       |       |   |   |   |   |   |   |   |   | (11,803 | ) |
| Issuance of common stock                                   |       | 28                    |       |        | 6          |           |       |             | 132        |              |       |            | —     |       |       |   | — |   |   |   | — |   |   | 138 |   |
| Balance at December 31, 2004, as restated             |       | 10,864                |       |        | 2,173      |           |       |             | 49,707     |              |       |            | (4,709     | )          |       |   | (42,726 | ) |   |   | (5,393 | ) |   | (948 | ) |
| Components of  comprehensive loss:                         |       |                  |       |        |       |           |       |             |       |              |       |            |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                   |       | —                |       |        | —     |           |       |             | —     |              |       |            | —     |       |       |   | (1,134 | ) |   |   | — |   |   | (1,134 | ) |
| Unrealized gains on marketable securities                  |       | —                |       |        | —     |           |       |             | —     |              |       |            | —     |       |       |   | — |   |   |   | (568 | ) |   | (568 | ) |
| Foreign currency translation                               |       | —                |       |        | —     |           |       |             | —     |              |       |            | —     |       |       |   | — |   |   |   | (96 | ) |   | (96 | ) |
| Additional minimum pension liability                       |       | —                |       |        | —     |           |       |             | —     |              |       |            | —     |       |       |   | — |   |   |   | (3,820 | ) |   | (3,820 | ) |
| Total comprehensive loss                                   |       |                  |       |        |       |           |       |             |       |              |       |            |       |       |       |   |   |   |   |   |   |   |   | (5,618 | ) |
| Issuance of common stock                                   |       | 21                    |       |        | 4          |           |       |             | 107        |              |       |            | —     |       |       |   | — |   |   |   | — |   |   | 111 |   |
| Balance at  December 31, 2005                         |       | 10,885                |       |        | $          | 2,177          |       |             |       | $                 | 49,814     |            |       |       | $          | (4,709 | ) |   |   | $ | (43,860 | ) |   |   | $ | (9,877 | ) |   | $ | (6,455 | ) |

 

See notes to consolidated financial statements.

38

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**CONSOLIDATED STATEMENTS OF CASH FLOWS***(In thousands)*

| ** **                                                                                                | ** ** | **Year ended December 31** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                | ** ** | ** **                                | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Cash flows from operating activities:                                                                     |       |                                      |       |   |   |   |   |
| Net loss                                                                                                  |       | $                                         | (1,134     | ) | $ | (8,729 | ) | $ | (35,337 | ) |
| Adjustments to reconcile net loss to net cash used in  operating activities:                              |       |                                      |       |   |   |   |   |
| Depreciation and  amortization                                                                            |       | 3,955                                     |       | 5,169 |   | 6,848 |   |
| Gain on sale of assets                                                                                    |       | —                                    |       | (3,817 | ) | — |   |
| Gain on sale of assets  held for sale                                                                     |       | (2,745                                    | )          | (4,298 | ) | (1,926 | ) |
| Inventory impairment                                                                                      |       | —                                    |       | — |   | 14,566 |   |
| Impairment loss                                                                                           |       | —                                    |       | — |   | 1,151 |   |
| (Gain) loss on disposal  of property, plant and equipment                                                 |       | 200                                       |       | (7 | ) | 16 |   |
| Income from equity  investment in joint venture                                                           |       | (425                                      | )          | (156 | ) | (64 | ) |
| Gain on sale of  investment securities                                                                    |       | (654                                      | )          | (133 | ) | — |   |
| Impairment of investment                                                                                  |       | —                                    |       | — |   | 500 |   |
| Provision for (recovery  of) losses on accounts receivable                                                |       | (495                                      | )          | 326 |   | 68 |   |
| Provision for excess and  obsolete inventory                                                              |       | 1,617                                     |       | 2,231 |   | 1,499 |   |
| Provision for warranty                                                                                    |       | 984                                       |       | 1,188 |   | 2,274 |   |
| Provision for  restructuring expense (recovery)                                                           |       | 1,759                                     |       | (491 | ) | 3,416 |   |
| Other                                                                                                     |       | 65                                        |       | 246 |   | 171 |   |
| Change in operating assets and liabilities:                                                               |       |                                      |       |   |   |   |   |
| Decrease in accounts  receivable                                                                          |       | 4,827                                     |       | 6,870 |   | 333 |   |
| Decrease (increase) in  inventories                                                                       |       | (1,960                                    | )          | 1,849 |   | 141 |   |
| Decrease (increase) in  costs and estimated earnings in excess of billings on uncompleted contracts,  net |       | (9,646                                    | )          | 5,798 |   | 11,346 |   |
| Decrease (increase) in  prepaid expenses and deposits                                                     |       | 1,400                                     |       | 1,793 |   | (1,903 | ) |
| (Decrease) increase in  accounts payable                                                                  |       | 1,184                                     |       | (1,991 | ) | (1,225 | ) |
| Decrease in accrued  liabilities                                                                          |       | (4,219                                    | )          | (5,582 | ) | (5,311 | ) |
| Increase in deferred rent  obligation                                                                     |       | 199                                       |       | 211 |   | 245 |   |
| (Decrease) increase in  customer deposits                                                                 |       | 2,306                                     |       | (961 | ) | 2,421 |   |
| Net cash used in  operating activities                                                                    |       | (2,782                                    | )          | (484 | ) | (771 | ) |
| Cash flows from investing activities:                                                                     |       |                                      |       |   |   |   |   |
| Proceeds from sale of  assets                                                                             |       | —                                    |       | 5,250 |   | — |   |
| Proceeds from sale of  investment securities                                                              |       | 778                                       |       | 633 |   | — |   |
| Purchases of property,  plant and equipment                                                               |       | (2,434                                    | )          | (1,869 | ) | (3,767 | ) |
| Proceeds from sale of  property, plant and equipment                                                      |       | 84                                        |       | 105 |   | 4 |   |
| Dividends from equity  investment in joint venture                                                        |       | 368                                       |       | — |   | — |   |
| Proceeds from sale of  assets held for sale                                                               |       | 6,277                                     |       | 8,288 |   | 4,760 |   |
| Increase in other assets                                                                                  |       | (206                                      | )          | (871 | ) | — |   |
| Purchases of investment  securities                                                                       |       | (37                                       | )          | — |   | — |   |
| Net cash provided by  investing activities                                                                |       | 4,830                                     |       | 11,536 |   | 997 |   |
| Cash flows from financing activities:                                                                     |       |                                      |       |   |   |   |   |
| Net repayments on line of  credit agreements                                                              |       | —                                    |       | (7,685 | ) | (250 | ) |
| Decrease (increase) in  restricted cash                                                                   |       | 2,315                                     |       | (3,057 | ) | 2,195 |   |
| Proceeds from issuance of  common stock                                                                   |       | 96                                        |       | 123 |   | 168 |   |
| Net cash provided by  (used in) financing activities                                                      |       | 2,411                                     |       | (10,619 | ) | 2,113 |   |
| Net change in cash and  cash equivalents                                                                  |       | 4,459                                     |       | 433 |   | 2,339 |   |
| Cash and cash equivalents  at beginning of year                                                           |       | 10,147                                    |       | 9,714 |   | 7,375 |   |
| Cash and cash equivalents  at end of year                                                                 |       | $                                         | 14,606     |   | $ | 10,147 |   | $ | 9,714 |   |
| Supplemental Disclosure of Cash Flow Information                                                          |       |                                      |       |   |   |   |   |
| Cash paid (received) during the year for:                                                                 |       |                                      |       |   |   |   |   |
| Interest                                                                                                  |       | $                                         | 1,227      |   | $ | 1,295 |   | $ | 1,376 |   |
| Income taxes                                                                                              |       | 52                                        |       | 140 |   | (209 | ) |

 

See notes to consolidated financial statements.

39

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

*All dollar amounts are in thousands unless otherwiseindicated.*

**Note1:  Business and Background**

***Description ofBusiness***

Evans &Sutherland Computer Corporation, referred to in these notes as “Evans &Sutherland,” “E&S,” “we,” “us,” “our” or the “Company,” produces visualsystems used to rapidly and accurately display images of the real world. Wedesign, manufacture, market and support our visual systems for a wide range ofmilitary and commercial applications, as well as for planetariums, sciencecenters, and entertainment venues. Our products and solutions range from thedesktop PC to what we believe are the most advanced visual systems in theworld. The Company operates as one segment, which is the visual simulation market.

On February 7, 2006,we entered into an asset purchase agreement with Rockwell Collins, Inc.,pursuant to which we will sell substantially all of the assets and certainliabilities primarily related to our commercial and military simulationbusinesses and related service and support operations to Rockwell Collins. SeeNote 25 for further details.

**Note2:  Summary of Significant AccountingPolicies**

***Basis ofPresentation***

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

***Use of Estimates***

The preparation offinancial statements in conformity with U. S. generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe amounts reported in the consolidated financial statements and accompanyingnotes. The accounting estimates that require management’s most difficult andsubjective judgments include revenue recognition based on the percentage-ofcompletion method, inventory reserves, accruals for liquidated damages and latepenalties, allowance for doubtful accounts, income tax valuation allowance,restructuring charges, impairment of long-lived assets, pension and retirementobligations and useful life of depreciable assets. Actual results could differfrom 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, 2005 and 2004 was$396 and $408, respectively.

***Trade AccountsReceivable***

In the normal course ofbusiness, we provide unsecured credit terms to our customers. Accordingly, wemaintain an allowance for doubtful accounts for possible losses onuncollectible accounts receivable. Weroutinely analyze accounts receivable and costs and estimated earnings inexcess of billings, and consider history, customer creditworthiness, facts andcircumstances specific to outstanding balances, current economic trends, andpayment term changes when evaluating adequacy of the allowance for 

40

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

doubtful accounts. Changes in these factors couldresult in material differences to bad debt expense. Past due balances arereviewed individually for collectibility.

For uncollectible accountsreceivable we record a loss against the allowance for doubtful accounts onlyafter exhaustive efforts have been made to collect and with management’sapproval.

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

| ** **                                                  | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Beginning balance                                           |       | $        | 650        |     | $          | 351      |       | $ | 856 |   |
| Provision for  (reduction in) losses on accounts receivable |       | (495     | )          | 326      |       | 68       |       |
| Charges against  the reserve                                |       | (33      | )          | (27      | )          | (573     | )          |
| Ending balance                                              |       | $        | 122        |     | $          | 650      |       | $ | 351 |   |

 

In 2004, we fully reserved$479 in the allowance for doubtful receivables for all receivables related toone customer in China due to management’s assertion that there was a lowprobability of collection. However, in 2005, this customer paid $428 and werecorded a recovery of losses on accounts receivable.

***Inventories***

Inventory includes materialsat standard costs, which approximate average costs, as well as inventoriedcosts on programs and long-term contracts. Inventoried costs include material,direct engineering and production costs, and applicable overhead, not in excessof estimated realizable value. Inventoried costs include amounts relating toprograms and contracts with long production cycles, a portion of which is notexpected to be realized within one year. Spare parts and general stock materialsare stated at cost not in excess of realizable value. We periodically reviewinventories for excess supply, obsolescence, and valuations above estimatedrealizable amounts, and provide a reserve we consider sufficient to cover theseitems. Revisions of these estimates could result in the need for adjustments.

***Property, Plant andEquipment***

Property, plant andequipment are stated at cost. Depreciation is computed using the straight-linemethod based on the estimated useful lives of the related assets. Expendituresthat materially increase values or capacities or extend useful lives ofproperty and equipment are capitalized. Routine maintenance, repairs andrenewal costs are expensed as incurred. When property is retired or otherwisedisposed of, the book value of the property is removed from the fixed assetsand the related accumulated depreciation accounts. Depreciation is included incost of sales, research and development or selling, general and administrativeexpenses depending on the nature of the asset.

***SoftwareDevelopment Costs***

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

***Investments***

We classify our marketabledebt and equity securities as available-for-sale. Available-for-sale securitiesare recorded at fair value. Unrealized holding gains and losses, net of therelated tax effect, are excluded from earnings and are reported as a componentof accumulated other comprehensive income (loss) until realized. Dividend andinterest income are recognized when earned. Realized gains and losses 

41

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

from thesale of securities are included in results of operations and are determined onthe specific-identification basis. A decline in the market value that is deemedother than temporary results in a charge to other income (expense) and theestablishment of a new cost basis for the 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 considered other-than-temporary. Any suchdecline is recognized as a loss in the statement of operations. In 2003, wedetermined the value of a nonmarketable investment had experienced a decline invalue deemed to be other-than-temporary. As a result we recorded a loss on thewrite-down of this investment of $500 representing the total value of thisinvestment.

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

Thetable below reflects changes in our warranty reserves during fiscal year:

| ** **                            | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Beginning balance                     |       | $        | 1,471      |     | $          | 1,290    |       | $ | 968 |   |
| Provision for  warranty expense       |       | 984      |       | 1,188    |       | 2,274    |       |
| Warranty charges  against the reserve |       | (1,470   | )          | (1,007   | )          | (1,952   | )          |
| Ending balance                        |       | $        | 985        |     | $          | 1,471    |       | $ | 1,290 |   |

 

42

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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** | ** ** | ** ** | ** ** | **2005** | ** ** | **2004  (Restated)** | ** ** | **2003  (Restated)** | ** ** |
|------------------------------------------|------------|------------|------------|----------|------------|----------------------|------------|----------------------|------------|
| Percentage-of-completion                 |       | $          | 51,913     |     |       | $                    | 41,961     |                 |       |   | $ | 38,623 |   |   |
| Completed  contract                      |       | 15,192     |       |     | 23,957     |                 |       |                 | 39,386     |   |   |
| Time and  materials                      |       | 1,331      |       |     | 716        |                 |       |                 | 4,602      |   |   |
| Other                                    |       | 5,131      |       |     | 1,225      |                 |       |                 | 1,226      |   |   |
| Total sales                              |       | $          | 73,567     |     |       | $                    | 67,859     |                 |       |   | $ | 83,837 |   |   |

 

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

In those arrangementswhere software is a significant component of the contract, the Company appliesthe guidance of Statement of Position 97-2 “Software Revenue Recognition,”which allows for use of the percentage-of-completion method as described above.

*Completed Contract.**  *Contract arrangements which typically require arelatively short period of time to complete the production, modification, andcustomization of our products are accounted for using the completed contractmethod. Accordingly, revenue is recognized upon delivery of the completedproduct, provided persuasive evidence of an arrangement exists, title and riskof loss has transferred, the fee is fixed and determinable, and collection isreasonably assured.

*Time and Materials.**  *When services are sold to customers on a time andmaterials or cost-plus basis, revenues are recognized as the related servicesand material costs are incurred.

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

*Anticipated Losses.**  *For contracts with anticipated losses at completion,a provision is recorded when the loss becomes known. After an anticipated lossis recorded, subsequent revenue and cost of sales are recognized in equal,offsetting amounts as contract costs are incurred and do not generate furthergross profits (losses).

43

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

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

***Stock-BasedCompensation***

We have adopted thefootnote disclosure provisions of Statements of Financial Accounting Standards(“SFAS”) No. 123, “Accounting forStock Based Compensation” (“SFAS 123”) and SFAS No. 148, “Accountingfor Stock Based Compensation—Transition and Disclosure—an amendment of FASBStatement No. 123” (“SFAS 148”). SFAS 123 encourages entities to adopt afair value based method of accounting for stock options or similar equityinstruments. However, it also allows an entity to continue measuringcompensation cost for stock-based compensation using the intrinsic-value methodof accounting prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB25”). We have elected tocontinue to apply the provisions of APB 25 and provide pro forma footnotedisclosures required by SFAS 123 and SFAS 148.

Stock-based compensationgranted to non-employees (consultants and independent contractors) isdetermined as either the fair value of the consideration received or the fairvalue of the equity instruments issued, whichever is more reliably measurable. Themeasurement date for these issuances is the earlier of either the date at whicha commitment by the recipient to earn the equity instruments is reached or thedate at which the recipient’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:

| ** **                                                                                                      | ** ** | **2005** | ** ** | **2004  (Restated)** | ** ** | **2003  (Restated)** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------------------|------------|----------------------|------------|
| Net loss as  reported                                                                                           |       |     | $          | (1,134               | )          |                 |       | $ | (8,729 | ) |   | $ | (35,337 | ) |
| Deduct: Total  stock based employee compensation expense determined under the fair value  method for all awards |       |     | (550       | )                    |       |                 | (397       | ) |   | (442 | ) |
| Pro forma net  loss                                                                                             |       |     | $          | (1,684               | )          |                 |       | $ | (9,126 | ) |   | $ | (35,779 | ) |
| Basic and diluted  net loss per common share—as reported                                                   |       |     | $          | (0.11                | )          |                 |       | $ | (0.83 | ) |   | $ | (3.37 | ) |
| Basic and diluted net  loss per common share—pro forma                                                     |       |     | (0.16      | )                    |       |                 | (0.87      | ) |   | (3.42 | ) |

 

***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.

44

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

***Derivatives***

We may enter into readilymarketable forward contracts with financial institutions to minimize the impactof foreign currency fluctuations on certain sales contracts. 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 as of December 31, 2004. As there is no net settlement provision inthe contract, we recorded an amount due from a financial institution in prepaidexpenses and deposits and an accrued liability for the amount owed by us to thefinancial institution in the amounts of $368 and $402, respectively, as of December 31,2004. The contract expired in January 2005.

***Other ComprehensiveLoss***

We have applied theprovisions of SFAS 109, “Accounting for Income Taxes,” (“SFAS 109”) to ourgains and losses included in other comprehensive loss but excluded from our netloss. On a net basis for 2005, 2004 and 2003, there was a deferred income taxasset as a result of the items reflected in comprehensive loss. However, inapplying SFAS 109 we determined that it is more likely than not that we willnot realize such net deferred income tax assets and have therefore establisheda valuation allowance against the full amount of the net deferred income taxasset. Accordingly, the net income tax effect of the items included in othercomprehensive loss is zero. Therefore, we have included no income tax expenseor benefit in relation to items reflected in other comprehensive loss.

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

| ** **                                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------------------------------|------------|----------|------------|----------|------------|
| Additional  minimum pension liability                         |       | $        | (9,657     | )        | $          | (5,838 | ) |
| Net unrealized  holding gain on available-for-sale securities |       | —   |       | 568      |       |
| Net foreign  currency translation                             |       | (220     | )          | (123     | )          |
| Total accumulated  other comprehensive loss                   |       | $        | (9,877     | )        | $          | (5,393 | ) |

 

***Leases***

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

***Recent AccountingPronouncements***

In May 2005, the FASBissued SFAS No. 154, “Accounting Changes and Error Corrections, areplacement of Accounting Principles Board (“APB”) Opinion No. 20 and FASBStatement No. 3.” SFAS No. 154 requires retrospective application toprior periods’ financial statements of a voluntary change in accountingprinciple unless it is impracticable. APB Opinion No. 20, “AccountingChanges,” previously required that most voluntary changes in accounting principlebe recognized by including in net income of the period of the change thecumulative effect of changing to the new accounting principle. SFAS No. 154became effective for our Company on January 1, 2006. We believe that theadoption of SFAS No. 154 will not have a material impact on ourconsolidated financial statements.

45

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

In December 2004,FASB issued Statement of Financial Accounting Standards No. 123R,“Share-Based Payment” (“SFAS 123R”). SFAS 123R is a revision of SFAS 123 and itwas to be effective for us as of the beginning of the first interim or annualreporting period that began after June 15, 2005. However, the Securitiesand Exchange Commission has permitted companies subject to its oversight todelay implementing SFAS 123R until the beginning of their next fiscal year.Accordingly, we will implement the guidance of SFAS 123R at the beginning ofour next fiscal year that starts January 1, 2006. We do not expect theadoption of SFAS 123R to have a material impact on our financial position orcash flows; however it will have a material impact on our results of operationsas we are required to recognize stock-based compensation to our employees ascompensation expense under the fair value method over their service period.

**Note3:  Restatement of Financial Statements**

During the fiscal 2005 year-end closing process, we reviewedour accounting practices with respect to leasing transactions and determinedthat our then-current method of accounting for rent expense for leased realproperty was not in compliance with Financial Accounting Standards BoardTechnical Bulletin No. 85-3, *Accountingfor Operating Leases with Scheduled Rent Increases*(“FTB 85-3”).FTB 85-3 indicates that the lessee should recognize scheduled rentincreases on a straight-line basis over the lease term, which may includeoptional lease renewal terms, and deferred rent expense should be recognized toreflect the difference between the rent paid in the current period and thecalculated straight-line amount. By not accounting for the future annualincreases on a straight-line basis, we understated rent expense by $211 and$245 in 2004 and 2003, respectively, and understated the deferred rentobligation by $4,482, $5,081 and $5,500 in 2004, 2003 and 2002, respectively.In addition, we understated the gain on sale of assets held for sale related toreal property leases that were assumed by the purchasers of certain of ourbuilding facilities in the amount of $810 and $520 for 2004 and 2003,respectively.

The Company has elected to correct other previouslyidentified errors which were considered immaterial individually and in theaggregate by the Company at the time these errors were first identified. Theseother previously identified errors included correction of i) the useful livesof leasehold improvements which reduced property, plant and equipment, net by$198 and $133 in 2004 and 2003, respectively, and increased depreciationexpense by $65 and $66 during 2004 and 2003, respectively, ii) the recognitionof revenue which decreased both sales and billings in excess of costs andestimated earnings on uncompleted contracts by $72 in 2004, iii) foreignexchange gains and losses which reduced sales by $247 in 2004, increased salesby $265 in 2003, increased other income by $31 and $27 in 2004 and 2003,respectively, and decreased billings in excess of costs and estimated earningson uncompleted contracts by $215 in 2003, iv) the recognition of a contingentloss accrual increased general and administrative expense by $150 in 2004,decreased general and administrative expense by $150 in 2003 and increasedtrade receivables and accrued liabilities by $1,575 and $1,425, respectively,in 2003, and v) the timing of a gain on disposal of fixed assets that increasedother income by $42 in 2004 and increased property, plant and equipment, net by$42 in 2004.

In addition to the adjustments mentioned previously,the Company restated sales and cost of sales from one contract to research anddevelopment expense, because the contract was determined to be a research anddevelopment arrangement. The effect of this restatement was to decrease salesand cost of sales by $981 and $1,204 for the years ended December 31, 2004 and2003, respectively.

The cumulative effect of these restatement amounts onprior years resulted in a decrease in retained earnings of approximately $5,500as of December 31, 2002 and a decrease in net loss of approximately $138and $651 for the fiscal years ended December 31, 2004 and 2003,respectively.

46

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

The following is a summaryof the effects of these changes on the Company’s consolidated balance sheet asof December 31, 2004, as well as the effect of these changes on theCompany’s statements of operations and stockholders’ equity (deficit) and comprehensiveloss for fiscal years ended December 31, 2004 and 2003. Certainreclassifications have been made in the 2004 and 2003 consolidated financialstatements and notes to conform to the 2005 presentations. Net cash provided by(used in) operating, investing and financing activities was unaffected by theserestatement adjustments for all periods presented.

**Selected BalanceSheet Data**

| ** **                                                                   | ** ** | **As Previously** | ** ** | ** **   | ** ** | ** **      | ** ** |
|------------------------------------------------------------------------------|------------|------------------------|------------|--------------|------------|-----------------|------------|
| **December 31, 2004**                                              | ** ** | ** **             | ** ** | **Reported** | ** ** | **Adjustments** | ** ** | **As Restated** | ** ** |
| Property, plant  and equipment, net                                          |       |                   | $          | 20,753       |       |            |       | $ | (156 | ) |   |   | $ | 20,597 |   |   |
| Total assets                                                                 |       |                   | 73,771     |         |       |            | (156       | ) |   |   | 73,615 |   |   |
| Billings in  excess of costs and estimated earnings on uncompleted contracts |       |                   | 11,703     |         |       |            | 73         |   |   |   | 11,776 |   |   |
| Deferred rent  obligation                                                    |       |                   | —     |         |       |            | 4,482      |   |   |   | 4,482 |   |   |
| Total liabilities                                                            |       |                   | 70,008     |         |       |            | 4,555      |   |   |   | 74,563 |   |   |
| Accumulated  deficit                                                         |       |                   | (38,015    | )            |       |            | (4,711     | ) |   |   | (42,726 | ) |   |
| Total stockholders’  equity (deficit)                                   |       |                   | 3,763      |         |       |            | (4,711     | ) |   |   | (948 | ) |   |
|                                                                              |            |                        |            |              |            |                 |            |  |  |  |  |  |  |  |  |  |  |  |

 

**SelectedStatements of Operations Data**

| ** **                                    | ** ** | **As Previously** | ** ** | ** **   | ** ** | ** **      | ** ** |
|-----------------------------------------------|------------|------------------------|------------|--------------|------------|-----------------|------------|
| **Fiscal Year 2004**                | ** ** | ** **             | ** ** | **Reported** | ** ** | **Adjustments** | ** ** | **As Restated** | ** ** |
| Sales                                         |       |                   | $          | 69,159       |       |            |       | $ | (1,300 | ) |   |   | $ | 67,859 |   |   |
| Cost of sales                                 |       |                   | 44,119     |         |       |            | (904       | ) |   |   | 43,215 |   |   |
| Selling, general  and administrative expenses |       |                   | 23,786     |         |       |            | 236        |   |   |   | 24,022 |   |   |
| Research and  development expenses            |       |                   | 16,621     |         |       |            | 113        |   |   |   | 16,734 |   |   |
| Gain on sale of  assets held for sale         |       |                   | 3,488      |         |       |            | 810        |   |   |   | 4,298 |   |   |
| Operating loss                                |       |                   | (7,571     | )            |       |            | 65         |   |   |   | (7,506 | ) |   |
| Total other  income (expense)                 |       |                   | (1,184     | )            |       |            | 73         |   |   |   | (1,111 | ) |   |
| Net loss                                      |       |                   | (8,867     | )            |       |            | 138        |   |   |   | (8,729 | ) |   |
| Basic and diluted net  loss per common share  |       |                   | $          | (0.84        | )          |            |       | $ | 0.01 |   |   |   | $ | (0.83 | ) |   |
|                                               |            |                        |            |              |            |                 |            |  |  |  |  |  |  |  |  |  |  |  |

 

| ** **                                    | ** ** | **As Previously** | ** ** | ** **   | ** ** | ** **      | ** ** |
|-----------------------------------------------|------------|------------------------|------------|--------------|------------|-----------------|------------|
| **Fiscal Year 2003**                | ** ** | ** **             | ** ** | **Reported** | ** ** | **Adjustments** | ** ** | **As Restated** | ** ** |
| Sales                                         |       |                   | $          | 84,776       |       |            |       | $ | (939 | ) |   |   | $ | 83,837 |   |   |
| Cost of sales                                 |       |                   | 53,252     |         |       |            | (1,100     | ) |   |   | 52,152 |   |   |
| Selling, general  and administrative expenses |       |                   | 27,039     |         |       |            | (40        | ) |   |   | 26,999 |   |   |
| Research and  development expenses            |       |                   | 21,730     |         |       |            | 97         |   |   |   | 21,827 |   |   |
| Gain on sale of  assets held for sale         |       |                   | 1,406      |         |       |            | 520        |   |   |   | 1,926 |   |   |
| Operating loss                                |       |                   | (34,972    | )            |       |            | 624        |   |   |   | (34,348 | ) |   |
| Total other  income (expense)                 |       |                   | (1,987     | )            |       |            | 27         |   |   |   | (1,960 | ) |   |
| Net loss                                      |       |                   | (35,988    | )            |       |            | 651        |   |   |   | (35,337 | ) |   |
| Basic and diluted net  loss per common share  |       |                   | $          | (3.44        | )          |            |       | $ | 0.07 |   |   |   | $ | (3.37 | ) |   |
|                                               |            |                        |            |              |            |                 |            |  |  |  |  |  |  |  |  |  |  |  |

 

47

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

**SelectedStatement of Stockholders’ Equity (Deficit) and Comprehensive Loss Data**

| ** **                       | ** ** | **As Previously** | ** ** | ** **   | ** ** | ** **      | ** ** |
|----------------------------------|------------|------------------------|------------|--------------|------------|-----------------|------------|
| **December 31, 2002**  | ** ** | ** **             | ** ** | **Reported** | ** ** | **Adjustments** | ** ** | **As Restated** | ** ** |
| Retained earnings                |       |                   | $          | 6,840        |       |            |       | $ | (5,500 | ) |   |   | $ | 1,340 |   |   |
| Total  stockholders’ equity |       |                   | 53,363     |         |       |            | (5,500     | ) |   |   | 47,863 |   |   |
|                                  |            |                        |            |              |            |                 |            |  |  |  |  |  |  |  |  |  |  |  |

 

**Note 4: Inventories**

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

| ** **              | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------|------------|----------|------------|----------|------------|
| Raw materials           |       | $        | 2,539      |     | $          | 5,078 |   |
| Work-in-process         |       | 4,122    |       | 1,300    |       |
| Finished goods          |       | 4,525    |       | 4,424    |       |
| Total  inventories, net |       | $        | 11,186     |     | $          | 10,802 |   |

 

**Note 5: Property, Plant and Equipment**

Thecost and estimated useful lives of property, plant and equipment and the totalaccumulated depreciation and amortization at fiscal year-end:

| ** **                                      | ** ** | **Estimated**         | ** ** | **2005**   | ** ** | **2004**       | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|------------|------------|----------------|------------|
| ** **                                      | ** ** | **useful lives** | ** ** | ** ** | ** ** | **(Restated)** | ** ** |
| Buildings and  improvements                     |       | 40  years             |       | $          | 20,098     |           | $          | 29,300 |   |
| Manufacturing  machinery and equipment          |       | 3 to  8 years         |       | 48,899     |       | 53,142         |       |
| Office furniture  and equipment                 |       | 8  years              |       | 3,099      |       | 4,902          |       |
| Construction-in-process                         |       | —                |       | 139        |       | 35             |       |
|                                            |       |                  |       | 72,235     |       | 87,379         |       |
| Less accumulated  depreciation and amortization |       |                  |       | (57,341    | )          | (66,782        | )          |
| Total property,  plant and equipment, net       |       |                  |       | $          | 14,894     |           | $          | 20,597 |   |

 

**Note 6: Impairments**

***Fiscal 2003***

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, specificallycommercial off-the-shelf PCs or our next-generation Harmony, the Harmony 2. Thus,the loss of these 

48

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

orders coupled with theoverall shift in market demand resulted in our determination that we had excessHarmony 1 inventory on hand. We have extremely limited prospects to sell thisexcess Harmony 1 inventory, and these components cannot be used in themanufacture of our other products. Accordingly, we determined that $10,000 ofinventory related to these systems was impaired. In addition, because we didnot expect to sell any additional Harmony 1 based visual systems, we determinedwe had no further need for certain fixed assets specifically used to build,test, and demonstrate our Harmony 1 based visual systems and recorded animpairment of $1,151 related to these fixed assets, as we believe thisequipment had no alternative 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 the 2003 impairment related toour TargetView 100 inventory. In 2003, we became convinced that the TargetView100 technology had been superseded by newer technology. Accordingly, ourbusiness opportunities for TargetView 100 systems had been nearly eliminatedand we determined that we had excess inventory on hand. Therefore, wedetermined that $1,266 of inventory related to these systems was impaired.

During the fourth quarterof 2004, our entire TargetView inventory, including impaired inventory, was soldalong with our ESCP assets to Video Display Corporation (see Note 24).

**Note7:  Costs and Estimated Earnings onUncompleted Contracts**

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

| ** **                                                               | ** ** | **2005** | ** ** | **2004  (Restated)** | ** ** |
|--------------------------------------------------------------------------|------------|----------|------------|----------------------|------------|
| Total accumulated  costs and estimated earnings on uncompleted contracts |       | $        | 189,850    |                 | $          | 186,249 |   |
| Less total  billings on completed contracts                              |       | (186,363 | )          | (192,409             | )          |
|                                                                     |       | $        | 3,487      |                 | $          | (6,160 | ) |

 

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

| ** **                                                                   | ** ** | **2005** | ** ** | **2004  (Restated)** | ** ** |
|------------------------------------------------------------------------------|------------|----------|------------|----------------------|------------|
| Costs and  estimated earnings in excess of billings on uncompleted contracts |       |     | $          | 9,509                |       |   | $ | 5,616 |   |
| Billings in  excess of costs and estimated earnings on uncompleted contracts |       |     | (6,022     | )                    |       | (11,776 | ) |
|                                                                         |       |     | $          | 3,487                |       |   | $ | (6,160 | ) |

 

49

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

**Note 8:  Leases**

We occupy real propertyand use certain equipment under lease arrangements that are accounted for asoperating leases. Our real property leases contain escalation clauses. Rentalexpenses for all operating leases for 2005, 2004, and 2003 were $1,690, $2,013 (restated)and $4,174 (restated), respectively.

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

| **Fiscal year** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------|------------|------------|------------|------------|------------|
| 2006                 |       | $          | 1,889      |       |
| 2007                 |       | 1,499      |       |
| 2008                 |       | 734        |       |
| 2009                 |       | 697        |       |
| 2010                 |       | 697        |       |
| Thereafter           |       | 11,210     |       |
| Total                |       | $          | 16,726     |       |

 

Sub-lease rental incomefor all operating leases for 2005, 2004 and 2003 was $117, $357 (restated) and$827 (restated), respectively. At December 31, 2005, we had no futurelease rental income from operating leases that have initial or remainingnoncancelable lease terms.

**Note 9:  Investments**

***MarketableSecurities Available-for-Sale***

Marketablesecurities, consisting of equity securities, are recorded at fair value asfollows:

| ** **              | ** ** | **Gross**    | ** ** | **Estimated**  | ** ** | ** ** | ** ** |
|-------------------------|------------|--------------|------------|----------------|------------|------------|------------|
| ** **              | ** ** | **Adjusted** | ** ** | **Unrealized** | ** ** | **Fair**   | ** ** |
| ** **              | ** ** | **Cost**     | ** ** | **Gains**      | ** ** | **Value**  | ** ** |
| December 31,  2004 |       |         | $          | 88             |       |       |       | $ | 568 |   |   | $ | 656 |   |
|                         |            |              |            |                |            |            |            |  |  |  |  |  |  |  |

 

Unrealized gains in 2004were due to market-price movement and foreign exchange movement related to onemarketable security that was traded on a foreign exchange and was priced inEuros. Marketable securities were sold during 2005 for $778 and a gain of $654was realized on the sales.

***NonmarketableSecurity***

Nonmarketablesecurities at fiscal year end consisted of:

| ** **                     | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|
| Quest Flight  Training Limited |       | $        | 1,224      |     | $          | 1,277 |   |
|                                |            |          |            |          |            |  |  |

 

We have a 50% interest inQuest Flight Training Limited (“Quest”), a joint venture with Quadrant Groupplc (“Quadrant”), providing aircrew training services for the United KingdomMinistry of Defence (“U.K. MOD”) under a 30-year contract. The investmentis accounted for under the equity method. In 2005 and 2004, we recorded $96 and$244, respectively, of foreign currency translation in accumulated othercomprehensive income on the investment in Quest. Also one member of our boardof directors is on the board of directors of Quest and Quadrant. In 2000 weentered a 30 year maintenance contract with 

50

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

Quest. Forthe years ended December 31, 2005, 2004 and 2003, we recognized sales of$104, $141 and $107, respectively, and cost of sales of $75, $20 and $(3),respectively.

Followingis summarized financial information of Quest and for our equity basisinvestment in Quest as of and for the year ended December 31, 2005:

| ** **                                  | ** ** | **2005**   | ** ** |
|---------------------------------------------|------------|------------|------------|
| ***Quest  summary financial information:*** | ** ** | ** ** | ** ** |
| Sales                                       |       | $          | 3,434      |   |
| Net income                                  |       | 821        |       |
| Current assets                              |       | 2,297      |       |
| Total assets                                |       | 11,761     |       |
| Current  liabilities                        |       | 1,694      |       |
| Total liabilities                           |       | 9,281      |       |
| ***E&S  interest:***                    |       |       |       |
| Share of net income                         |       | $          | 410        |   |
| Equity in net  assets                       |       | 1,224      |       |

 

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, 2005, 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 $1,721), 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 31,2005, the outstanding loan balance was £8,077 (approximately $8,413). Quadranthas made identical guarantees for this obligation of Quest. Pursuant to thefourth guarantee, we have guaranteed payment, up to a maximum of £125(approximately $215), 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 31,2005, 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. Subsequentto December 31, 2005, the Company entered into an asset purchase agreementwith Rockwell Collins, Inc. (see Note 25). Upon completion of the assetsale contemplated by the asset purchase agreement, Rockwell Collins willacquire our entire interest in Quest and will assume our obligations under theguarantees related to Quest.

51

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

**Note 10: Accrued Liabilities**

Accruedliabilities at fiscal year-end were as follows:

| ** **                                | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|
| Compensation and  benefits                |       | $        | 4,242      |     | $          | 4,275 |   |
| Building rental  guarantees (see Note 23) |       | 1,644    |       | 1,755    |       |
| Other                                     |       | 3,445    |       | 5,002    |       |
| Total accrued liabilities                 |       | $        | 9,331      |     | $          | 11,032 |   |

 

**Note11:  Employee Retirement Benefit Plans**

***Pension Plan***

The Pension Plan is a funded noncontributory definedbenefit pension plan. Our funding policy is to contribute amounts sufficient tosatisfy regulatory funding standards, based upon independent actuarialvaluations. Benefits at normal retirement age (65) are based upon theemployee’s years of service, as of the date of the curtailment for employeesnot yet retired, and the employee’s compensation prior to the curtailment.

***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 based on our profitability and other financial andoperational considerations. Our contributions to the 401(k) plan for 2005,2004 and 2003 were $591, $625 and $647, respectively.

***Executive Savings Plan***

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

We purchase company-ownedlife insurance policies insuring the lives of participants in the ESP. Thepolicies accumulate asset values and exist to cover the cost of employeesupplemental retirement benefit liabilities. At December 31, 2005 and2004, prepaid expenses and deposits included our investments in the policies of$2,181 and $2,260, respectively. Net insurance expense from these policies was$96, $160 and $340 for the years ended December 31, 2005, 2004 and 2003,respectively.

52

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

***Obligations and Funded Status***

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

As of December 31,2005 and 2004, the projected benefit obligations related to our defined benefitplans were equal to the accumulated benefit obligations. Information concerningthe obligations, plan assets and funded status of employee retirement definedbenefit plans are provided below:

| ** **                                         | ** ** | **Pension Plan** | ** ** | **SERP**   | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|------------|------------|
| ** **                                         | ** ** | **2005**              | ** ** | **2004**   | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Changes in benefit obligation**                  | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Projected benefit  obligation at beginning of year |       | $                     | 41,327     |       | $          | 38,820 |   | $ | 8,303 |   | $ | 7,665 |   |
| Service cost                                       |       | —                |       | —     |       | 146 |   | 519 |   |
| Interest cost                                      |       | 2,401                 |       | 2,498      |       | 486 |   | 508 |   |
| Actuarial loss                                     |       | 2,711                 |       | 2,050      |       | 465 |   | 30 |   |
| Benefits paid                                      |       | (236                  | )          | (2,041     | )          | (481 | ) | (419 | ) |
| Settlement  payments                               |       | (2,913                | )          | —     |       | — |   | — |   |
| Projected benefit  obligation at end of year       |       | $                     | 43,290     |       | $          | 41,327 |   | $ | 8,919 |   | $ | 8,303 |   |
| **Changes  in plan assets**                        | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fair value of  plan assets at beginning of year    |       | $                     | 29,916     |       | $          | 31,028 |   | $ | — |   | $ | — |   |
| Actual return on  plan assets                      |       | 846                   |       | 929        |       | — |   | — |   |
| Contributions                                      |       | —                |       | —     |       | 481 |   | 419 |   |
| Benefits paid                                      |       | (3,149                | )          | (2,041     | )          | (481 | ) | (419 | ) |
| Fair value of  plan assets at end of year          |       | $                     | 27,613     |       | $          | 29,916 |   | $ | — |   | $ | — |   |
| **Net  Amount Recognized**                         |       |                  |       |       |       |   |   |   |   |
| Unfunded status                                    |       | $                     | (15,677    | )          | $          | (11,411 | ) | $ | (8,919 | ) | $ | (8,303 | ) |
| Unrecognized net  actuarial loss                   |       | 9,255                 |       | 5,838      |       | 1,158 |   | 693 |   |
| Unrecognized  prior service cost                   |       | —                |       | —     |       | (756 | ) | (815 | ) |
| Net amount recognized                              |       | $                     | (6,422     | )          | $          | (5,573 | ) | $ | (8,517 | ) | $ | (8,425 | ) |

 

Amounts recognized in the consolidated balance sheetsconsist of:

| ** **                              | ** ** | **Pension Plan** | ** ** | **SERP** | ** ** |
|-----------------------------------------|------------|-----------------------|------------|----------|------------|
| ** **                              | ** ** | **2005**              | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Accrued liability                       |       | $                     | (15,677    | )        | $          | (11,411 | ) | $ | (8,919 | ) | $ | (8,425 | ) |
| Accumulated other  comprehensive income |       | 9,255                 |       | 5,838    |       | 402 |   | — |   |
| Net amount recognized                   |       | $                     | (6,422     | )        | $          | (5,573 | ) | $ | (8,517 | ) | $ | (8,425 | ) |

 

**Componentsof net periodic benefit cost**

| ** **                               | ** ** | **Pension Plan** | ** ** | **SERP** | ** ** |
|------------------------------------------|------------|-----------------------|------------|----------|------------|
| ** **                               | ** ** | **2005**              | ** ** | **2004** | ** ** | **2003** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Service cost                             |       | $                     | —     |     | $          | — |   | $ | — |   | $ | 146 |   | $ | 519 |   | $ | 451 |   |
| Interest cost                            |       | 2,401                 |       | 2,498    |       | 2,533 |   | 485 |   | 508 |   | 480 |   |
| Expected return on  assets               |       | (2,288                | )          | (2,362   | )          | (2,813 | ) | — |   | — |   | — |   |
| Amortization of  actuarial loss          |       | 112                   |       | 67       |       | — |   | — |   | — |   | — |   |
| Amortization of prior  year service cost |       | —                |       | —   |       | — |   | (59 | ) | (59 | ) | (59 | ) |
| Settlement charge                        |       | 623                   |       | —   |       | — |   | — |   | — |   | — |   |
| Net periodic benefit cost (benefit)      |       | $                     | 848        |     | $          | 203 |   | $ | (280 | ) | $ | 572 |   | $ | 968 |   | $ | 872 |   |

 

53

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

**Additional information**

The increases to our unrecognized net actuarial lossrecorded in other comprehensive income for the Pension Plan of $3,417 and$3,417 during 2005 and 2004, respectively, arose from the difference betweenthe accumulated benefit obligation and the accrued pension expense at the endof each year.

The increases to ourminimum liability recorded in other comprehensive income for the SERP of $402and $0 during 2005 and 2004, respectively, arose from the difference betweenthe accumulated benefit obligation and the accrued pension expense at the endof each year.

**Assumptions**

The weighted average assumptions used to determinebenefit obligations at December 31, 2005 and 2004, included discount ratesof 5.75% and 6.00%, respectively, for the Pension Plan and SERP. The weightedaverage assumptions used to determine net periodic cost for years ended December 31,2005 and 2004, included a discount rate of 6.00% and 6.25%, respectively, forthe Pension and SERP, and an expected long-term rate of return on Pension Planassets of 8.00%.

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

***Pension Plan Assets***

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

| ** **                                                            | ** ** | ** ** | ** ** | **2005**          | ** ** | **2004**          | ** ** | **Expected**      | ** ** |
|-----------------------------------------------------------------------|------------|------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|
| **Asset allocation category of plan assets** | ** ** | ** ** | ** ** | **Target %** | ** ** | **Actual %** | ** ** | **Actual %** | ** ** | **Return %** | ** ** |
| Cash and cash  equivalents                                            |       |       | 0          |              |       |              | 57         |              |       |   | 77 |   |   |   | — |   |   |
| Fixed income                                                          |       |       | 45         |              |       |              | —     |              |       |   | — |   |   |   | 2.5 |   |   |
| Domestic equity                                                       |       |       |       |              |       |              |       |              |       |   |   |   |   |   |   |   |   |
| Small cap growth                                                      |       |       | 8          |              |       |              | 6          |              |       |   | 3 |   |   |   | 0.9 |   |   |
| Small cap value                                                       |       |       | 7          |              |       |              | 6          |              |       |   | 3 |   |   |   | 0.8 |   |   |
| Large cap growth                                                      |       |       | 15         |              |       |              | 11         |              |       |   | 6 |   |   |   | 1.4 |   |   |
| Large cap value                                                       |       |       | 15         |              |       |              | 12         |              |       |   | 7 |   |   |   | 1.4 |   |   |
| International  Equities                                               |       |       | 10         |              |       |              | 8          |              |       |   | 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. Assets will be invested in a manner that will providefor long-term growth with a goal to achieve returns equal to or greater thanapplicable benchmarks. Investments will be managed by registered investmentadvisors. When investing Pension Plan assets, the investment managers ofseparately managed accounts shall not utilize derivative instruments forspeculative purposes or to create leveraged positions.

No equity securities ofE&S were part of the Pension Plan assets as of December 31, 2005 or2004.

54

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

***Cash Flow***

**Employer contributions**

Our funding policy is to contribute amounts sufficientto satisfy regulatory funding standards, based upon independent actuarialvaluations. In addition, we are notrequired to fund the SERP. All benefit payments are made by us directly tothose who receive benefits from the SERP. As such, these payments are treatedas both contributions and benefits paid for reporting purposes.

E&S expects tocontribute approximately $562 to the SERP and $520 to the Pension Plan in 2006.Subsequent to December 31, 2005, the Company has entered into an asset purchaseagreement with Rockwell Collins, Inc. (see Note 25). The successfulcompletion of this transaction will require E&S to contribute to the SERPan amount equal to 90% of the accumulated benefit obligation. In addition, weintend to use a portion of the proceeds to satisfy a portion of our fundingobligations under our Pension Plan and ESP.

**Estimated future benefit payments**

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

| ** **            | ** ** | **Pension** | ** ** | ** ** | ** ** |
|-----------------------|------------|-------------|------------|------------|------------|
| **Fiscal years** | ** ** | ** **  | ** ** | **Plan**   | ** ** | **SERP** | ** ** |
| 2006                  |       | $           | 3,105      |       | $          | 562 |   |
| 2007                  |       | 2,278       |       | 563        |       |
| 2008                  |       | 3,444       |       | 577        |       |
| 2009                  |       | 3,684       |       | 592        |       |
| 2010                  |       | 3,005       |       | 529        |       |
| 2011-2015             |       | 23,045      |       | 2,769      |       |
|                       |            |             |            |            |            |  |  |  |  |

 

**Note 12:  Debt**

***6% Convertible Subordinated Debentures***

As of December 31,2005 and 2004, $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. Subsequent to December 31, 2005, theCompany has entered into an Asset Purchase Agreement with Rockwell Collins, Inc.(see Note 25). The indenture pursuant to which the 6% Debentures were issuedprohibit the conveyance or transfer of our assets substantially as an entiretyto any person unless such person expressly assumes all of the obligations andliabilities of the 6% Debentures. Accordingly, under the terms of the RockwellPurchase Agreement, we agreed to satisfy and discharge our obligations underthe 6% Debenture and the indenture upon the closing of the transaction withRockwell Collins.

**Note 13:  IncomeTaxes**

Income (loss) before income taxes consists principallyof results of operations in the United States. The income tax benefit of $430for 2005 is primarily attributable to favorable resolution of income taxcontingencies. The income tax expense of $112 for 2004 is primarilyattributable to foreign income taxes. 

55

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

The income tax benefit of$971 for 2003 is primarily attributable to favorable resolution of certainincome tax contingencies.

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:

| ** **                                                | ** ** | **2005** | ** ** | **2004  (Restated)** | ** ** | **2003  (Restated)** | ** ** |
|-----------------------------------------------------------|------------|----------|------------|----------------------|------------|----------------------|------------|
| Tax benefit at  U.S. federal statutory rate               |       | $        | (547       | )                    |       | $                    | (3,016     | ) |   | $ | (12,708 | ) |
| Adjustment to  prior year tax provisions                  |       | (430     | )          |                 | —     |                 |       | (1,002 | ) |
| Change in  valuation allowance attributable to operations |       | 489      |       |                 | 2,987      |                 |       | 12,579 |   |
| Other, net                                                |       | 58       |       |                 | 141        |                 |       | 160 |   |
| Tax expense (benefit)                                     |       | $        | (430       | )                    |       | $                    | 112        |   |   | $ | (971 | ) |

 

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

| ** **                                                                  | ** ** | **2005**   | ** ** | **2004  (Restated)** | ** ** |
|-----------------------------------------------------------------------------|------------|------------|------------|----------------------|------------|
| **Deferred income tax assets:**                                             | ** ** | ** ** | ** ** | ** **           | ** ** |
| Warranty,  vacation, and other accruals                                     |       | $          | 2,853      |                 | $          | 3,552 |   |
| Inventory  reserves and other inventory related temporary basis differences |       | 5,717      |       | 5,785                |       |
| Deferred rent  obligation                                                   |       | 1,434      |       | 1,748                |       |
| Pension accrual                                                             |       | 5,948      |       | 5,459                |       |
| Long-term  contract related temporary differences                           |       | 122        |       | 209                  |       |
| Net operating  loss carryforwards                                           |       | 55,938     |       | 55,105               |       |
| Write-down of  investment securities                                        |       | 397        |       | 1,711                |       |
| Credit  carryforwards                                                       |       | 6,015      |       | 5,719                |       |
| Plant and  equipment, principally due to differences in depreciation        |       | 1,597      |       | —               |       |
| Other                                                                       |       | 220        |       | 273                  |       |
| Total deferred income tax assets                                            |       | 80,241     |       | 79,561               |       |
| Less valuation allowance                                                    |       | (80,220    | )          | (79,443              | )          |
| Net deferred income tax assets                                              |       | 21         |       | 118                  |       |
| **Deferred  income tax liabilities:**                                       | ** ** | ** ** | ** ** | ** **           | ** ** |
| Plant and  equipment, principally due to differences in depreciation        |       | —     |       | (95                  | )          |
| Other                                                                       |       | (21        | )          | (23                  | )          |
| Total deferred income tax liabilities                                       |       | 21         |       | (118                 | )          |
| Net deferred income tax  assets and liabilities                             |       | $          | —     |                 | $          | — |   |

 

We have total federal net operating loss carryforwardsof approximately $145,700 of which, $1,000 expires in 2007, $1,000 expires in2008 and the remainder expires between 2011 and 2025. We have various federaltax credit carryforwards of approximately $3,400 of which expire between 2007and 2021. We also have state net operating loss carryforwards of approximately $123,400and state tax credit carryforwards of approximately $2,600 that expiredepending on the rules of the various states to which the loss or creditis allocated.

56

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

During the years ended December 31,2005, 2004 and 2003, we increased the valuation allowance on deferred incometax assets by approximately $777, $6,434, and $16,213, respectively, as it ismore likely than not that the net deferred income tax assets will not berealized.

**Note14:  Disclosures About the Fair Value ofFinancial 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 wasimpractical. The fair value of our 6% Debentures of $11,530 and $12,250 as of December 31,2005 and 2004, respectively, is based on quoted market prices.

**Note15:  Commitments and Contingencies**

In December 2005, we entered into a research anddevelopment agreement with a third party to pay $60 a month for 24 months in returnfor design and development services to be provided by the third party. Inaddition, we agreed to pay $2 million in exchange for future exclusive rightsto the application of the results of the research and development efforts to beprovided by the third party. We had $1,750 remaining to pay as of December 31,2005, and expect to pay $1,000 and $750 in 2006 and 2007, respectively. We alsoagreed to pay $400 in cash or freely tradable common stock upon the earlier of2 years or a public announcement of a product utilizing the results of theresearch and development efforts. Because the agreement relates to technologythat is under development and has not reached technological feasibility, allpayments made under the agreement are expensed as research and development asincurred, except for the $400 payment due in cash or freely tradable commonstock, which will be recorded as a research and development cost ratably over aperiod of two years, or until an announcement of a product utilizing the resultsof the research and development efforts is made. As of December 31, 2005,E&S had paid $310 under the agreement and had recognized $310 of researchand development expenses.

As of December 31, 2005, we had various purchaseobligations for goods and services. We expect to pay approximately $3,644 in2006 and $397 in 2007 related to these purchase obligations.

In 2005, we entered into a 21 month rental guaranteewith the buyer of one of our office buildings, obligating us to make certainmonthly payments through September 2007. As of December 31, 2005, wehad $1,197 accrued representing the maximum remaining amount under theguarantee. See Note 23 for further information.

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 2007. As of December 31, 2005 we had$447 accrued representing the maximum remaining amount under the guarantee. SeeNote 23 for further information.

As of December 31,2005, we had outstanding letters of credit and bank guarantees of $1,495. Lettersof credit that expire in 2006 total $988 and those that expire in 2007-2010total $396.

As of December 31,2005, we had guarantees related to Quest. See Note 9 for further details.

57

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

**Note 16:  Legal Proceedings**

In December 2005, we settleda lawsuit previously filed by E&S against an insurance company with respectto an insurance claim made by E&S for losses incurred due to thecancellation of a significant contract by a customer. Under the terms of thesettlement, E&S received a payment of $8,000 and agreed to dismiss thelawsuit and to provide a release of claims against the insurance company. Theinsurance settlement proceeds of $8,000 were recorded as gain on insurancesettlement as a separate component of operating income for the year endedDecember 31, 2005.

In March 2004,through mediation, we settled a claim initiated against us in May 2003 byRealVision, Inc. relative to matters arising from the sale of a businessunit to RealVision, Inc. in 2001. Under the agreement reached, RealVisionreceived a settlement of approximately $2,425. We paid approximately $850 ofthe settlement and our insurance carrier paid the remainder.

In the normal course ofbusiness, we may have various legal claims and other contingent matters.Although the final outcome of such matters cannot be predicted, we believe theultimate disposition of these matters will not have a material adverse effecton our consolidated financial condition, liquidity or results of operations.

**Note 17:  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 value 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, 2005, options to purchase 621,490 shares ofcommon stock were authorized and reserved for future grant. Upon our executionof the Rockwell Purchase Agreement (see Note 25), all options granted under the2004 Plan and outstanding on February 7, 2006 were subject to acceleratedvesting and became fully vested by their terms (unaudited).

58

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

Asummary of activity follows (shares in thousands):

| ** **                                                            | ** ** | **2005**           | ** ** | **2004**      | ** ** | **2003**           | ** ** |
|-----------------------------------------------------------------------|------------|--------------------|------------|---------------|------------|--------------------|------------|
| ** **                                                            | ** ** | ** **         | ** ** | **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                                     |       |               | 2,183      |          |       |               | $          | 10.68 |   |   |   | 2,344 |   |   |   | $ | 11.33 |   |   |   | 2,410 |   |   |   | $ | 11.58 |   |   |
| Granted                                                               |       |               | 257        |          |       |               | 7.30       |   |   |   | 288 |   |   |   | 4.79 |   |   |   | 243 |   |   |   | 5.85 |   |   |
| Exercised                                                             |       |               | (3         | )             |       |               | 3.52       |   |   |   | (2 | ) |   |   | 4.56 |   |   |   | — |   |   |   | — |   |   |
| Cancelled                                                             |       |               | (211       | )             |       |               | 9.81       |   |   |   | (447 | ) |   |   | 10.24 |   |   |   | (309 | ) |   |   | 8.83 |   |   |
| Outstanding at  end of year                                           |       |               | 2,226      |          |       |               | 10.38      |   |   |   | 2,183 |   |   |   | 10.68 |   |   |   | 2,344 |   |   |   | 11.33 |   |   |
| Exercisable at  year end                                              |       |               | 1,775      |          |       |               | 11.43      |   |   |   | 1,758 |   |   |   | 12.00 |   |   |   | 1,951 |   |   |   | 12.41 |   |   |
| Weighted average fair  value of options granted during the year  |       |               | $          | 2.79          |       |               |       |   |   |   |   | $ | 1.99 |   |   |   |   |   |   |   | $ | 2.48 |   |   |   |   |   |   |
|                                                                       |            |                    |            |               |            |                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Thefollowing table summarizes information about fixed stock options outstanding asof December 31, 2005 (options in thousands):

| ** **                                                | ** ** | **Options outstanding** | ** ** | **Options exercisable** | ** ** |
|-----------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                                | ** ** | ** **                   | ** ** | **Weighted-**                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                | ** ** | ** **                   | ** ** | **average**                  | ** ** | **Weighted-** | ** ** | ** ** | ** ** | **Weighted-** | ** ** |
| ** **                                                | ** ** | ** **                   | ** ** | **remaining**                | ** ** | **average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| **Range of**                                         | ** ** | **Number**                   | ** ** | **contractual**              | ** ** | **exercise** | ** ** | **Number** | ** ** | **Exercise** | ** ** |
| **exercise prices**                                  | ** ** | **outstanding**              | ** ** | **life (years)**        | ** ** | **price** | ** ** | **exercisable** | ** ** | **Price** | ** ** |
| $ 3.15 - $ 5.94                       |       |                         | 388        |                         |       |   | 8.07 |   |   |   | $ | 4.95 |   |   |   | 161 |   |   |   | $ | 4.81 |   |   |
|    6.00 -    7.38 |       |                         | 410        |                         |       |   | 6.27 |   |   |   | 6.46 |   |   |   | 326 |   |   |   | 6.37 |   |   |
|    7.50 -  11.44            |       |                         | 406        |                         |       |   | 6.09 |   |   |   | 9.30 |   |   |   | 266 |   |   |   | 10.05 |   |   |
|  11.50 -  13.38                       |       |                         | 121        |                         |       |   | 3.18 |   |   |   | 12.89 |   |   |   | 121 |   |   |   | 12.89 |   |   |
|  13.56 -  13.56                       |       |                         | 614        |                         |       |   | 2.64 |   |   |   | 13.56 |   |   |   | 614 |   |   |   | 13.56 |   |   |
|  13.57 -  32.88                       |       |                         | 287        |                         |       |   | 1.97 |   |   |   | 17.01 |   |   |   | 287 |   |   |   | 17.01 |   |   |
| Total                                                     |       |                         | 2,226      |                         |       |   | 4.83 |   |   |   | 10.38 |   |   |   | 1,775 |   |   |   | 11.43 |   |   |

 

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 2005, 2004 and 2003:

| ** **                | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|----------|------------|
| Expected life (in  years) |       |     | 2.6        |     |       |     | 2.6        |   |   |   | 2.6 |   |   |
| Risk free  interest rate  |       |     | 3.8        | %        |       |     | 1.8        | % |   |   | 1.5 | % |   |
| Expected  volatility      |       |     | 71         | %        |       |     | 69         | % |   |   | 69 | % |   |
| 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, 17,702shares in 2005, 26,132 shares in 2004 and 30,031 shares in 2003 were purchased.As of December 31, 2005, there were 221,917 shares available for purchaseunder this plan.

59

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

**Note 18:  PreferredStock**

***Class APreferred Stock***

We have 5,000,000authorized shares of Class A Preferred Stock. As of December 31, 2005 and2004, there were no Class A Preferred shares of stock outstanding. Prior to1998, we had reserved 300,000 shares of Class A Preferred Stock as Series AJunior Preferred Stock under a shareholder rights plan which expired in November 1998.In November 1998, the Board of Directors declared a dividend of onepreferred stock purchase right (“Right”) for each outstanding share of commonstock, par value $0.20 per share of E&S for shareholders of record on November 19,1998, and for all future issuances of common stock. The Rights are notcurrently exercisable or transferable apart from the common stock and do nothave voting rights or rights to receive dividends. Each Right entitles theregistered holder to purchase from E&S one thousandth of a share ofPreferred Stock at a price per share of $60.00, subject to adjustment. TheRights will be exercisable ten business days following a public announcement ofa person or group of affiliated persons acquiring beneficial ownership of 15%or more of our outstanding common shares or following the announcement of atender offer or exchange offer upon the consummation of which would result inthe beneficial ownership by a person or group of affiliated persons of 15% ormore of the outstanding E&S stock. The Rights may be redeemed by E&S ata price of $0.01 per Right before November 30, 2008.

In the event that we areacquired in a merger or other business combination transaction, provision shallbe made so that each holder of a Right, excluding the Rights beneficially ownedby the acquiring persons, will have the right to receive, upon exercise thereofat the then current exercise price, that number of common shares of thesurviving company which at the time of such transaction will have a marketvalue of two times the exercise price of the Right. In the event that a personor group of affiliated persons acquires beneficial ownership of 15% or more ofour outstanding common shares, provision shall be made so that each holder of aRight, excluding the Rights beneficially owned by the acquiring persons, shallhave the right to receive, upon exercise thereof, a share of common stock at apurchase price equal to 50% of the then current exercise price.

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

***Class BPreferred Stock***

We have 5,000,000authorized shares of Class B Preferred Stock. As of December 31, 2005and 2004, no shares were outstanding.

**Note19:  Net Loss per Common Share**

Net loss per common shareis computed based on the weighted-average number of common shares and, asappropriate, dilutive common stock equivalents outstanding during the period. Stockoptions and the 6% Debentures are considered to be common stock equivalents.

Basic net loss per commonshare is the amount of net loss for the period attributable to each share ofcommon stock outstanding during the reporting period. Diluted net loss pershare is the amount of net loss for the period attributable to each share ofcommon stock outstanding during the reporting period and the 

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

amountof net loss for the period attributable to each share that would have beenoutstanding assuming the issuance of common shares for all dilutive potentialcommon shares outstanding during the period.

In calculating net lossper common share, the net loss was the same for both the basic and dilutedcalculation because the diluted weighted average number of common sharesoutstanding during 2005, 2004 and 2003 excluded common stock issuable pursuantto outstanding stock options and the 6% Debentures because such inclusions ofcommon stock equivalents would have had an anti-dilutive effect on loss percommon share. The total number of common stock equivalents excluded fromdiluted loss per share was approximately 2,654,000, 2,611,000 and 2,772,000 in2005, 2004 and 2003, respectively.

**Note 20: 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**    | ** ** | ** ** | ** ** | **2005** | ** ** | **2004  (Restated)** | ** ** | **2003  (Restated)** | ** ** |
|------------------------------------|------------|------------|------------|----------|------------|----------------------|------------|----------------------|------------|
| United States                      |       | $          | 35,411     |     |       | $                    | 27,656     |                 |       |   | $ | 38,509 |   |   |
| United Kingdom                     |       | 14,988     |       |     | 13,642     |                 |       |                 | 11,924     |   |   |
| Europe (excluding United  Kingdom) |       | 8,102      |       |     | 16,663     |                 |       |                 | 15,681     |   |   |
| Pacific Rim                        |       | 12,598     |       |     | 8,654      |                 |       |                 | 14,788     |   |   |
| Other                              |       | 2,468      |       |     | 1,244      |                 |       |                 | 2,935      |   |   |
| Total sales                        |       | $          | 73,567     |     |       | $                    | 67,859     |                 |       |   | $ | 83,837 |   |   |

 

Thetable below presents net property, plant and equipment by geographic locationbased on the location of the assets at fiscal year-end:

| ** **                               | ** ** | **2005** | ** ** | **2004  (Restated)** | ** ** |
|------------------------------------------|------------|----------|------------|----------------------|------------|
| United States                            |       | $        | 14,626     |                 |       | $ | 20,474 |   |   |
| Europe                                   |       | 268      |       |                 | 123        |   |   |
| Total property, plant and equipment, net |       | $        | 14,894     |                 |       | $ | 20,597 |   |   |

 

**Note 21: 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** | ** ** | ** ** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| Customer A   |       |       | n/a        |     |       |     | 12         | %        |       |   | n/a |   |   |
| Customer B   |       |       | 21         | %        |       |     | 11         | %        |       |   | 18 | % |   |

 

At December 31, 2005, accounts receivable fromCustomer A was 11% of gross receivables. In addition, at December 31,2005, accounts receivable from one other customer was 20% of gross receivables.Also at December 31, 2005, three customers had costs and estimatedearnings in excess of billings that represented 15%, 13% and 10% of the total.

At December 31, 2004,accounts receivable from Customer A and Customer B were 17% and 10%,respectively, of gross receivables and costs and estimated earnings in excessof billings from Customer A was 22% of the total. In addition, at December 31,2004, accounts receivable from one other customer was 19% of gross receivables.Also at December 31, 2004, two customers had costs and estimated earningsin excess of billings of 15% and 11% of the total.

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

**Note 22:  RestructuringCharges**

Thetable below represents the restructuring provision activity during our fiscalyear:

| ** **           | ** ** | ** **    | ** ** | **Restructuring** | ** ** | **Severance**  | ** ** | ** ** | ** ** |
|----------------------|------------|---------------|------------|-------------------|------------|----------------|------------|------------|------------|
| ** **           | ** ** | **Beginning** | ** ** | **charges**       | ** ** | **benefits**   | ** ** | **Ending** | ** ** |
| **Fiscal Year** | ** ** | ** **    | ** ** | **balance**       | ** ** | **(recovery)** | ** ** | **paid**   | ** ** | **Balance** | ** ** |
| 2005                 |       |          | $          | 61                |       |           |       | $          | 1,759      |   |   |   | $ | (1,746 | ) |   | $ | 74 |   |
| 2004                 |       |          | 1,618      |              |       |           | (491       | )          |       |   | (1,066 | ) |   | 61 |   |
| 2003                 |       |          | 2,032      |              |       |           | 3,416      |       |       |   | (3,830 | ) |   | 1,618 |   |
| 2002                 |       |          | 990        |              |       |           | 4,492      |       |       |   | (3,450 | ) |   | 2,032 |   |
|                      |            |               |            |                   |            |                |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

The restructuring charges incurred in fiscal years2001 through 2005 were initiated in order to reduce the overall cost structureof the 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. The main component of our coststructure is our labor costs. As such, in order to reduce labor costs thisrequired a reduction in headcount. Each restructuring was a separate event, andwas not intended to be a continuing long-term process.

In 2001, we recorded a restructuring charge of $2,843relating to a reduction in force of approximately 92 employees. We paid $11,$0, $42 and $901 in fiscal years 2005, 2004, 2003 and 2002, respectively. Wehave paid severance benefits of $2,807 related to this restructure plan. In2004, we recovered $18 of our original accrual due to a re-evaluation of ourestimated obligation. At December 31, 2005, we have $19 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 of 2003, we recorded arestructuring charge of $1,279 related to a reduction in force of approximately50 employees. We paid $10, $30 and $1,078 in fiscal years 2005, 2004 and 2003,respectively. In 2004, we recovered $139 of our original accrual due to are-evaluation of our estimated obligation. Our estimated remaining obligationas of the 2005 fiscal year-end is $32. We expect this to be paid out over thenext three years. In the third quarter of 2003, we recorded a restructuringcharge of $2,137. This charge primarily related to a reduction in force ofapproximately 70 full-time equivalent employees. We paid $971 and $1,096 infiscal years 2004 and 2003, respectively. In 2004, we recovered $70 of ouroriginal accrual due to a re-evaluation of our estimated obligation. We have nofurther obligations related to this restructure.

During the first quarterof 2005, we recorded a restructuring charge of $1,891: which included $1,601 oftermination benefits, $134 of operating lease termination costs, $105 ofrelocation costs and $51 of outplacement costs. During the second quarter of2005, we recorded an additional restructuring charge of $35, which representsadditional operating lease termination costs incurred as part of the firstquarter 

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

restructuring.As of December 31, 2005, we had recovered $167 of our original accrual dueto reevaluating our estimated obligation. For the year ended December 31,2005, we paid $1,736. We have $23 in further obligations related to thisrestructure.

**Note 23:  Assets Held for Sale**

In December 2005, E&S sold a buildingpreviously classified as an asset held for sale with a net book value of$3,820, for proceeds of $6,277, net of closing costs. As part of the sale, weentered into a 21 month lease agreement with the buyer obligating us to make certain monthly payments throughSeptember 2007 depending on the remaining space available for lease in thebuilding sold. Evans & Sutherland is required to pay a monthlypro rata share of operating expenses not to exceed $319 over the twenty-onemonth lease term. As ofDecember 31, 2005, we had a maximum remaining guarantee related to theseobligations of $1,197 recorded as an accrued liability. The maximum rentalguarantee may decrease as available space is leased by the buyer, based onterms of the rental guarantee. To the extent the maximum rental guarantee isreduced, additional gain will be realized. As a result of the sale, we haveinitially recognized a gain of $2,745, which included the release of $1,002 ofdeferred rent obligation.

In June 2004, we sold a building previouslyclassified as an asset held for sale with a book value of $2,473 for $8,288 netof closing costs. As part of the sale, we entered into a three-year rentalguarantee 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, 2005 and 2004, we had a maximum remaining guarantee of$447 and $1,755, respectively, recorded as an accrued liability. The maximumrental guarantee may decrease as available space is leased, based on terms ofthe rental guarantee. To the extent the maximum rental guarantee is reduced,additional gain will be realized. As a result of the sale, we recognized a gainof $4,298. As of December 31, 2005, we have recognized additional gain of$579 due to reduction of available leaseable space in the building sold.

In 2003, we sold abuilding we had classified as an asset held for sale for $4,760 net of closingcosts, resulting in a $1,926 gain.

**Note 24:  Saleof 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. No additional gain has been recognized as of December 31,2005.

**Note 25: Subsequent Events**

On February 7, 2006, we entered into an assetpurchase agreement (the “Rockwell Purchase Agreement”) with RockwellCollins, Inc. (“Rockwell Collins”), pursuant to which we will sellsubstantially all of the assets and certain liabilities primarily related toour commercial and military simulation businesses and related service andsupport operations (the “Simulation Business”) to Rockwell Collins. As part ofthe transaction, pursuant to a laser projection systems agreement (the“Rockwell Laser Agreement”) E&S will provide, and grant exclusive andnon-exclusive licenses to use and sell, fixed-based 

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

and motion-based laserprojection systems in connection with the Simulation Business and certainrelated businesses of Rockwell Collins.

We will receive aggregate consideration of $71,500 incash in connection with the transaction with Rockwell Collins, consisting of$66,500, subject to a potential post-closing adjustment, under the RockwellPurchase Agreement and $5,000 under the Rockwell Laser Agreement, subject to achievingcertain milestones. At the closing, $7,000 of the $66,500 purchase price underthe Rockwell Purchase Agreement and $3,000 of the $5,000 under the RockwellLaser Agreement, or a total of $10,000, will be deposited into escrow. Theclosing of the transaction contemplated by the Rockwell Purchase Agreement issubject to~~~~approval by E&S shareholders and other customary closingconditions, including regulatory approvals. The transaction is currentlyexpected to close in the second quarter of 2006.

We intend to use the proceeds from the proposedtransaction to retire the entire outstanding aggregate principal amount of our6% Convertible Subordinated Debentures due 2012, to satisfy a portion of our obligationsunder the pension and retirement plans, and for working capital.

Theunaudited pro forma information below reflects the disposal of the SimulationBusiness as if it had occurred on December 31, 2005 and the results ofoperations for the years ended December 31, 2005 and 2004 as if theproposed sale of our Simulation Business occurred at the beginning of each yearpresented, after giving effect to certain adjustments (to reflect the estimateduse of proceeds and related impact on interest and other expenses.) The proforma results have been prepared for comparative purposes only and do notpurport to be indicative of what would have occurred had the acquisition beenmade at December 31, 2005, the beginning of each year presented or of theresults which may occur in the future. 

| ** **                           | ** ** | **As of December 31, 2005** | ** ** |
|--------------------------------------|------------|-------------------------------------------------|------------|
| **Balance Sheet**               | ** ** | ** **                                      | ** ** | **Actual** | ** ** | **Pro forma** | ** ** |
| ** **                           | ** ** | ** **                                      | ** ** | **(unaudited)** | ** ** |
| Current Assets                       |       | $                                               | 50,938     |   |   | $ | 43,837 |   |   |
| Total Assets                         |       | 68,050                                          |       |   | 51,104 |   |   |
| Current  Liabilities                 |       | 28,216                                          |       |   | 14,835 |   |   |
| Total Liabilities                    |       | 74,505                                          |       |   | 21,112 |   |   |
| Stockholders’ Equity  (Deficit) |       | (6,455                                          | )          |   | 30,244 |   |   |
|                                      |            |                                                 |            |  |  |  |  |  |  |  |  |

 

| ** **                                  | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                  | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| **Statements of Operations**      | ** ** | ** **                                 | ** ** | **Actual** | ** ** | **Pro forma** | ** ** | **Actual** | ** ** | **Pro forma** | ** ** |
| ** **                                  | ** ** | ** **                                 | ** ** | **(unaudited)** | ** ** | ** ** | ** ** | **(unaudited)** | ** ** |
| Sales                                       |       | $                                          | 73,567     |   |   | $ | 15,111 |   |   | $ | 67,859 |   |   | $ | 9,479 |   |   |
| Gross profit                                |       | 27,279                                     |       |   | 6,810 |   |   | 24,644 |   |   | 3,380 |   |   |
| Operating  expenses                         |       | 30,809                                     |       |   | 2,481 |   |   | 40,265 |   |   | 9,882 |   |   |
| Operating income  (loss)                    |       | (785                                       | )          |   | 7,074 |   |   | (7,506 | ) |   | (6,347 | ) |   |
| Other income  (expense), net                |       | (779                                       | )          |   | 1,544 |   |   | (1,111 | ) |   | 1,413 |   |   |
| Net income (loss)                           |       | (1,134                                     | )          |   | 8,613 |   |   | (8,729 | ) |   | (5,010 | ) |   |
| Basic net income (loss) per  common share   |       | $                                          | (0.11      | ) |   | $ | 0.82 |   |   | $ | (0.83 | ) |   | $ | (0.48 | ) |   |
| Diluted net income (loss)  per common share |       | (0.11                                      | )          |   | 0.81 |   |   | (0.83 | ) |   | (0.48 | ) |   |
|                                             |            |                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

On February 7,2006, E&S entered into a stock purchase agreement (the “SpitzAgreement”) with Transnational Industries, Inc. (“Transnational”) andSpitz, Inc. (“Spitz”). Under the Spitz agreement, E&S will acquire allthe issued and outstanding shares of common stock of Spitz, whichspecializes in 

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

planetariumtheaters, projection domes, architectural domes and custom immersive theaterattractions. As consideration for Spitz we will issue and deliver 412,500shares of E&S common stock subject to post-closing shareadjustment depending on the average trading price of our commonstock for the 60-day period prior to registration of the sharesissued at closing. The closing of the Spitz transaction is subject to approvalby the shareholders of Transnational and is currently expected to close in thesecond quarter of 2006.

**Note26:  Quarterly Financial Data (Unaudited)**

Selectedunaudited quarterly financial data (in thousands, except per share data) forfiscal 2005 and 2004, restated as discussed in Note 3, is as follows:

| **Selected 2005 Unaudited Quarterly Data   Statements of Operations** | ** ** | ** ** | ** ** | **As Previously Reported** | ** ** | **Adjustments** | ** ** | **As Restated** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------|------------|---------------------------------|------------|-----------------|------------|----------------------|------------|
| ***For the Three Months Ended  September 30, 2005***                                           | * *   | * *   | * *   | * *                        | * *   | * *        | * *   | * *             | * *   | * * | * * | * * | * * |
| Sales                                                                                               |       |       | $          | 21,148                          |       |            |       | $                    | —     |   |   |   | $ | 21,148 |   |   |
| Cost of sales                                                                                       |       |       | 13,691     |                            |       |            | (45        | )                    |       |   | 13,646 |   |   |
| Selling, general and  administrative expenses                                                       |       |       | 4,836      |                            |       |            | (49        | )                    |       |   | 4,787 |   |   |
| Research and development  expenses                                                                  |       |       | 3,563      |                            |       |            | (72        | )                    |       |   | 3,491 |   |   |
| Operating loss                                                                                      |       |       | (942       | )                               |       |            | 166        |                 |       |   | (776 | ) |   |
| Net loss before income  taxes                                                                       |       |       | (1,392     | )                               |       |            | 166        |                 |       |   | (1,226 | ) |   |
| Net loss applicable to  common stock                                                                |       |       | (1,404     | )                               |       |            | 166        |                 |       |   | (1,238 | ) |   |
| Basic and diluted net  loss per common share                                                        |       |       | $          | (0.13                           | )          |            |       | $                    | 0.01       |   |   |   | $ | (0.12 | ) |   |
| ***For the Three Months Ended  July 1, 2005***                                                 | * *   | * *   | * *   | * *                        | * *   | * *        | * *   | * *             | * *   | * * | * * | * * | * * |
| Sales                                                                                               |       |       | $          | 20,426                          |       |            |       | $                    | (149       | ) |   |   | $ | 20,277 |   |   |
| Cost of sales                                                                                       |       |       | 12,521     |                            |       |            | (128       | )                    |       |   | 12,393 |   |   |
| Selling, general and administrative  expenses                                                       |       |       | 5,130      |                            |       |            | 24         |                 |       |   | 5,154 |   |   |
| Research and development  expenses                                                                  |       |       | 3,988      |                            |       |            | 34         |                 |       |   | 4,022 |   |   |
| Operating loss                                                                                      |       |       | (1,248     | )                               |       |            | (79        | )                    |       |   | (1,327 | ) |   |
| Net loss before income  taxes                                                                       |       |       | (1,389     | )                               |       |            | (79        | )                    |       |   | (1,468 | ) |   |
| Net loss applicable to  common stock                                                                |       |       | (1,415     | )                               |       |            | (79        | )                    |       |   | (1,494 | ) |   |
| Basic and diluted net  loss per common share                                                        |       |       | $          | (0.13                           | )          |            |       | $                    | (0.01      | ) |   |   | $ | (0.14 | ) |   |
| ***For the Three Months Ended  April 1, 2005***                                                | * *   | * *   | * *   | * *                        | * *   | * *        | * *   | * *             | * *   | * * | * * | * * | * * |
| Sales                                                                                               |       |       | $          | 13,859                          |       |            |       | $                    | (579       | ) |   |   | $ | 13,280 |   |   |
| Cost of sales                                                                                       |       |       | 9,287      |                            |       |            | (635       | )                    |       |   | 8,652 |   |   |
| Selling, general and  administrative expenses                                                       |       |       | 4,535      |                            |       |            | 17         |                 |       |   | 4,552 |   |   |
| Research and development  expenses                                                                  |       |       | 4,284      |                            |       |            | 25         |                 |       |   | 4,309 |   |   |
| Operating loss                                                                                      |       |       | (6,138     | )                               |       |            | 14         |                 |       |   | (6,124 | ) |   |
| Net loss before income  taxes                                                                       |       |       | (6,403     | )                               |       |            | 14         |                 |       |   | (6,389 | ) |   |
| Net loss applicable to  common stock                                                                |       |       | (5,992     | )                               |       |            | 14         |                 |       |   | (5,978 | ) |   |
| Basic and diluted net loss per common share                                                         |       |       | $          | (0.57                           | )          |            |       | $                    | 0.00       |   |   |   | $ | (0.57 | ) |   |

 

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

 

| **Selected 2004 Unaudited Quarterly Data  Statements of Operations ** | ** ** | ** ** | *** *** | **As Previously  Reported** | ** ** | **Adjustments** | *** *** | **As Restated** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|------------|--------------|----------------------------------|------------|-----------------|--------------|----------------------|------------|
| ***For  the Three Months Ended December 31, 2004***                                                 | * *   |       | * *     |                             |       | * *        | * *     | * *             | * *   |   | * * |   |   |
| Sales                                                                                                    |       |       | $            | 18,671                           |       |            |         | $                    | (1,320     | ) |   |   | $ | 17,351 |   |   |
| Cost of sales                                                                                            |       |       | 11,575       |                             |       |            | (783         | )                    |       |   | 10,792 |   |   |
| Selling, general and  administrative expenses                                                            |       |       | 6,150        |                             |       |            | 20           |                 |       |   | 6,170 |   |   |
| Research and development  expenses                                                                       |       |       | 3,338        |                             |       |            | 25           |                 |       |   | 3,363 |   |   |
| Operating income (loss)                                                                                  |       |       | 1,270        |                             |       |            | (582         | )                    |       |   | 688 |   |   |
| Total other income  (expense)                                                                            |       |       | 73           |                             |       |            | (196         | )                    |       |   | (123 | ) |   |
| Net income (loss) before  income taxes                                                                   |       |       | 1,343        |                             |       |            | (778         | )                    |       |   | 565 |   |   |
| Net income (loss)  applicable to common stock                                                            |       |       | 1,365        |                             |       |            | (778         | )                    |       |   | 587 |   |   |
| Basic and diluted net  income (loss) per common share                                                    |       |       | $            | 0.13                             |       |            |         | $                    | (0.07      | ) |   |   | $ | 0.06 |   |   |
| ***For  the Three Months Ended October 1, 2004***                                                   | * *   |       | * *     |                             |       | * *        | * *     | * *             | * *   |   | * * |   |   |
| Sales                                                                                                    |       |       | $            | 15,882                           |       |            |         | $                    | (50        | ) |   |   | $ | 15,832 |   |   |
| Cost of sales                                                                                            |       |       | 10,681       |                             |       |            | 16           |                 |       |   | 10,697 |   |   |
| Selling, general and  administrative expenses                                                            |       |       | 5,498        |                             |       |            | 19           |                 |       |   | 5,517 |   |   |
| Research and development  expenses                                                                       |       |       | 4,126        |                             |       |            | 25           |                 |       |   | 4,151 |   |   |
| Operating loss                                                                                           |       |       | (4,423       | )                                |       |            | (110         | )                    |       |   | (4,533 | ) |   |
| Total other income  (expense)                                                                            |       |       | (433         | )                                |       |            | 112          |                 |       |   | (321 | ) |   |
| Net loss before income  taxes                                                                            |       |       | (4,856       | )                                |       |            | 2            |                 |       |   | (4,854 | ) |   |
| Net loss applicable to  common stock                                                                     |       |       | (4,894       | )                                |       |            | 2            |                 |       |   | (4,892 | ) |   |
| Basic and diluted net  loss per common share                                                             |       |       | $            | (0.47                            | )          |            |         | $                    | 0.00       |   |   |   | $ | (0.47 | ) |   |
| ***For  the Three Months Ended July 2, 2004***                                                      | * *   |       | * *     |                             |       | * *        | * *     | * *             | * *   |   | * * |   |   |
| Sales                                                                                                    |       |       | $            | 16,816                           |       |            |         | $                    | 53         |   |   |   | $ | 16,869 |   |   |
| Cost of sales                                                                                            |       |       | 10,955       |                             |       |            | 20           |                 |       |   | 10,975 |   |   |
| Selling, general and  administrative expenses                                                            |       |       | 6,052        |                             |       |            | 24           |                 |       |   | 6,076 |   |   |
| Research and development  expenses                                                                       |       |       | 5,203        |                             |       |            | 30           |                 |       |   | 5,233 |   |   |
| Gain on sale of assets  held for sale                                                                    |       |       | 3,488        |                             |       |            | 811          |                 |       |   | 4,299 |   |   |
| Operating income (loss)                                                                                  |       |       | (1,906       | )                                |       |            | 790          |                 |       |   | (1,116 | ) |   |
| Total other income  (expense)                                                                            |       |       | (334         | )                                |       |            | 148          |                 |       |   | (186 | ) |   |
| Net loss before income  taxes                                                                            |       |       | (2,240       | )                                |       |            | 938          |                 |       |   | (1,302 | ) |   |
| Net loss applicable to  common stock                                                                     |       |       | (2,298       | )                                |       |            | 938          |                 |       |   | (1,360 | ) |   |
| Basic and diluted net  loss per common share                                                             |       |       | $            | (0.22                            | )          |            |         | $                    | 0.09       |   |   |   | $ | (0.13 | ) |   |
| ***For  the Three Months Ended April 2, 2004***                                                     | * *   |       | * *     |                             |       | * *        | * *     | * *             | * *   |   | * * |   |   |
| Sales                                                                                                    |       |       | $            | 17,790                           |       |            |         | $                    | 17         |   |   |   | $ | 17,807 |   |   |
| Cost of sales                                                                                            |       |       | 10,908       |                             |       |            | (157         | )                    |       |   | 10,751 |   |   |
| Selling, general and  administrative expenses                                                            |       |       | 6,086        |                             |       |            | 176          |                 |       |   | 6,262 |   |   |
| Research and development  expenses                                                                       |       |       | 3,954        |                             |       |            | 34           |                 |       |   | 3,988 |   |   |
| Operating loss                                                                                           |       |       | (2,512       | )                                |       |            | (36          | )                    |       |   | (2,548 | ) |   |
| Total other income  (expense)                                                                            |       |       | (490         | )                                |       |            | 8            |                 |       |   | (482 | ) |   |
| Net loss before income  taxes                                                                            |       |       | (3,002       | )                                |       |            | (28          | )                    |       |   | (3,030 | ) |   |
| Net loss applicable to  common stock                                                                     |       |       | (3,040       | )                                |       |            | (28          | )                    |       |   | (3,068 | ) |   |
| Basic and diluted net loss per common share                                                              |       |       | $            | (0.29                            | )          |            |         | $                    | (0.00      | ) |   |   | $ | (0.29 | ) |   |

 

 

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

The Board of Directors and StockholdersEvans & Sutherland Computer Corporation:

We have audited the accompanying consolidated balancesheets of Evans & Sutherland Computer Corporation and subsidiaries asof December 31, 2005 and 2004, and the related consolidated statements ofoperations, stockholders’ equity (deficit) and comprehensive loss, and cashflows for each of the years in the three-year period ended December 31,2005. In connection with our audits of the consolidated financial statements,we also have audited financial statement schedule II. These consolidatedfinancial statements and financial statement schedule are the responsibility ofthe Company’s management. Our responsibility is to express an opinion on these consolidatedfinancial statements and financial statement schedule based on our audits.

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

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of Evans & Sutherland Computer Corporation and subsidiariesas of December 31, 2005 and 2004, and the results of their operations andtheir cash flows for each of the years in the three-year period ended December 31,2005, in conformity with U.S. generally accepted accounting principles. Also inour opinion, the related financial statement schedule, when considered in relationto the basic consolidatedfinancial statements taken as a whole, presents fairly, in all materialrespects, the information set forth therein.

As discussed in Note 3,the consolidated financial statements as of December 31, 2004 and for eachof the years ended December 31, 2004 and 2003 have been restated.

/s/ KPMG LLP

Salt Lake City, UtahMarch 31, 2006

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

None.

**ITEM 9A.**        CONTROLSAND PROCEDURES

The Company’s management, with the participation of ourprincipal executive officer and principal financial officer, evaluated theeffectiveness of our “disclosure controls and procedures” (as defined in Rule13a-15(e) of the Securities Exchange Act of 1934 (the "Exchange Act")as of the end of the fourth quarter of fiscal 2005. In addition, the Company’smanagement, with the participation of our principal executive officer andprincipal financial officer, evaluated any change in our “internal control overfinancial reporting” (as defined in Rule 13a-15(f) of the Exchange Act) thatoccurred during the fourth quarter of fiscal 2005 that has materially affected,or is reasonably likely to materially affect, our internal control overfinancial reporting.

Disclosure controls and procedures are designed toensure that information required to be disclosed in our reports filed orsubmitted under the Exchange Act, such as this Annual Report on Form 10-K, isrecorded, processed, summarized and reported within the required time periods.These disclosure controls and procedures are also designed to ensure that suchinformation is accumulated and communicated to our management, including ourprincipal executive officer and principal financial officer, as appropriate toallow timely decisions regarding required disclosure. 

During the 2005 year-end closing process, theCompany’s management became aware that our then-current method of accounting ofrent expense for leased real property was not in compliance with FinancialAccounting Standards Board Technical Bulletin No. 85-3, *Accountingfor Operating Leases with Scheduled Rent Increases*, and concluded,after discussion with our Audit Committee and our independent registered publicaccounting firm, that a restatement of our previously issued auditedconsolidated financial statements for fiscal years 2004 and 2003 and quarterlyfinancial statements for 2005 and 2004 was necessary to correct our accountingfor annual rent rate escalations under our real property leases. In conjunctionwith the restatement, the Company identified a material weakness in internalcontrol over financial reporting related to its accounting for leases.Therefore, the Company’s management, with the participation of our principalexecutive officer and principal financial officer, concluded that ourdisclosure controls and procedures were not effective as of December 31, 2005.

Management and the Audit Committee assessed theunderlying issues giving rise to the restatement in order to ensure propersteps were taken to improve our internal controls over financial reporting.During the first quarter of fiscal 2006, the Company, under the supervision of ourprincipal executive officer and principal financial officer, took the necessarysteps to remediate the material weakness by implementing certain controls,including the review by the Company’s Controller of all new leases and leaseamendments, to ensure that all leases are reviewed and accounted for inaccordance with Statement of Financial Accounting Standards No. 13, *Accounting for Leases*, and Financial Accounting StandardsBoard Technical Bulletin No. 85-3, *Accounting for OperatingLeases with Scheduled Rent Increases*.

It should be noted that a control system, no matterhow well designed and operated, can provide only reasonable, not absolute,assurance that the objectives of the control system are met. As a result, therecan be no assurance that a control system will operate effectively under allcircumstances. Our disclosure controls and procedures are designed to providereasonable assurance of achieving their objectives, and the conclusions of ourprincipal executive officer and principal financial officer are made at the“reasonable assurance” level.

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Our principal executiveofficer and principal financial officer also have indicated that there were nochanges in our internal control over financial reporting during the fourthquarter of fiscal 2005 that materially affected, or that are reasonably likelyto materially affect, our internal control over financial reporting.

**ITEM 9B.**       OTHERINFORMATION

None.

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**PART III**

**ITEM 10.**         DIRECTORSAND EXECUTIVE OFFICERS

Certain information with respect to directors of theCompany is set forth below.

**David J. Coghlan**,****51,Chairman of the Board, has been a director of Evans &Sutherland since May 2002. Mr. Coghlan currently serves as Chairmanof the Board of Quadnetics Group plc, a publicly quoted company based in theUnited Kingdom, where he has served in various senior capacities since 1993.Mr. Coghlan also currently serves as a non-executive Chairman of the Boardof Quadrant Group Limited, and as a non-executive member of the Board ofTrafficLand, Inc. Previously, Mr. Coghlan served as a Partner at Bain &Company. Mr. Coghlan earned his MBA from the Wharton School, University ofPennsylvania, and has degrees in law and financial management from theUniversity of New South Wales, Australia. Mr. Coghlan’s term will expireat the 2007 annual meeting of the Company’s shareholders.

**Wolf-Dieter Hass**, 67, has been a Director of Evans &Sutherland since May 2001. Mr. Hass is currently Managing Director ofLufthansa Flight Training Berlin GmbH, a position he has held since 1990. Heretired in 2004 as Vice-President and Corporate Secretary for Lufthansa FlightTraining GmbH, positions he had held since 1990 and 1997, respectively.Mr. Hass studied Aeronautical Engineering at the Technical University ofBerlin, earning the degree of Diplom-Ingenieur and joined Lufthansa GermanAirlines in 1965. Mr. Hass is the chairman of the Royal AeronauticalSociety’s Flight Simulation Group Committee. Mr. Hass’ term will expire atthe 2008 annual meeting of the Company’s shareholders.

**Dr. William Schneider**, 64, has been a director of Evans &Sutherland since May 2002. Dr. Schneider is the president ofInternational Planning Services, Inc., a Washington-based internationaltrade and finance firm, since 1986. In addition, Dr. Schneider iscurrently an adjunct fellow of the Hudson Institute. Dr. Schneider servesas an advisor to the U.S. government in several capacities; he is a consultantto the Departments of Defense, Energy, and State, and was appointed bySecretary of Defense Donald H. Rumsfeld in March 2001 to serve as chairmanof the Defense Science Board. Dr. Schneider is also chairman of theDepartment of State’s Defense Trade Advisory Group. Dr. Schneider servesas a member of the board of directors for several foreign public companies’U.S. subsidiaries: BAE Systems, Inc.; MBDA USA, Inc.; EADS NorthAmerica, Inc.; ABB Susa, Inc, Meggit USA, Selex Airborne Sensors &Sytstems, and WorldSpace Satellite Systems. He earned his Ph.D. degree from NewYork University in 1968. Dr. Schneider’s term will expire at the 2008annual meeting of the Company’s shareholders.

**General James P. McCarthy, USAF (ret.)**,71, has been a director of Evans & Sutherland since May 2004. GeneralMcCarthy has been teaching at the U.S. Air Force Academy since retirement in1992 and currently is the ARDI Professor of National Security and the Directorof the Institute for Information Technology Applications. General McCarthychairs the Task Force on Operation Enduring Freedom Lessons Learned inAfghanistan and Iraq and is a member of the Defense Science Board. GeneralMcCarthy has served on the Defense Policy Board advising the Secretary ofDefense, among others. General McCarthy serves as a member of the board ofdirectors of three other companies: EADS North America, Inc.; ISXCorporation; and NAVSYS Corporation. The term of General McCarthy expires at thenext annual meeting of the Company’s shareholders, although, he has beennominated by the Nominating and Corporate Governance Committee for election toa new three year term.

**James R.Oyler**, 60, was appointed President and Chief ExecutiveOfficer of Evans & Sutherland and a member of the Board of Directorsin November 1994. Before joining Evans & Sutherland, Mr. Oylerserved as a Senior Vice President for Harris Corporation. He has eleven yearsof service with E&S. Mr. Oyler’s term will expire at the 2007 annualmeeting of the Company’s shareholders.

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**AffirmativeDetermination Regarding Board Independence**

The Board of Directors has determined each of thefollowing outside directors to be an “independent director” under Rule 4200(a)(15)of the NASDAQ Stock Market, Inc. Corporate Governance Rules: David J.Coghlan, Wolf-Dieter Hass, William Schneider, and James P. McCarthy.

In assessing theindependence of the directors, the Board of Directors determines whether or notany director has a material relationship with the Company (either directly oras a partner, shareholder or officer of an organization that has a relationshipwith the Company). The Board of Directors considers all relevant facts andcircumstances in making independence determinations.

**Audit Committee**

The Audit Committeeconsists of Wolf-Dieter Hass, David J. Coghlan, William Schneider, and James P.McCarthy, all of whom are outside directors. The Board of Directors hasdetermined that all members of the Audit Committee are independent as definedby The NASDAQ Stock Market, Inc. Corporate Governance Rule 4200(a)(15).Its functions are (i) to review and approve the selection of, and allservices performed by, the Company’s Independent auditors; (ii) to reviewthe Company’s internal controls and audit functions; and (iii) to reviewand report to the Board of Directors with respect to the scope of internal andexternal audit procedures, accounting practices and internal accounting andfinancial and risk controls of the Company. The Audit Committee operates underthe Audit Committee Charter and is a separately designated standing auditcommittee established in accordance with Section 3(a)(58)(A) of theExchange Act of 1934. The Audit Committee Charter can be found on Evans &Sutherland’s website, www.es.com, in the Investor Relations, CorporateGovernance section. The Board of Directors has reviewed the Securities andExchange Commission’s definition of an “audit committee financial expert,” andhas determined that David J. Coghlan qualifies as an audit committee financialexpert.

**Code of Ethics**

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

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

**ExecutiveOfficers of the Registrant**

In addition to Mr. Oyler, our President and ChiefExecutive Officer, the following are our executive officers.

**Lance Sessions**, 38, wasappointed Acting Chief Financial Officer and Corporate Secretary of E&S in November 2005.Mr. Sessions joined E&S in July 2000 as a Senior FinancialAnalyst and has served as a Director of Finance and as Manager of Treasury andSEC Reporting. Mr. Sessions is a Certified Public Accountant. He has fiveyears of service with E&S.

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**BobMorishita**, 54, is Vice President of Human Resources. Hejoined Evans & Sutherland as Compensation Manager in 1982 and wasappointed Human Resources Director in 1997 and Human Resources Vice Presidentin 2000. He has 24 years of service with E&S.

**Compliancewith Section 16(a) of the Exchange Act**

Section 16(a) of the Securities Exchange Actof 1934, as amended, requires Evans & Sutherland’s directors,executive officers and persons who beneficially own more than ten percent of aregistered class of Evans & Sutherland’s equity securities to filewith the Securities and Exchange Commission initial reports of ownership andreports of changes in ownership of common stock and other equity securities ofEvans & Sutherland. Officers, directors and greater than ten percentbeneficial owners are required by SEC regulation to furnish Evans &Sutherland with copies of all Section 16(a) reports they file.

Based solely upon reviewof the copies of such reports furnished to Evans & Sutherland andwritten representations from certain reporting persons that no other reportswere required, Evans & Sutherland believes that there was compliancefor the fiscal year ended December 31, 2005, with all Section 16(a) filingrequirements applicable to Evans & Sutherland’s officers, directorsand greater than ten percent beneficial owners.

**ITEM 11.**         EXECUTIVECOMPENSATION

**Summary Compensation Table**

Thefollowing table sets forth information for the fiscal years ended December 31,2005, 2004, and 2003, regarding the compensation of (i) the ChiefExecutive Officer of Evans & Sutherland during the 2005 fiscal yearand (ii) all other executive officers of Evans & Sutherland whowere serving as executive officers on December 31, 2005; and (iii) oneindividual who would have been included within the preceding clause (ii) butfor the fact that he was not serving as an executive officer as of December 31,2005 (the “Named Executive officers”). No bonuses were earned by NamedExecutives in 2005, 2004, or 2003 because specified performance goals were notmet.

| ** **                                                 | ** ** | **Annual**       | ** ** | **Long-Term  Compensation** | ** ** | ** **     | ** ** |
|------------------------------------------------------------|------------|------------------|------------|-----------------------------|------------|----------------|------------|
| ** **                                                 | ** ** | **Compensation** | ** ** | **Awards**                  | ** ** | ** **     | ** ** |
| ** **                                                 | ** ** | ** **       | ** ** | ** **                  | ** ** | **Securities** | ** ** | **All** | ** ** |
| **Name and**                                          | ** ** | ** **       | ** ** | ** **                  | ** ** | **Underlying** | ** ** | **Other** | ** ** |
| Principal Position                                    | ** ** | ** **       | ** ** | **Year**                    | ** ** | **Salary(1)**  | ** ** | **Options** | ** ** | **Compensation(2)** | ** ** |
| James R. Oyler—President and  Chief Executive Officer |       | 2005             |       | $                           | 391,100    |           |       | 100,000 |   |   |   | $ | 114,029 |   |   |
|                                                            |       | 2004             |       | 391,100                     |       |           | 15,000     |   |   |   | 114,241 |   |   |
|                                                            |       | 2003             |       | 406,142                     |       |           | 15,000     |   |   |   | 56,417 |   |   |
| Lance Sessions—Acting Chief Financial Officer and     |       | 2005             |       | 79,518                      |       |           | 10,000     |   |   |   | 2,466 |   |   |
| Corporate Secretary                                        |       | 2004             |       | 69,394                      |       |           | —     |   |   |   | 2,081 |   |   |
|                                                       |       | 2003             |       | 71,902                      |       |           | —     |   |   |   | 2,157 |   |   |
| Kevin A. Paprzycki(3)—Chief  Financial Officer        |       | 2005             |       | 141,841                     |       |           | 15,000     |   |   |   | 8,338 |   |   |
| and Corporate Secretary                                    |       | 2004             |       | 106,950                     |       |           | 20,000     |   |   |   | 5,512 |   |   |
|                                                            |       | 2003             |       | 95,458                      |       |           | —     |   |   |   | 4,570 |   |   |
| Bob Morishita—Vice President, Human Resources         |       | 2005             |       | 153,077                     |       |           | 10,000     |   |   |   | 23,698 |   |   |
|                                                       |       | 2004             |       | 140,400                     |       |           | 10,000     |   |   |   | 22,808 |   |   |
|                                                       |       | 2003             |       | 145,800                     |       |           | 10,000     |   |   |   | 22,872 |   |   |
|                                                            |            |                  |            |                             |            |                |            |  |  |  |  |  |  |  |  |  |  |

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(1)          Evans &Sutherland pays its payroll biweekly. In a normal year, this results in 26payroll payments. However, in 2003, this resulted in 27 payroll payments. Thesalary information in 2003 reflects the 27th payroll payment. Thisadditional payroll payment was not an increase in salaries.

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(2)          All other compensationfor fiscal year 2005 includes (i) premiums paid for executive lifeinsurance polices (Mr. Oyler $39,282 and Mr. Morishita); (ii) matchingcontributions to Evans & Sutherlands Executive Savings Plan (Mr. Oyler$11,733, Mr. Paprzycki $4,260 and Mr. Morishita $4,592); (iii) discretionarycontributions to Evans & Sutherland’s Executive Savings Plan (Mr. Oyler$57,075); and (iv) matching contributions to Evans & Sutherland’s401(k) Deferred Savings Plan (Mr. Oyler $5,939, Mr. Paprzycki $4,078,Mr. Sessions $2,466 and Mr. Morishita $4,469).

All other compensation for fiscal year 2004 includes (i) premiumspaid for executive life insurance policies (Mr. Oyler $39,282 and Mr. Morishita$14,636); (ii) matching contributions to Evans & Sutherland’sExecutive Savings Plan (Mr. Oyler $11,733, Mr. Paprzycki $2,451 and Mr. Morishita$4,212); (iii) discretionary contributions to Evans & SutherlandExecutive Savings Plan (Mr. Oyler $57,075); and (iv) matchingcontributions to Evans & Sutherland’s 401(k) Deferred SavingsPlan (Mr. Oyler $6,150, Mr. Paprzycki $3,061, Mr. Sessions$2,081 and Mr. Morishita $3,959).

All othercompensation for fiscal year 2003 includes (i) premiums paid for executivelife insurance policies (Mr. Oyler $38,235 and Mr. Morishita$14,246); (ii) matching contributions to Evans & Sutherland’sExecutive Savings Plan (Mr. Oyler $12,182, Mr. Paprzycki $1,181 and Mr. Morishita$4,374); and (iii) matching contributions to Evans & Sutherland’s401(k) Deferred Savings Plan (Mr. Oyler $6,000, Mr. Paprzycki$2,749, Mr. Sessions $2,151, and Mr. Morishita $4,264).

(3)          KevinA. Paprzycki resigned as Chief Financial Officer and Corporate Secretary on November 9,2005.

**Option Grants in Last Fiscal Year**

Thefollowing table sets forth information regarding stock options granted duringthe fiscal year 2005 to the Named Executive Officers. Evans &Sutherland has not issued any stock appreciation rights.

| ** **                        | ** ** | **Individual Grants(1)** | ** ** | **Potential Realizable** | ** ** |
|-----------------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| ** **                        | ** ** | **Number of**            | ** ** | **Percent of**           | ** ** | ** ** | ** ** | ** ** | ** ** | **Value at Assumed** | ** ** |
| ** **                        | ** ** | **Securities**                | ** ** | **Total Options**        | ** ** | **Exercise** | ** ** | ** ** | ** ** | **Annual Rates of Stock** | ** ** |
| ** **                        | ** ** | **Underlying**                | ** ** | **Granted to**           | ** ** | **or Base** | ** ** | ** ** | ** ** | **Price Appreciation** | ** ** |
| ** **                        | ** ** | **Options**                   | ** ** | **Employees in**         | ** ** | **Price** | ** ** | **Expiration** | ** ** | **For Option Term(2)** | ** ** |
| **Named Executive  Officer** | ** ** | ** **                    | ** ** | **Granted**                   | ** ** | **Fiscal Year** | ** ** | **($/sh)** | ** ** | **Date** | ** ** | **At 5%** | ** ** | **At 10%** | ** ** |
| James R. Oyler                    |       |                          | 100,000    |                          |       |   | 46.04 | % |   |   | $ | 7.87 |   |   |   | 1/03/15 |   |   | $ | 378,160 |   | $ | 1,068,026 |   |
| Lance Sessions                    |       |                          | 10,000     |                          |       |   | 4.60 | % |   |   | 5.40 |   |   |   | 11/15/15 |   |   | 25,969 |   | 73,343 |   |
| Kevin A.  Paprzycki(3)            |       |                          | 15,000     |                          |       |   | 6.91 | % |   |   | 7.24 |   |   |   | 2/24/15 |   |   | 52,202 |   | 147,432 |   |
| Bob Morishita                     |       |                          | 10,000     |                          |       |   | 4.60 | % |   |   | 7.24 |   |   |   | 2/24/15 |   |   | 34,801 |   | 98,288 |   |
|                                   |            |                               |            |                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          The options were grantedto employees under the 2004 Stock Incentive Plan and were scheduled to becomeexercisable in three equal installments on the first, second and thirdanniversaries of the date of the grant. The options have a 10-year term,subject to earlier termination in the event of the optionee’s cessation ofservice with Evans & Sutherland. The total number of options grantedto employees during fiscal year 2005 was 217,200 shares. All previously unvestedoptions granted under the 2004 Plan that were outstanding on February 7,2006 were subject to accelerated vesting and became fully vested by their termsupon our execution of the Rockwell Purchase Agreement.

(2)          Thesepotential realizable values are based on an assumed annual rate of increase inthe value of Evans & Sutherland’s common stock over the ten-year termof the options of five percent and ten percent, compounded annually, asrequired by the rules of the Securities and Exchange Commission. Theserates of increase in value are not indicative of the past performance of Evans &Sutherland’s common stock and are not intended to be a forecast of futureappreciation in value of Evans & Sutherland’s common stock. The actualrealizable value, if any, of these options is dependent upon the 

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actual future valueof Evans & Sutherland’s common stock, which cannot be predicted withany assurance at this time.

(3)          UponMr. Paprzycki’s resignation, his options granted in 2005 were cancelled.

**AggregatedOption Exercises in Last Fiscal Year and Fiscal Year-End Option Values**

Thefollowing table sets forth information concerning the exercise of stock optionsduring fiscal year 2005 by each of the Named Executive Officers and lists thevalue of their unexercised options on December 31, 2005. None of the NamedExecutive Officers exercised any stock options during 2005. Evans &Sutherland has not issued any stock appreciation rights.

| ** **                        | ** ** | **Number of Securities**            | ** ** | **Value of Unexercised**       | ** ** |
|-----------------------------------|------------|-----------------------------------------------|------------|------------------------------------------|------------|
| ** **                        | ** ** | **Underlying Unexercised**               | ** ** | **In-the-Money Options**            | ** ** |
| ** **                        | ** ** | **Options at Fiscal Year-End** | ** ** | **At Fiscal Year End(1)** | ** ** |
| **Named Executive  Officer** | ** ** | ** **                                    | ** ** | **Exercisable**                          | ** ** | **Unexercisable(2)** | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
| James R. Oyler                    |       |                                          | 292,103    |                                     |       |   | 115,000 |   |   |   | $ | 3,157 |   |   |   | $ | 6,000 |   |   |
| Lance Sessions                    |       |                                          | 300        |                                     |       |   | 10,000 |   |   |   | 175 |   |   |   | — |   |   |
| Bob Morishita                     |       |                                          | 59,603     |                                     |       |   | 19,999 |   |   |   | 2,157 |   |   |   | 4,000 |   |   |
| Kevin A. Paprzycki                |       |                                          | —     |                                     |       |   | — |   |   |   | — |   |   |   | — |   |   |
|                                   |            |                                               |            |                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Basedon the closing price of Evans & Sutherland’s common stock as reportedon the NASDAQ Stock Market on December 31, 2005 of $4.90 less the exerciseprice.

(2)          Alloptions outstanding on February 7, 2006 were subject to acceleratedvesting and became fully vested by their terms upon our execution of the RockwellPurchase Agreement.

**Pension Plan, ESP and SERP**

We believe that sponsoring retirement plans is a keyelement of maintaining a competitive compensation program. Accordingly, wesupport a qualified 401(k) Deferred Savings Plan (“401(k) Plan”) anda non-qualified Executive Savings Plan (the “ESP”), under which Evans &Sutherland and employees contribute to future retirement benefits. Participantsin the 401(k) Plan are those employees who meet the service and agerequirements of the 401(k) Plan. Participants in the ESP are managementemployees selected by the Compensation Committee of the Board of Directors. The401(k) Plan and ESP are funded by employee deferrals and contributions byEvans & Sutherland. Directors of Evans & Sutherland who arenot employees are not eligible to participate in the 401(k) Plan and ESP.

We maintain two defined benefit plans, a qualifiedpension plan and a non-qualified Supplemental Executive Retirement Plan, orSERP. In 2002, E&S closed both plans to new participation when weredesigned our employee retirement plans. In 2002, we also curtailed theaccrual of future benefits under the pension plan and restricted thecompensation used to calculate SERP and pension plan benefits. Participants whowere not vested in their accrued pension plan benefits in 2002 can becomevested through future service credit

Under the pension provisions, the credited years ofservice for the Named Executive Officers listed in the preceding SummaryCompensation Table are as follows: Messrs. James R. Oyler, 7 years; LanceSessions, 1 year; Bob Morishita, 19 years; and Kevin Paprzycki, 2 years.

Under the amended SERP, participants as of January 1,2002 will be credited with future service that will allow vesting in a benefitbased on an average base salary whereby the executive’s average base salarywill not include any base salary increases that occur after January 1,2002. Under the amended SERP, an executive’s annual retirement incomecommencing at age 65 equals 66.7% of the executive’s average base salary in2002, reduced by the executive’s annual benefit under the pension planmultiplied by a fraction, 

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the numerator of which isthe total number of years of service with us while a participant of the SERP(up to a maximum of ten) and the denominator of which is ten. For purposes ofthe SERP, the term “average base salary” is defined as the average of theexecutive’s base compensation over a three year period, excluding all otherforms of compensation except amounts deferred under Evans & Sutherland’sESP and 401(k) Plan. Messrs. Oyler and Morishita are currentlyparticipating in the SERP and have 10 and 5 years of service, respectively,credited under the SERP.

We have purchased life insurance for its benefit onthe lives of all of the participants in the ESP and SERP. It is anticipatedthat the life insurance proceeds payable upon the death of plan participantswill fully reimburse us for the after-tax cost of SERP and ESP benefitpayments, premiums, and a factor for the cost of money.

Thefollowing table illustrates the approximate annual retirement benefits (notincluding social security benefits) under the pension plan and the SERP,assuming retirement at age 65, based upon years of accredited service and finalqualifying earnings as defined in the pension plan and SERP, and also assumingthat the employee elects a straight life annuity.

| ** **          | ** ** | **Years of Service(2)** | ** ** |
|---------------------|------------|-----------------------------------|------------|
| **Remuneration(1)** | ** ** | ** **                        | ** ** | **10** | ** ** | **15** | ** ** | **20** | ** ** | **25** | ** ** | **30** | ** ** | **35** | ** ** |
| $125,000            |       | $                                 | 83,375     |   | $ | 83,375 |   | $ | 83,375 |   | $ | 83,375 |   | $ | 83,375 |   | $ | 83,375 |   |
|   150,000 |       | 100,050                           |       | 100,050 |   | 100,050 |   | 100,050 |   | 100,050 |   | 100,050 |   |
|   175,000 |       | 116,725                           |       | 116,725 |   | 116,725 |   | 116,725 |   | 116,725 |   | 116,725 |   |
|   200,000 |       | 133,400                           |       | 133,400 |   | 133,400 |   | 133,400 |   | 133,400 |   | 133,400 |   |
|   225,000 |       | 150,075                           |       | 150,075 |   | 150,075 |   | 150,075 |   | 150,075 |   | 150,075 |   |
|   250,000 |       | 166,750                           |       | 166,750 |   | 166,750 |   | 166,750 |   | 166,750 |   | 166,750 |   |
|   300,000 |       | 200,100                           |       | 200,100 |   | 200,100 |   | 200,100 |   | 200,100 |   | 200,100 |   |
|   400,000 |       | 266,800                           |       | 266,800 |   | 266,800 |   | 266,800 |   | 266,800 |   | 266,800 |   |
|   450,000 |       | 300,150                           |       | 300,150 |   | 300,150 |   | 300,150 |   | 300,150 |   | 300,150 |   |
|   500,000 |       | 333,500                           |       | 333,500 |   | 333,500 |   | 333,500 |   | 333,500 |   | 333,500 |   |
|                     |            |                                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          For purposes ofdetermining benefits at normal retirement, remuneration is based upon the averagequalifying earnings of the employee. Under the pension plan, this is theaverage of the five consecutive calendar years that will produce the highestaverage earnings out of the last ten calendar years of employment. Under theSERP, this is the average base salary of the three consecutive calendar yearsof employment with E&S that produces the highest annual average. Under the2002 amendment to the pension plan, remuneration will not include compensationpaid after April 23, 2002. Under the 2002 amendment to the SERP,remuneration will not take into account any adjustments to base salaries thatoccur after January 1, 2002.

(2)          Underthe pension plan amendments, credit for future service will be limited to yearsneeded to vest accrued benefits under the pension plan. Under the amended SERP,no executive will earn a benefit greater than that which would be based on tenyears of service.

**Compensation of Directors**

Employee members of the Board of Directors do notreceive any separate compensation for services performed as a director. Ournon-employee Chairman of the board receives a $10,250 retainer each quarter heor she is the Chairman plus $1,000 for each board meeting attended. Each of ournon-employee directors receives a $5,000 retainer each quarter he or she is adirector plus $1,000 for each board meeting attended. There is no separatecompensation for committee meeting attendance.

 

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Each non-employee directorfirst appointed or elected to the board after the date of adoption of the Evans &Sutherland Computer Corporation 2004 Stock Incentive Plan receives, as of thedate of such appointment or election, an option to purchase up to 10,000 sharesof our common stock. In addition, on the first day of each fiscal yearthereafter, each non-employee director then serving as a director receives anoption to purchase up to 10,000 shares of our common stock; provided, however,that in no event shall any non-employee director be granted additional optionsif options previously granted to such non-employee director equals or exceeds100,000 shares of our common stock. The exercise price for options granted tonon employee directors is equal to 110% of the fair market value of our commonstock as of the date of grant. The options have a term of ten years and becomeexercisable in three annual installments on the first, second and thirdanniversaries of the date of the grant. However, each option expires upon theboard member’s termination for cause or willful termination from the board;expires 90 days after the board member’s termination from the Board by E&Sif not for cause; and becomes fully vested and exercisable until the expirationdate of such option as a result of retirement from the Board. Options grantedpursuant to the 2004 Stock Incentive Plan to non-employee directors arenonqualified stock options. Generally, option recipients will be subject to therestrictions of Section 16(b) of the Securities Exchange Act of 1934.

**EmploymentContracts, Termination of Employment and Change-in-Control Arrangements**

***Employee Arrangements***

We entered into employment agreements with Mr. Oyleron May 16, 2000, and with Mr. Morishita on September 22, 2000. Theemployment agreements with each of Messrs. Oyler and Morishita were lateramended and the current employment agreements as amended are dated September 22,2000 for Mr. Oyler and August 26, 2002 for Mr. Morishita. Pursuantto the agreement with Mr. Oyler, he shall continue to serve in hisposition until December 31, 2006, unless his term of service is furtherextended or sooner terminated in accordance with the terms of his agreement. Pursuantto the agreement with Mr. Morishita, he shall continue to serve in hisposition or such other position as may be assigned by the Chief ExecutiveOfficer until his term of service is terminated or amended in accordance withhis agreement. Further, E&S agreed to continue to pay Messrs. Oylerand Morishita their annualized base salary subject to adjustment as provided intheir respective agreements. Such annualized base salary may be increased fromtime to time in accordance with the normal business practices. We also agreedthat Messrs. Oyler and Morishita shall be entitled to participate in ourSERP and that Messrs. Oyler and Morishita shall be entitled to participatein our incentive program, ESP and other benefits normally provided to employeesof E&S similarly situated, including being added as a named officer on ourexisting directors’ and officers’ liability insurance policy.

In the case of termination of employment for Messrs. Oyleror Morishita as a result of death or disability, the terminated employee willbe entitled to a termination payment equal to such individual’s then currentcalendar year base salary plus targeted cash bonus and to continuation ofcertain other benefits for a period of one year. If Mr. Oyler terminateshis employment for good reason (as defined in Mr. Oyler’s agreement), or Mr. Oyler’semployment is terminated by E&S for any reason other than death, disabilityor cause (as defined in Mr. Oyler’s agreement), Mr. Oyler shall beentitled to a termination payment equal to two (2) times his then currentcalendar year base salary plus targeted cash bonus and to continuation ofcertain other benefits for a period of two years. In addition, if we terminate Mr. Oyler’semployment without cause, or if Mr. Oyler terminates his employment forgood reason, then all outstanding but unvested options held by Mr. Oyleron the date of termination shall immediately vest. If Mr. Morishitaterminates his employment for good reason (as defined in Mr. Morishita’sagreement), or his employment is terminated by E&S for any reason otherthan death, disability or cause (as defined in Mr. Morishita’s agreement),Mr. Morishita shall be entitled to a termination payment equal to hiscurrent 

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calendar year base salaryplus targeted cash bonus and to continuation of certain other benefits for aperiod of one year.

Under their employmentagreements, Messrs. Oyler and Morishita are subject to customarynoncompetition provisions during their employment and for 12 months followingthe termination of their employment and to customary assignment of inventionsprovisions during their employment and to customary confidentiality provisionsat all times during and after their employment.

***Change-in-Control Agreements***

Pursuant to change-in-control provisions included inthe employment agreement entered into by E&S and Mr. Oyler, if upon achange in control Mr. Oyler terminates his employment for good reason (asdefined in the agreement), or E&S terminates Mr. Oyler’s employmentfor any reason other than death, disability, or cause (as defined in theagreement), Mr. Oyler shall be entitled to a termination payment equal totwo (2) times his then current calendar year base salary plus targetedbonus and to continuation of certain other benefits for a period of two years. However,if Mr. Oyler terminates his employment within one hundred eighty (180)days of a change in control, Mr. Oyler shall be entitled to a terminationpayment of two and one-half (2.5) times his then current calendar year basesalary plus targeted bonus and to continuation of certain other benefits for aperiod of 2.5 years.

Pursuant tochange-in-control provisions included in the employment agreements entered intoby E&S and Mr. Morishita, if in conjunction with a change in control Mr. Morishitaterminates his employment for good reason (as defined in the agreement), orE&S terminates Mr. Morishita’s employment for any reason other thandeath, disability, or cause (as defined in the agreement), Mr. Morishitashall be entitled to a termination payment equal to one (1) times his thencurrent calendar year base salary plus targeted bonus and to continuation ofcertain other benefits for a period of one year.

**CompensationCommittee Interlocks and Insider Participation**

The members of ourCompensation Committee are Mr. Coghlan, Mr. Hass, General McCarthyand Dr. Schneider. Mr. Coghlan is a member of the Board of Directorsof Quest Flight Training Limited., a joint venture between E&S and QuadrantGroup Limited., of which Mr. Coghlan is also a director. Members of Mr. Coghlan’sfamily own an indirect beneficial ownership interest in a majority ofoutstanding shares of Quadrant Group Limited. Mr. Coghlan has disclaimedany beneficial ownership in Quadrant Group Limited.

**CEO Compensation**

Mr. Oyler’s 2005annual base salary rate was $391,100 which has remained unchanged since 2002. During2005, Mr. Oyler received base salary payments totaling $391,100 and othercompensation of $114,029. Mr. Oyler’s 2005 compensation is more fullydescribed above under the headings “Executive Compensation” and “EmploymentContracts, Termination of Employment and Change-in-Control Arrangements.” Duringfiscal 2005, under the 2004 Stock Incentive Plan, Mr. Oyler was grantedstock options to purchase 100,000 shares at an exercise price of $7.87 pershare, ten percent greater than the fair market values of E&S’s commonstock on the date of the grant. These stock options were scheduled to vestannually in approximately equal installments on the first, second, and thirdanniversaries of the date of grant, but were subject to accelerated vesting andbecame fully vested by their terms upon the execution of the Rockwell PurchaseAgreement on February 7, 2006. This award was based on, among otherthings, the Committee’s subjective assessment of Mr. Oyler’s performanceand impact upon our performance in 2004 and the extent to which his performancein the future is expected to create value for Evans & Sutherland’sshareholders.

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**ITEM12.**         SECURITY OWNERSHIP OFCERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

**SecuritiesAuthorized for Issuance Under Equity Compensation Plans as of December 31,2005**

| ** **                                                  | ** ** | ** **                           | ** ** | ** **                        | ** ** | **Number of securities**          | ** ** |
|-------------------------------------------------------------|------------|--------------------------------------|------------|-----------------------------------|------------|---------------------------------------------|------------|
| ** **                                                  | ** ** | **Number of securities**   | ** ** | ** **                        | ** ** | **remaining available for**       | ** ** |
| ** **                                                  | ** ** | **to be issued upon** | ** ** | **Weighted average**         | ** ** | **future issuance**                    | ** ** |
| ** **                                                  | ** ** | **exercise of**                 | ** ** | **exercise price of**   | ** ** | **under equity compensation**     | ** ** |
| ** **                                                  | ** ** | **outstanding options,**        | ** ** | **outstanding options,**     | ** ** | **plans (excluding securities**   | ** ** |
| ** **                                                  | ** ** | **warrants and rights**    | ** ** | **warrants and rights** | ** ** | **reflected in column (a))** | ** ** |
| ** **                                                  | ** ** | **(a)**                              | ** ** | **(b)**                           | ** ** | **(c)**                                     | ** ** |
| Equity compensation  plans approved by security holders     |       |                                 | 2,225,794  |                              |       |                                        | $          | 10.38 |   |   |   | 621,490 |   |   |
| Equity  compensation plans not approved by security holders |       |                                 | —     |                              |       |                                        | —     |   |   |   | — |   |   |
| Total                                                       |       |                                 | 2,225,794  |                              |       |                                        | $          | 10.38 |   |   |   | 621,490 |   |   |

 

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**SecurityOwnership of Certain Beneficial Owners and Management**

The following table setsforth certain information regarding beneficial ownership of Evans &Sutherland’s common stock: (i) by each person who is known by Evans &Sutherland to own beneficially more than five percent of Evans &Sutherland’s common stock, (ii) by each of Evans & Sutherland’sdirectors as of March 24, 2006, (iii) by the Chief Executive Officerand each of Evans & Sutherland’s other Named Executive Officers as of March 24,2006 and (iv) by all directors and Named Executive Officers as a group asof March 24, 2006.

|                                                                       | ** ** | **Shares Beneficially Owned** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                            | ** ** | **Number(1)**                           | ** ** | **Percent(2)** | ** ** |
| **PRINCIPAL SHAREHOLDERS**                                            |       |                                    |       |   |   |   |   |
| State of Wisconsin Investment Board(3)                                |       | 2,042,250                               |       |   | 19.4 | % |   |
| P.O. Box 7842, Madison, Wisconsin 53707                          |       |                                    |       |   |   |   |   |
| Peter R. Kellog(4)                                                    |       | 1,781,253                               |       |   | 16.9 | % |   |
| 48 Wall Street, 30th Fl., New York, New York 10005               |       |                                    |       |   |   |   |   |
| Wells Fargo & Company(5)                                     |       | 1,597,048                               |       |   | 15.2 | % |   |
| 420 Montgomery Street, San Francisco, California  94104               |       |                                    |       |   |   |   |   |
| Royce & Associates,  LLC(6)                                  |       | 980,125                                 |       |   | 9.3 | % |   |
| 1414 Avenue of the Americas,  New York, New York 10019                |       |                                    |       |   |   |   |   |
| Dimensional Fund Advisers Inc.(7)                                     |       | 625,458                                 |       |   | 5.9 | % |   |
| 1299 Ocean Avenue, 11th Fl., Santa Monica, California 90401      |       |                                    |       |   |   |   |   |
| **DIRECTORS**                                                         |       |                                    |       |   |   |   |   |
| David J. Coghlan(8)                                                   |       | 40,000                                  |       |   | * |   |   |
| Wolf-Dieter Hass(9)                                                   |       | 50,000                                  |       |   | * |   |   |
| James P. McCarthy(10)                                                 |       | 20,500                                  |       |   | * |   |   |
| James R. Oyler(11)                                                    |       | 334,103                                 |       |   | 3.1 | % |   |
| William Schneider(12)                                                 |       | 40,000                                  |       |   | * |   |   |
| **OTHER NAMED EXECUTIVE OFFICERS**                                    |       |                                    |       |   |   |   |   |
| Bob Morishita(13)                                                     |       | 81,252                                  |       |   | * |   |   |
| Lance Sessions(14)                                                    |       | 10,400                                  |       |   | * |   |   |
| Kevin Paprzycki(15)                                                   |       | 557                                     |       |   | * |   |   |
| All directors and Named Executive  Officers as a group—8 persons |       | 576,812                                 |       |   | 5.2 | % |   |

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*       Less thanone percent

(1)          The number of sharesbeneficially owned by each person or group as of March 24, 2006 includes sharesof common stock that such person or group has a right to acquire on or within60 days after that date, including, but not limited to, upon the exercise ofoptions. To our knowledge, except as otherwise indicated in the footnotes tothis table and subject to applicable community property laws, the shareholdernamed in the table has sole voting and dispositive power with respect to theshares set forth opposite such shareholder’s name.

(2)          For each person andgroup included in the table, percentage ownership is calculated by dividing thenumber of shares beneficially owned by such person or group as described aboveby the sum of the 10,538,464 shares of common stock outstanding on March 24,2006 and the number of shares of common that such a person or group had theright to acquire on or within 60 days of the date, including but not limitedto, upon the exercise of options.

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(3)          State of WisconsinInvestment Board has sole voting power and sole dispositive power as to2,042,250 shares according to Schedule 13G/A filed with the Securities andExchange Commission on February 14, 2006.

(4)          Peter R. Kellogg hassole voting power and sole dispositive power as to 1,420,553 shares and sharedvoting power and shared dispositive power as to 360,700 shares according to theForm 4 filed with the Securities and Exchange Commission on October 25, 2004and the Schedule 13G/A filed with the Securities and Exchange Commission onFebruary 14, 2005. Of the 1,420,553 shares over which Mr. Kellogg has solevoting and dispositive power, 1,285,185 shares and 135,368 shares issuable uponconversion of E&S 6% convertible bonds are held by I.A.T. ReinsuranceCompany Ltd. (“IAT”), and its subsidiaries. IAT is a Bermuda corporation ofwhich Mr. Kellogg is the sole holder of voting stock and its director,president and chief executive officer. Of the 360,700 shares with respect towhich Mr. Kellogg shares voting and dispositive power, 359,700 shares areheld by Mr. Kellogg’s spouse, Cynthia Kellogg, and 1,000 shares are held by anIRA controlled by Mr. Kellogg and his wife. Mr. Kellogg has disclaimedbeneficial ownership of the shares held by his wife and by IAT and itssubsidiaries.

(5)          Wells Fargo &Company and its subsidiaries have sole voting power as to 1,554,738 shares andsole dispositive power as to 1,597,048 shares according to Schedule 13G/A filedwith the Securities and Exchange Commission on February 1, 2006. Wells Fargo& Company is the parent holding company of Wells Fargo Capital ManagementIncorporated and Wells Fargo Funds Management, LLC, both registered investmentadvisors. Wells Fargo Capital Management has sole voting power as to 368,932 sharesand sole dispositive power as to 1,543,995. Wells Fargo Funds Management, LLChas sole voting power as to 1,185,806 shares and sole dispositive power as to53,053 shares.

(6)          Royce & Associates,LLC has sole voting power and sole dispositive power as to 980,125 sharesaccording to Schedule 13G/A filed with the Securities and Exchange Commissionon January 20, 2006.

(7)          Dimensional FundAdvisors Inc. has sole voting power and sole dispositive power as to 625,458shares according to Schedule 13G/A filed with the Securities and ExchangeCommission on February 6, 2006. According to this filing, these shares areowned by certain investment companies, group trusts and accounts for whichDimensional Fund Advisors, an investment advisor, provides investment advice. AlthoughDimensional Fund Advisors possesses voting and/or investment power over theseshares, it has disclaimed beneficial ownership of those shares.

(8)          Includes 40,000 sharesissuable upon exercise of options exercisable within 60 days of March 24, 2006under E&S’s 2004 Plan and 1989 Stock Option Plan for Non-EmployeeDirectors.

(9)          Includes 50,000 sharesissuable upon exercise of options exercisable within 60 days of March 24, 2006under E&S’s 2004 Plan and 1989 Stock Option Plan for Non-EmployeeDirectors.

(10)   Includes 20,000 shares issuableupon exercise of options exercisable within 60 days of March 24, 2006 underE&S’s 2004 Plan.

(11)   Includes 307,103 sharesissuable upon exercise of options exercisable within 60 days of March 24, 2006under E&S’s 2004 Plan, 1998 Stock Options Plan and 1995 Long-Term IncentiveEquity Plan.

(12)   Includes 40,000 shares issuableupon exercise of options exercisable within 60 days of March 24, 2006 underE&S’s 2004 Plan and 1989 Stock Option Plan for Non-Employee Directors.

(13)   Includes 10,300 shares issuableupon exercise of options exercisable within 60 days of March 24, 2006 underE&S’s 2004 Plan.

(14)   Includes 79,602 shares issuableupon exercise of options exercisable within 60 days of March 24, 2006 underE&S’s 2004 Plan, 1998 Stock Options Plan and 1995 Long-Term IncentiveEquity Plan.

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(15)   Doesnot include any shares issuable upon exercise of option exercisable within 60days of March 24, 2006 under E&S’

**ITEM 13.**         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS

Mr. Coghlan is a director of Quest FlightTraining Limited. (“Quest”), a joint venture between E&S and Quadrant GroupLimited, of which Mr. Coghlan is also a non-executive chairman. Members ofMr. Coghlan’s family own an indirect beneficial ownership in a majority ofthe outstanding shares of Quadrant Group Limited. Mr. Coghlan hasdisclaimed any beneficial ownership in said interest in Quadrant Group Limited.

E&S and Quadrant Group Limited each own a 50%interest in Quest. E&S and Quadrant Systems Ltd., wholly owned by QuadrantGroup Limited, are under contract with Quest to provide certain services inorder for Quest to meet its contract requirements to provide turnkey trainingto the United Kingdom Royal Air Force and other third party training. E&Sand Quest entered into a twenty-five year contract requiring Evans &Sutherland to provide maintenance support to Quest for an annual base yearvalue adjusted for inflation each year. The current yearly contract value is£69,500 (approximately $120,000 as of December 31, 2005). Payments arepayable to Evans & Sutherland on a quarterly basis. In 2005, totalpayments made to E&S by Quest were approximately $145,000. In the currentand future years, payments are estimated to be £69,500 (approximately $120,000as of December 31, 2005) or slightly greater due to inflation adjustments.Quadrant Systems Ltd. and Quest entered into a twenty-five year contractrequiring Quadrant Systems Ltd. to provide engineering support for an annualbase year value adjusted for inflation each year. The current yearly contractvalue is £73,000 (approximately $126,000 as of December 31, 2005). If thetransaction between E&S and Rockwell Collins, as discussed in Part Iand Part II of this annual report on Form 10-K, is consummated,E&S will sell its interest in Quest to Rockwell Collins.

Mr. Hassis currently Managing Director of Lufthansa Flight Training Berlin GmbH. E&Shad sales to Lufthansa Flight Training Berlin GmbH during the years ended December 31,2003, 2004, and 2005 of $3,185,000, $3,944,000, and $3,554,000 respectively.

**ITEM 14.**         PRINCIPALACCOUNTANT FEES AND SERVICES

Thefollowing table shows the fees paid by the Company for audit, tax, and otherservices provided by KPMG LLP for fiscal years 2005 and 2004.

| ** **             | ** ** | **2005** | ** **                                                                | **2004** | ** ** |
|------------------------|------------|----------|---------------------------------------------------------------------------|----------|------------|
| Audit Fees(1)          |       | $        | 566,000                                                                   |     | $          | 365,000 |   |
| Audit-Related  Fees(2) |       | 32,000   |                                                                      | 52,000   |       |
| Tax Fees(3)            |       | 116,000  |                                                                      | 153,000  |       |
| All Other Fees(4)      |       | —   |                                                                      | —   |       |
|                   |       | $        | 714,000            |     | $          | 570,000 |   |

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(1)          Audit Fees representfees and expenses for professional services provided in connection with theaudit of the Company’s financial statements found in the annual report on Form 10-Kand reviews of the Company’s quarterly reports on Form 10-Q.

(2)          Audit-Related Feesprimarily consisted of fees and expenses for professional services provided inconnection with the audits of certain employee benefit plans; Securities andExchange Commission registration statements; and for research and consultationrelated to accounting, Securities and Exchange Commission, and Sarbanes-Oxleymatters.

(3)          Tax Fees consistedprimarily of fees and expenses for professional services related to taxcompliance and tax consulting.

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(4)          No other fees for otherservices were paid to KPMG.

The Audit Committee pre-approved all audit,audit-related and non-audit services performed by the Company’s independentauditors and subsequently reviewed the actual fees and expenses paid to KPMG.The Audit Committee has determined that the fees paid to KPMG for non-auditservices are compatible with maintaining KPMG’s independence as the Company’sauditors

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**PART IV**

**ITEM 15.**         EXHIBITSAND FINANCIAL STATEMENT SCHEDULES

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

1.                FinancialStatements

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

·        ConsolidatedBalance Sheets as of December 31, 2005 and 2004

·        ConsolidatedStatement of Operations for each of the years in the three-year period ended December 31,2005

·        ConsolidatedStatements of Stockholders’ Equity and Comprehensive Loss for each of the yearsin the three-year period ended December 31, 2005

·        ConsolidatedStatement of Cash Flows for each of the years in the three-year period ended December 31,2005

·        Notes to ConsolidatedFinancial Statements

2.                FinancialStatement Schedules

The following financialstatement schedule I filed as part of this report on Form 10-K.

·        ScheduleII—Valuation and Qualifying Accounts

Schedules otherthan those listed above are omitted because of the absence of conditions underwhich they are required or because the required information is presented in theconsolidated financial statements or the notes thereto.

3.                Exhibits

Articlesof 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.                                                                                                       |

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| 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. |
|-------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Instrumentsdefining the rights of security holders

| 4.1 | Form of  Rights Agreement, dated as of November 19, 1998, between  Evans & Sutherland Computer Corporation and American Stock Transfer  Trust Company which includes as Exhibit A, the form of Certificate of  Designation for the Rights, as Exhibit B, the form of Rights Certificate  and as Exhibit C, a Summary of Rights, filed as Exhibit 1 to  Evans & Sutherland Computer Corporation’s Registration Statement on  Form 8-A filed December 8, 1998, and incorporated herein by  this reference. |
|-----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.2 | First Amendment  to Rights Agreement dated as of June 7, 2000 between Evans &  Sutherland Computer Corporation and American Stock Transfer & Trust  Company, filed as Exhibit 10.14 to Evans & Sutherland Computer  Corporation’s Form 10-Q for the quarter ended June 30, 2000,  and incorporated herein by this reference.                                                                                                                                                                                        |
| 4.3 | Second Amendment  to Rights Agreement dated as of August 13, 2004 between Evans &  Sutherland Computer Corporation and American Stock Transfer & Trust  Company, filed as Exhibit 4.1 to Evans & Sutherland Computer  Corporation’s Form 8-K filed on August 16, 2004, and  incorporated herein by this reference.                                                                                                                                                                                                  |

 

Material contracts

Managementcontracts and compensatory 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.              |

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| 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 | Employment  agreement between Evans & Sutherland Computer Corporation and Kevin  A. Paprzycki, effective August 19, 2004, filed as Exhibit 10.13 to  Evans & Sutherland Computer Corporation’s Form 10-K for  the year ended December 31, 2004, and incorporated herein by reference.                     |
| 10.13 | Employment  agreement between Evans & Sutherland Computer Corporation and Kirk  Johnson, dated August 26, 2002, filed as Exhibit 10.14 to  Evans & Sutherland Computer Corporation’s Form 10-K for  the year ended December 31, 2004, and incorporated herein by reference.                               |

 

Othermaterial contracts

| 10.14 | 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. |
|-------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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| 10.15 | 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.                                                                                                                                                                                                                                                                |
|-------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.16 | 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.                                                                                                                                                                                    |
| 10.17 | 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.       |
| 10.18 | Asset Purchase  Agreement between Video Display Corporation and Evans & Sutherland  Computer Corporation, dated October 12, 2004, filed as  Exhibit 10.28 to Evans & Sutherland Computer Corporation’s Form 10-K  for the year ended December 31, 2004, and incorporated herein by  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.           |
| 10.19 | Credit Agreement  between Evans & Sutherland Computer Corporation and Wells Fargo  Bank, National Association effective December 1, 2004, filed as  Exhibit 10.29 to Evans & Sutherland Computer Corporation’s  Form 10-K for the year ended December 31, 2004, and  incorporated herein by reference.                                                                                                                                                                                                                                                  |
| 10.20 | Security  Agreement between Evans & Sutherland Computer Corporation and Wells  Fargo Bank, National Association effective December 1, 2004, filed as Exhibit 10.30  to Evans & Sutherland Computer Corporation’s Form 10-K  for the year ended December 31, 2004, and incorporated herein by  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. |
| 10.21 | Confidential  Settlement Agreement and Mutual Release, dated December 28, 2005, by and  between Evans & Sutherland Computer Corporation and Federal  Insurance Company, filed herein.                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.22 | Asset Purchase  Agreement, dated February 7, 2006, by and between Evans &  Sutherland Computer Corporation and Rockwell Collins, Inc. filed as  Exhibit 10.1 to Evans & Sutherland Computer Corporation’s Form 8-K  filed February 9, 2006, and incorporated herein by this reference.                                                                                                                                                                                                                                                             |
| 10.23 | Stock Purchase  Agreement, dated February 7, 2006, by and among Evans &  Sutherland Computer Corporation, Spitz, Inc., and Transnational  Industries, Inc. filed as Exhibit 10.2 to Evans &  Sutherland Computer Corporation’s Form 8-K filed February 9,  2006, and incorporated herein by this reference.                                                                                                                                                                                                                                   |

 

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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. |
|------|--------------------------------------------------------------------------|

 

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. |
|------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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

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

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**SCHEDULEII—VALUATION AND QUALIFYING ACCOUNTSEvans & 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**                | ** ** |
| ***Accrued  liquidated damages and penalties*** |       |                  |       |                      |       |            |       |                    |       |   |   |   |   |   |   |   |   |
| December 31,  2005                         |       |                  | $          | 562                       |       |            |       | $                       | —     |   |   |   | $ | (197 | ) |   |   | $ | 365 |   |   |
| December 31,  2004                         |       |                  | 1,734      |                      |       |            | 115        |                    |       |   | (1,287 | ) |   |   | 562 |   |   |
| December 31, 2003                          |       |                  | 1,050      |                      |       |            | 1,850      |                    |       |   | (1,166 | ) |   |   | 1,734 |   |   |
|                                                 |            |                       |            |                           |            |                 |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.

|        | EVANS &  SUTHERLAND COMPUTER CORPORATION |
|--------|---------------------------------------------------|
|   | By                                                | /s/ JAMES R. OYLER |
|   |                                              | James R. Oyler |
|   |                                              | Chief Executive Officer and Director |

 

March 30, 2006

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

| Signature                      | ** ** | **Title**                                                       | ** ** | **Date**             |
|--------------------------------|------------|-----------------------------------------------------------------|------------|----------------------|
| /s/JAMES R. OYLER              |       | Chief  Executive Officer and Director                           |       | March 30,  2006 |
| James R. Oyler                 |       | (Principal Executive  Officer)                                  |       |                 |
| /s/LANCE SESSIONS              |       | Acting  Chief Financial Officer                                 |       | March 30,  2006 |
| Lance Sessions                 |       | (Principal  Financial Officer and Principal Accounting Officer) |       |                 |
| /s/DAVID J. COGHLAN            |       | Chairman  of the Board                                          |       | March 30,  2006 |
| David J. Coghlan               |       |                                                            |       |                 |
| /s/WOLF-DIETER HASS            |       | Director                                                        |       | March 30,  2006 |
| Wolf-Dieter Hass               |       |                                                            |       |                 |
| /s/WILLIAM SCHNEIDER, JR. |       | Director                                                        |       | March 30,  2006 |
| William  Schneider, Jr.   |       |                                                            |       |                 |
| /s/JAMES P. MCCARTHY           |       | Director                                                        |       | March 30,  2006 |
| James P. McCarthy              |       |                                                            |       |                 |

 

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