**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

**FORM 10-K/A**

**(Mark One)**

**x**                              ANNUALREPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF1934

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

**o**                                 TRANSITIONREPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF1934

**Forthe transition period from               to               **

**CommissionFile No. 001-33253**

**FORCE PROTECTION, INC.**

(Exact name of issuer asspecified in its charter)

| **Nevada**                                                       |   | **84-1383888**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
| **9801 Highway 78, Building No. 1, Ladson, SC**             |   | **29456**                             |
| (Address of  principal executive offices)                        |   | (Zip Code)                            |

 

Registrant’s telephonenumber, including area code: **(843) 740-7015**

Securities registeredunder Section 12(b) of the Exchange Act:

| **Common Stock, par value $0.001 per share.** |   | **NASDAQ  Stock Market**                     |
|-----------------------------------------------|--------|----------------------------------------------|
| (Title of class)                              |   | (Name of Each  Exchange On Which Registered) |

 

Securities registeredunder Section 12(g) of the Exchange Act: **None.**

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act. o

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or15(d) of the Act. Yes o  No x

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

Indicate by check mark ifdisclosure of delinquent filers in response to Item 405 of Regulation S-K(§229.405 of this chapter) is not contained in this form, and no disclosurewill be contained, to the best of registrant’s knowledge, in definitive proxyor information statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K. o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. (Check one).

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

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes o  No x

The aggregate market valueof the voting and non-voting common equity held by non-affiliates as of March 14,2007 was $1,102,410,688 based on a total of 66,934,468 shares of our commonstock held by non-affiliates on March 14, 2007 at the closing price of$16.47 per share.

We had 67,817,003 sharesof common stock outstanding as of March 14, 2007.

Documentsincorporated by reference: Part III incorporates information from certainportions of the registrant’s definitive proxy statement for the 2007 annualmeeting of shareholders to be filed with the Securities and Exchange Commissionwithin 120 days after the close of the fiscal year.

 

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**FORCE PROTECTION,INC. FORM 10-K**

**TABLEOF CONTENTS**
| Part I   |   |                                                                                             |   |
|---------------|--------|--------------------------------------------------------------------------------------------------|--------|
| Item 1.  |   | Business                                                                                         | 3      |
| Item 1A.      |   | Risk  Factors                                                                                    | 9      |
| Item 1B.      |   | Unresolved Staff Comments                                                                        | 12     |
| Item 2.       |   | Properties                                                                                       | 12     |
| Item  3.      |   | Legal  Proceedings                                                                               | 13     |
| Item 4.       |   | Submission of Matters to a Vote of Security Holders                                              | 14     |
| Part II  |   |                                                                                             |   |
| Item 5.       |   | Market for Common Equity, Related Stockholder Matters  and Issuer Purchases of Equity Securities | 14     |
| Item 6.       |   | Selected Financial Data                                                                          | 16     |
| Item 7.       |   | Management’s Discussion and Analysis of Financial  Condition and Results of Operations      | 17     |
| Item 7A.      |   | Quantitative and Qualitative Disclosures About Market  Risk                                      | 24     |
| Item 8.       |   | Financial Statements and Supplementary Data                                                      | 25     |
| Item 9.       |   | Changes In and Disagreements With Accountants on  Accounting and Financial Disclosure            | 63     |
| Item 9A.      |   | Control and Procedures                                                                           | 64     |
| Item  9B.     |   | Other  Information                                                                               | 64     |
| Part III |   |                                                                                             |   |
| Item 10.      |   | Directors, Executive Officers and Corporate Governance                                           | 64     |
| Item 11.      |   | Executive Compensation                                                                           | 64     |
| Item 12.      |   | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters  | 65     |
| Item 13.      |   | Certain Relationships and Related Transactions, and  Director Independence                       | 65     |
| Item 14.      |   | Principal Accountant Fees and Services                                                           | 65     |
| Part IV  |   |                                                                                             |   |
| Item 15.      |   | Exhibits, Financial Statement Schedules                                                          | 65     |
|          |   | Signatures                                                                                       | 70     |

 

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**PART I**

**ITEM 1.**                BUSINESS

*Business Overview*

We organized under the laws of the State of Coloradoin November 1996. In June 2002, we acquired Technical Solutions Group, Inc.,a development stage manufacturer of ballistic and blast protected vehiclesbased in Charleston, South Carolina. In August 2003, we changed our nameto Force Protection, Inc. to better reflect our focus on blast andmine-protected vehicles. Effective January 1, 2005, we reincorporated fromColorado to Nevada and changed the name of our wholly-owned subsidiary to “ForceProtection Industries, Inc.”

Our specialty vehicles areprotected against landmines, hostile fire and Improvised Explosive Devices orIEDs, commonly referred to as roadside bombs. We believe our mine and ballisticprotection technology is among the most advanced in the world. Our facility,located 10 miles from the Charleston Air Force Base in Ladson, South Carolina,is on a 260-acre campus comprised of three manufacturing buildings with acombined floor area of approximately 452,240 square feet and an additional90,000 square feet targeted for occupancy in mid 2007. At December 31,2006, we employed 658 employees.

*INDUSTRY OVERVIEW*

Mine Protected Vehicles were initially developed inRhodesia and South Africa in response to the landmine problems arising from thewars in Southern Africa. The vehicles were designed to protect personnel duringtransport, removal of unexploded ordnance, route clearance, humanitariande-mining, and other missions that require protection from landmines andhostile fire. The technology has been developed and used in several parts ofthe world, principally Africa, over the last 20 years in response to theintense use of landmines in that region.

We believe the world market for mine-protectedvehicles is growing rapidly. Landmines and IEDs are weapons of choice forterrorists and insurgent groups because they are highly effective yet haverelatively low cost. The global war on terror, especially in Iraq andAfghanistan, has confirmed the sober reality that IEDs, roadside bombs, andland mines will continue to be a significant danger to troops. Vehicles thatmove troops or ordnance economically and provide significant protection againstballistic, incendiary, landmine hazards, and IEDs are useful in these situations.Missions include troop transport in and around unexploded ordnance or minethreat areas as well as route clearance and humanitarian de-mining whichrequire entrance into known mine fields or areas of known terrorist activities.

These missions requireoperating in areas of known terrorist activities and have traditionally beenaccomplished using light weight wheeled utility vehicles, including for examplethe High Mobility Multi Wheeled Vehicle or Humvee. However, Humvees were notdesigned to sustain high powered explosive blasts and these un-armored utilityvehicles are vulnerable to enemy fire and offer a prime target for attack. Inresponse to the increasing number of casualties from IEDs and other explosiveduring Operation Enduring Freedom in Afghanistan and Operation Iraqi Freedom,the U.S. has sought to rapidly increase the armor and blast protection of manyof its vehicle fleet, including the Humvee, by retrofitting heavy armor to thehulls of these normally lightly armored vehicles. The results have not beensatisfactory due in part to the high costs of retrofitting armor into the bodyof the vehicles and the increased mechanical wear caused by the added weight.

*Products*

We currently produce threeblast-protected vehicles with different mission capabilities: (1) theBuffalo series, (2) the Cougar series and (3) the Cheetah series.

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*The Buffalo series*

The Buffalo can be configured for multiple missionsand is specifically designed to be repaired in the field. Cutting-edgetechnology combined with the best American automotive components give thisvehicle the maximum visibility, load carrying capacity, interior space andparts availability of any vehicle in its class. The Buffalo is our heaviestvehicle—weighing 22 tons—and is designed principally for route clearingactivities. It integrates a blast resistant capsule with an American-made truckengine and drive train. The Buffalo is designed to deflect and dissipate theexplosive blast away from the passenger compartment, thus protecting the occupantsfrom harm.

We believe that the geometric, V-hull design, alongwith the materials used, the components selected, our relationship withcritical component suppliers and the overall manufacturing process make ourvehicles a desirable solution for blast and ballistic protected vehicles.

The U.S. Army tested theBuffalo at the Aberdeen Proving Grounds to determine its measure of “survivability”—i.e.the ability of the Buffalo’s blast capsule to effectively protect the occupantsand the critical automotive components from the effects of explosive blasts.Following such tests, the U.S. Army has ordered and deployed approximately 77Buffalos for service worldwide, and has announced its desire to use the Buffaloin the newly established “Route Clearance Companies” being developed as part ofthe IED Defeat Task Force. We believe that the Buffalo fills a niche in theU.S. Army’s route clearance systems.

*The Cougar series*

The Cougar is a family of medium mine-protectedvehicles which can be supplied in 4X4 or 6X6 layout. It can be configured asseveral different variants for a wide range of tasks as required by ourcustomers. These tasks include troop transport (up to 12 in the 6X6), ExplosiveOrdinance Disposal or EOD (4 troops and a large EOD robot in the 4X4), commandand control, artillery prime mover, recovery and ambulance duty. There areseveral variants including the Iraqi Light Armored Vehicle or, ILAV Cougar,being produced for the Iraqi National Army, and the Mastiff Cougar vehicle thatis being produced for the British Ministry of Defense.

Launched in 2004, theCougar was designed to serve a broader market and mission range than theBuffalo. Its missions include urban patrol, route clearance support, utilitytransport and special unit activities. Like the Buffalo, the Cougar employs thegeometric V-Hull design to deflect blast energy along with an armored steelcapsule affording ballistic protection, and while lighter than the Buffalo, itoffers a similar level of blast protection. The Cougar uses a standard Americanautomotive drive train and control components which allow service andmaintenance similar to that of a commercial truck, making servicing the Cougarless expensive and easier to maintain. We have produced approximately 304Cougars through December 31, 2006, all of which have been deployed inactive service.

*The Cheetah series*

The Cheetah is our newestvehicle series. It is designed specifically for reconnaissance, forward commandand control, urban operations, and combines state-of-the-art ballistic andblast protection with the mobility of a unique light-armored vehicle. The U.S.military is planning to start replacement of the Humvee fleet in the 2009-2011timeframe under the Joint Light Tactical Vehicle, or JLTV, program with hopesof accelerating the program to early 2008. The Cheetah is being developed as apotential platform for this market. Its speed and road handling make it idealfor homeland security missions. Given the size of the potential market forreplacing the Humvee fleet that we believe to be in excess of 200,000 vehicles,it is a fair certainty that there will be strong competition from across theU.S. defense industrial base as well as from international companies for theJLTV program.

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*CUSTOMER ACTIVITY*

Our primary customer is the U.S. Department of Defensewhere we service two principal services, the U.S. Army and the U.S. MarineCorps. In the twelve months ended December 31, 2006, approximately 59.2%of our revenues were derived directly or indirectly from the U.S. Army andapproximately 14.3% from the U.S. Marine Corps. Additionally, 10.5% of ourrevenues were sales to foreign governments via the U.S. Department of Defense.We expect to continue to depend upon contracts with governmental agencies for asubstantial portion of our revenue for the foreseeable future. In 2006, we alsoentered into contracts with the U.S. Department of Defense to provide vehiclesfor the Iraqi Army and the British Military of Defense through the Departmentof Defense’s Foreign Military Sales section. The vehicle design for the IraqiArmy is based on our Cougar design and is proprietary to Force Protection. Wehave field service representatives deployed to Iraq in support of this program.

Thefollowing chart illustrates our product deliveries in the last two calendaryears and our backlog as of December 31, 2006:

| **Vehicle**            | ** ** | ** ** | ** ** | **2005** | ** ** | **2006** | ** ** | **Backlog** | ** ** |
|------------------------|------------|------------|------------|----------|------------|----------|------------|-------------|------------|
| Buffalo                |       |       | 31         |     |       |     | 26         |        |       |   | 59 |   |   |
| Cougar HEV             |       |       | 22         |     |       |     | 1          |        |       |   | 0 |   |   |
| Cougar JERRV           |       |       | 18         |     |       |     | 173        |        |       |   | 8 |   |   |
| Cougar MRAP            |       |       | 0          |     |       |     | 0          |        |       |   | 200 |   |   |
| ILAV (Iraq)            |       |       | 0          |     |       |     | 55         |        |       |   | 102 |   |   |
| Mastiff (British  MOD) |       |       | 0          |     |       |     | 30         |        |       |   | 55 |   |   |
| Total                  |       |       | 71         |     |       |     | 285        |        |       |   | 424 |   |   |

 

The U.S. Military has indicated that it is beginningto transition away from the Humvee towards armored vehicles that will offergreater protection to the men and women of our armed forces. As part of thistransition, the U.S. Marine Corps is managing the Mine Resistant AmbushProtected, or MRAP, Program for all branches of the U.S. Military and, as partof that program, is demanding vehicles that offer more effective protection forthe servicemen and service women of the U.S. armed forces. Under the MRAPProgram, we have submitted bids through Requests for Proposals, or RFPs, to theU.S. Marine Corps for three different categories of armored vehicles. CategoryI vehicles need to transport no less than six personnel and will be used inurban operations. The U.S. Marine Corps expects to purchase a minimum of 1,500Category I vehicles with an option to buy an additional 7,500 vehicles. Our 4x4Cougar design and our Cheetah design both meet the requirements for vehicles inthis Category. The U.S. Marine Corps have also released an RFP to purchase2,600 Category II vehicles with an option to buy as many as 13,000 vehicles.The Category II vehicles need to transport no less than ten personnel and willhave multi-mission purposes including transport, explosive ordnance disposaland combat engineering. We believe the U.S. Marine Corps will continue tofavorably consider our 6x6 Cougar to meet their demands in this category. InCategory III of the MRAP Program, the Marines have already sole sourced 44vehicles to Force Protection as part of the agreement of November 9, 2006,with an option to buy an additional 36 vehicles. The Category III vehiclesneed to transport no less than twelve personnel and will support routeclearance.

In addition, the U.S. Armyis also in the process of improving its fleet of armored vehicles under theGround Standoff Mine Detection System, or GSTAMIDS, Program. Contracts underthis existing and funded program are to be awarded for two types of vehicles,the Mine Protected Clearance Vehicle, or MPCV, and the Medium Mine ProtectedVehicle, or MMPV. Our Buffalo vehicle meets the Army’s MPCV specifications andour Cougar JERRV meets the specifications for the MMPV. The Army has a requirementfor approximately 180 MPCVs and over 600 MMPVs at a total estimated value of$1.4 billion.

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*COMPETITIVEPOSITIONING*

We are subject to significant competition fromcompanies that market products that perform similar functions to our products.This competition could harm our ability to win business and increase the pricepressure on our products. The firms we compete against include large,multinational vehicle, defense and aerospace firms such as BAE Land Systems,Textron, Armor Holdings, International Truck, OshKosh Truck, Australian DefenseIndustries and General Dynamics. Most of our competitors have considerablygreater financial, marketing and technological resources than we do that maymake it difficult to win new contracts and we may not be able to competesuccessfully. Certain competitors operate fabrication facilities and havelonger operating histories and presence in key markets, greater namerecognition, larger customer bases and significantly greater financial, salesand marketing, manufacturing, distribution, technical and other resources. As aresult, these competitors may be able to adapt more quickly to new or emergingtechnologies and changes in customer requirements. They may also be able todevote greater resources to the promotion and sale of their products.

We believe ourcompetitive advantages include:

·       The level of blast and ballistic protectionincorporated into our vehicles;

·       Our vehicles are currently deployed in Iraq andAfghanistan and are creating a track record of performance;

·       Our ability to innovate;

·       The high level of supportability of ourvehicles;

·       Our “Made in America” status;

·       Our excellent manufacturing facilities; and

·       The prior testing and acceptance of our designsby the U.S. Military.

We believe our products are superior to other vehiclescurrently in use by the U.S. military for mine and blast protection. Existingmilitary vehicles include Humvees and other non-armored utility supportvehicles, or heavy-weight troop transport and offensive armor such as theBradley Fighting Vehicle the (“Bradley”) or the M1A1 Abrams Tank (the “Abrams”).The un-armored utility vehicles offer a prime target for attack and efforts to “up-armor”these vehicles have not been totally successful due to the high costsassociated with retrofitting armor onto the body of the vehicle and theincreased mechanical wear caused by the weight of the armor. Conventionalarmored vehicles such as the Bradley and the Abrams offer protection fromballistic and blast threats, but are expensive, require substantial resourcesto maintain, are large and difficult to maneuver in crowded urban environmentsand are not well-suited to peace keeping missions due to their intimidatingoffensive weapon systems.

As recent events haveshown, there is also an increasing concern over death or injury of U.S.military personnel during operations such as Operation Iraqi Freedom andOperation Enduring Freedom, particularly to reservists and or civiliancontractors who are not expected to face front line combat, but whoincreasingly have become the target of insurgents and terrorists. Theseconcerns have led the U.S. military to adopt armor protection as a baserequirement for many of its transport vehicles and to look for ways to defeatthe threat of IEDs and other booby trap devices, including developing “routeclearance” and other explosive detection and removal teams.

*FORCE DYNAMICS LLC*

On December 15, 2006, we entered into a jointventure agreement with General Dynamics Land Systems Inc., pursuant to which weagreed to work together to win and execute contracts for the MRAP Program, aU.S. joint services program to produce and provide lifecycle support to addressthe current threat of IEDs 

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in the Middle East, as more fully described insolicitation number M67854-07-R-5000 issued by the Departmentof the Navy and the U.S. Marine Corps. Together with General Dynamics LandSystems, we formed a new Delaware limited liability company named ForceDynamics, LLC whose purpose will be to win contracts under the MRAP Program.Under the joint venture agreement, the MRAP Program is defined to include anyand all solicitations and requests for proposals for MRAP production andLifecycle Support and/or any follow up work that may be performed including anyprogram name change, changed or future program requirements, product evolutionsand technology insertions related to the MRAP vehicles whether for U.S. orinternational sales, or non-military/commercial sales. The scope of work to beundertaken by Force Dynamics is limited to the use of our Cougar 4x4 and6x6 armored vehicles for the MRAP Category I and Category II requirements.

Our intent, along with that of General Dynamics LandSystems, as declared in the joint venture agreement, is to combine respectivestrengths to market and promote our Cougar vehicles for the Category I andCategory II requirements of the MRAP Program. We will make available to eachother our respective resources so that together, we may undertake to develop,manufacture, produce and sustain any vehicle contracts awarded under the MRAPprogram, in accordance with the plan set forth in the joint venture agreement. Bothparties are expected to contribute resources equally to the venture, to shareequally the costs and responsibilities associated with the performance of the jointventure and to share equally the resulting benefits. To this end, we agreed todivide the joint venture work between us on a 50%/50% basis and to dividerevenues from the joint venture on the basis of 50% for General Dynamics LandSystems and 50% for us. Whenever practicable, Force Dynamics will act as theprime contractor for joint venture work, and we, along with General DynamicsLand Systems, shall act as the exclusive subcontractors; provided however thatForce Dynamics, General Dynamics Land Systems and we intend to give effect tothe production plan consistent with the undertaking of the Agreement.

As of March 12, 2007,we have received two contract awards under the MRAP program for vehicles thatare to be manufactured by Force Dynamics. On January 25, 2007, we receiveda four-vehicle letter contract from the U.S. Marine Corps for testing,production and sustainability for the MRAP vehicle program. Subsequently, on February 14,2007, we received an additional contract award from the U.S. Marine Corps for125 vehicles as part of the MRAP vehicle program. The contract award has atotal value of approximately $67 million. Under the contract award, ForceDynamics will produce 65 vehicles for Category I and 60 vehicles for CategoryII of the MRAP program.

*PRODUCTION*

Our manufacturingprocess includes production and/or assembly of all critical components of ourvehicles as follows:

·       We utilize proprietary technology to designballistic and blast protected vehicle capsules that we believe are capable ofwithstanding the explosive effects of landmines, IEDs and other blast threatsencountered in wars, insurgency and urban conflicts.

·       We integrate commercial American-made automotivedrive-trains and other components onto the capsules to produce vehicles thathave a high level of commonality with the existing U.S. military fleet and canbe repaired and maintained by traditional truck mechanics.

·       We have also secured sufficient tools andequipment, and have access to a local pool of labor, including many skilledwelders and skilled automotive mechanics.

·       We maintain a dedicated staff of engineers toprovide in-house engineering support and utilize various manufacturingapproaches to increase efficiency and product quality.

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·       We source steel and otherraw materials from various key vendors in the United States and overseas, andsecure our automotive components from a variety of U.S. suppliers including:Caterpillar; Mack Trucks, a member of the Volvo Group; and AllisonTransmission.

*SALES AND MARKETING*

Our employees, including senior management and theVice President of Sales, conduct our primary sales and marketing efforts.Currently our primary sales staff resides in South Carolina and Connecticut,but we also have agreements in place for exclusive marketing agents instrategic foreign countries.

We actively participate inshows involving countermine operations and technology, military vehicle, lawenforcement technology and military force protection including the Associationof the U.S. Army Annual Conference and Winter Symposium, Marine Expo, andTactical Wheeled Vehicle conferences. Additionally, our marketing effortsinclude our web site, some advertising focused on the military community andbrochures. We do not use independent referral sources to assist in identifyingopportunities for our products and services and we do not pay any referral feesor sales commissions.

*RESEARCH ANDDEVELOPMENT*

In 2006, 2005, and 2004 wespent $3,204,165, $1,657,918 and $1,230,290, respectively, on research anddevelopment. None of our research and development costs were funded by ourcustomers.

*RAW MATERIALS*

We depend on suppliers andsubcontractors for raw materials and components. These supply networks canexperience price fluctuations and capacity constraints. Raw materials canexperience cost growth, which would put pressure on pricing. We have notexperienced, and do not foresee, significant difficulties in obtaining thematerials, components or supplies necessary for our business operations.

*INTELLECTUAL PROPERTY*

We are party to two long term intellectual propertyagreements covering technology used in the production of our ballistic andblast protected vehicles. One agreement is with the CSIR Defencetek, a divisionof the Council for Scientific and Industrial Research, a statutory councilestablished in accordance with the Laws of the Republic of South Africa. Theother is with Mechem, a division of Denel Pty Ltd, a company established inaccordance with the Laws of the Republic of South Africa. Under theseagreements, we pay a per vehicle fee in exchange for the exclusive transfer tous of the South African technology used in certain of our products.

On September 28,2006, we extended our period of exclusive cooperation and the payment ofvehicle fees to Mechem for an additional five years through September 2011.Pursuant to the terms of the agreement we will pay Mechem a fee of $1,500 foreach Cougar vehicle, or variant thereof, that we deliver, and $5,000 for eachBuffalo vehicle, or variant thereof, that we deliver.

*PERSONNEL*

As of December 31,2006, we had a total of 658 employees, 612 in the U.S. and 46 located invarious foreign countries in support of our vehicles and troops. Employees canbe broken down into 396 hourly employees and 262 salaried employees. We are nota party to any collective bargaining agreement. We believe our relations withemployees are good.

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*ENVIRONMENTALMATTERS*

We are subject to federal,state, local and foreign laws and regulations regarding protection of theenvironment, including air, water, and soil. Our manufacturing businessinvolves the use, handling, storage, and contracting for recycling or disposalof hazardous or toxic substances or wastes, including environmentally sensitivematerials, such as batteries, solvents, lubricants, degreasing agents, gasolineand resin. We must comply with certain requirements for the use, management,handling, and disposal of these materials. We do not, however, maintaininsurance for pollutant cleanup and removal. If we are found responsible forany hazardous contamination, any fines or penalties we may be required to payor any clean up we are required to perform, could be very costly. Even if weare charged, and later found not responsible, for such contamination or cleanup the cost of defending the charges could be high. If either of the foregoingoccurs, our business, results from operations and financial condition could bematerially adversely affected. We do not believe we have any materialenvironmental liabilities or that compliance with environmental laws,ordinances, and regulations will, individually or in the aggregate, have amaterial adverse effect on our business, financial condition, or results ofoperations.

*OTHER REGULATORYMATTERS*

Our operations and products are subject to extensivegovernment regulation, supervision, and licensing under various federal, state,local and foreign statutes, ordinances and regulations. Certain governmentalagencies such as the Environmental Protection Agency, or EPA, and theOccupational Safety and Health Administration, or OSHA, monitor our compliancewith their regulations, require us to file periodic reports, inspect ourfacilities and products, and may impose substantial penalties for violations ofthe regulations.

While we believe that we maintainall requisite licenses and permits and are in compliance with all applicablefederal, state, local and foreign regulations, there can be no assurance thatwe will be able to maintain all requisite licenses and permits. The failure tosatisfy those and other regulatory requirements could have a materially adverseeffect on our business, financial condition, and results of operations.

**ITEM 1A.**        RISKFACTORS

An investment in ourcommon stock is subject to risks and uncertainties. Investors should considerthe following factors, in addition to the other information contained orincorporated by reference in this Annual Report on Form 10-K, aswell as our other filings with the SEC, before deciding to purchase oursecurities.

**We depend on theU.S. government for a substantial amount of our sales. If we do not findacceptance of our products within the U.S. government, our business may fail.**

We serve the defense market and our sales are highlyconcentrated within the U.S. government. The customer relationship with theU.S. government involves certain risks that are unique such as the ongoingdevelopment of high-technology products, price, availability and quality ofmaterials and suppliers.

U.S. defense spending hashistorically been cyclical. Defense budgets have received their strongestsupport when perceived threats to national security raise the level of concernover the country’s safety. As these threats subside, spending on the militarytends to decrease. Accordingly, while Department of Defense funding has grownrapidly over the past few years, there is no assurance that this trend willcontinue. Rising budget deficits, the cost of the Global War on Terrorism andincreasing costs for domestic programs continue to put pressure on all areas ofdiscretionary spending, which could ultimately impact the defense budget.Wartime support for defense spending could wane if the country’s troopdeployments in support of operations in Iraq and Afghanistan are reduced. Adecrease in U.S. government defense spending or changes in spending allocationcould result in one or more of our programs being reduced, delayed or 

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terminated. Reductions inour existing programs, unless offset by other programs and opportunities, couldadversely affect our ability to sustain and grow our future sales and earnings.

**U.S. governmentcontracts generally are not fully funded at inception and are subject totermination. If the U.S. government does not order as many vehicles as weanticipate, our business will be adversely affected.**

Government contracts and subcontracts typicallyinvolve long purchase and payment cycles, competitive bidding, qualificationrequirements, delays or changes in funding, extensive specificationdevelopment, price negotiations and milestone requirements. Each governmentagency also maintains its own rules and regulations with which we mustcomply and which can vary significantly among agencies. Governmental agenciesalso often retain some portion of fees payable upon completion of a project andcollection of these fees may be delayed for several months or even years, insome instances.

In addition, an increasing number of governmentcontracts are fixed price contracts which may prevent us from recovering costsincurred in excess of our budgeted costs. Fixed price contracts require us toestimate the total project cost based on preliminary projections of the project’srequirements. The financial viability of any given project depends in largepart on our ability to estimate such costs accurately and complete the projecton a timely basis. In the event actual costs exceed the fixed contractual cost,we may not be able to recover the excess costs.

Some government contractsare also subject to termination or renegotiation at the convenience of thegovernment, which could result in a large decline in revenue in any givenquarter. Although government contracts have provisions providing for thereimbursement of costs associated with termination, the termination of amaterial contract at a time when our funded backlog does not permitredeployment of staff could result in a reduction in the number of employees.In addition, the timing of payments from government contracts is also subjectto significant fluctuation and potential delay, depending on the governmentagency involved. Any such delay could result in a temporary shortage in workingcapital.

**We must comply withenvironmental regulations or we may have to pay expensive penalties or clean upcosts.**

We are subject to federal,state, local and foreign laws, and regulations regarding protection of theenvironment, including air, water, and soil. Our manufacturing businessinvolves the use, handling, storage, and contracting for recycling or disposalof, hazardous or toxic substances or wastes, including environmentally sensitivematerials, such as batteries, solvents, lubricants, degreasing agents, gasolineand resin. We must comply with certain requirements for the use, management,handling, and disposal of these materials. We do not maintain insurance forpollutant cleanup and removal. If we are found responsible for any hazardouscontamination, we may have to pay expensive fines or penalties or performcostly clean-up. Even if we are charged, and later found not responsible, forsuch contamination or clean up, the cost of defending the charges could behigh. If we do not comply with government regulations, we may be unable to shipour products or have to pay expensive fines or penalties. We are subject toregulation by county, state and federal governments, governmental agencies, andregulatory authorities from several different countries. If we fail to obtainregulatory approvals or suffer delays in obtaining regulatory approvals, we maynot be able to market our products and services, and generate product andservice revenues. Further, we may not be able to obtain necessary regulatoryapprovals. Although we do not anticipate problems satisfying any of theregulations involved, we cannot foresee the possibility of new regulations,which could adversely affect our business. Further our products are subject toexport limitations and we may be prevented from shipping our products tocertain nations or buyers.

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**Our earnings andmargins depend on our ability to perform under our contracts and if we do notperform our margins may erode.**

Our contracts requiremanagement to make various assumptions and projections about the outcome offuture events over a period of several years. These projections can includefuture labor productivity and availability, the nature and complexity of thework to be performed, the cost and availability of materials, the impact ofdelayed performance, and the timing of product deliveries. If there is asignificant change in one or more of these assumptions, circumstances orestimates, or if we are unable to control the costs incurred in performingunder these contracts, the profitability of one or more of these contracts maybe adversely affected.

**If the pricing andavailability of subcontractor performance and raw materials change, ourprofitability may be adversely affected.**

We rely on subcontractorsand other companies to provide raw materials, major components and subsystemsfor our products or to perform a portion of the services that we provide to ourcustomers. Occasionally we rely on only one or two sources of supply, which, ifdisrupted, could have an adverse effect on our ability to meet our commitmentsto customers. We depend on these subcontractors and vendors to fulfill ourcontractual obligations in a timely and satisfactory manner in full compliance withcustomer requirements. If one or more of our subcontractors or suppliers areunable to satisfactorily provide on a timely basis the agreed-upon supplies orperform the agreed-upon services, our ability to perform our obligations as aprime contractor may be adversely affected.

**Some of our productcomponents are manufactured in other foreign countries and if any of thosebecome unstable or government regulations change, our costs may increase or wemay become unable to source certain parts.**

Some of our productcomponents are manufactured in and supplied from other foreign countries. Ifimport tariffs or taxes increase for any reason, our cost of goods wouldincrease. Our financial performance may be affected by changes in political,social and economic environment. The role of the central and local governmentsin the economy is significant. Policies toward economic liberalization, andlaws and policies affecting foreign companies, foreign investment, currencyexchange rates and other matters could change, resulting in greaterrestrictions on our ability to do business with suppliers based in othercountries. The government could impose surcharges, increase tax rates, orrevoke, terminate or suspend operating licenses without compensating us. Also,other countries, from time to time, experience instances of civil unrest andhostilities. Confrontations have occurred between the military, insurgentforces, and civilians. If for these or any other reason, we lose our ability tosub-contract or manufacture the components to our products, or the cost ofdoing business increases, our business, financial condition, and results ofoperations would be materially and adversely affected.

**We may be subjectto personal liability claims for our products and if our insurance is notsufficient to cover such claims, our expenses may increase substantially.**

As a result, a significantlawsuit could adversely affect our business. We may be exposed to liability forpersonal injury or property damage claims relating to the use of the products.Any future claim against us for personal injury or property damage couldmaterially adversely affect the business, financial condition, and results ofoperations and result in negative publicity. Even if we are not found liable,the costs of defending a lawsuit can be high. We do not currently maintaininsurance for this type of liability. Additionally, even if we do purchaseinsurance, we may experience legal claims outside of our insurance coverage, orin excess of our insurance coverage, or that insurance will not cover.

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**We must develop newtechnologies and maintain a qualified workforce in order to remain competitive.**

Virtually all of theproducts we produce and sell are highly engineered and require sophisticatedmanufacturing and system integration techniques and capabilities. Governmentmarkets in which the company operates are characterized by rapidly changingtechnologies. The product and program needs of our government customers changeand evolve regularly. Accordingly, our future performance in part depends onour ability to identify emerging technological trends, develop and manufacturecompetitive products, and bring those products to market quickly atcost-effective prices. In addition, because of the highly specialized nature ofour business, we must be able to hire and retain the skilled and appropriatelyqualified personnel necessary to perform the services required by ourcustomers. If we are unable to develop new products that meet customers’changing needs or successfully attract and retain qualified personnel, futuresales and earnings may be adversely affected.

**We rely onproprietary designs and rights and if we have to litigate those rights, ourexpenses could substantially increase.**

Our success and ability tocompete depend, in part, on the protection of our designs and technology. Inaddition, our technology could infringe on patents or proprietary rights ofothers. We have not undertaken or conducted any comprehensive patentinfringement searches or studies. If any third parties hold any conflictingrights, we may be required to stop making, using or selling our products or toobtain licenses from and pay royalties to others. Further, in such event, wemay not be able to obtain or maintain any such licenses on acceptable terms, ifat all. We may need to engage in future litigation to enforce intellectualproperty rights or the rights of customers, to protect trade secrets or todetermine the validity and scope of proprietary rights of others, includingcustomers. This litigation could result in substantial costs and diversion ofresources and could materially and adversely affect our results of operations.

**Failure to maintaineffective internal controls in accordance with section 404 of theSarbanes-Oxley Act could have an adverse effect on our business and stockprice.**

Section 404 of theSarbanes-Oxley Act requires us to evaluate annually the effectiveness of ourinternal controls over financial reporting as of the end of each fiscal yearand to include a management report assessing the effectiveness of our internalcontrols over financial reporting in our annual report on Form 10-K.Section 404 also requires our independent registered public accountingfirm to attest to, and report on, management’s assessment of our internal controlsover financial reporting. If we fail to maintain the adequacy of our internalcontrols, as such standards are modified, supplemented or amended from time totime, we cannot assure you that we will be able to conclude in the future thatwe have effective internal controls over financial reporting in accordance withSection 404. If we fail to maintain a system of effective internalcontrols, it could have an adverse effect on our business and stock price.

**ITEM 1B.**       UNRESOLVEDSTAFF COMMENTS.

There were no unresolvedstaff comments outstanding more than 180 days as of December 31, 2006.

**ITEM 2.**                PROPERTIES.

We currently lease space in three buildings located ona single campus in Ladson, South Carolina for our executive offices andmanufacturing facilities, designated Building #1, Building #2 and Building #3.

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We use a portion of Building #1 as our executiveoffices and warehouse. The term of this office lease is June 1, 2005 to July 14,2008, with an option to renew for an additional five years. Annual rent is$119,880 plus utilities, taxes and maintenance. The base rent is subject to anannual escalation at the Consumer Price Index or CPI rate with a minimum of 3% anda maximum of 7% per year. We have approximately 7,190 square feet of officespace and 9139 square feet of warehouse space pursuant to the Building #1office lease. The remaining portion of Building #1 is under an industrial leasefor additional administration offices, engineering and integrated logisticssupport or ILS. The term of this lease is January 15, 2006 to July 14,2008 with no options. The total square footage is 169,767 and the currentannual rental is $604,898 plus utilities, taxes and maintenance.

Building #2 has a lease term of July 15, 2005 to July 14,2008, with an option to renew for another five years. Annual rent is $439,500for the first year plus utilities, taxes and maintenance. which will beadjusted by increases to the CPI rate with a minimum of 3% and a maximum of 7%per year. This building is used principally for manufacturing and warehousingof production and ILS “aftermarket” parts**.**

Building #3 has a lease term of three years starting July 15,2004 with an option to renew for another five years. Annual rent is$258,000 for the first year plus utilities, taxes and maintenance, which willbe adjusted by increases to the CPI rate with a minimum of 3% and amaximum of 7% per year. We have 80,096 square feet of space in Building #3and 6,300 square feet in and adjacent paint and blast building. This buildingis used principally for manufacturing, manufacturing training and research anddevelopment.

On March 9, 2007, we purchased a blast range ofapproximately 306 acres in Edgefield County, South Carolina along with thepurchase of selected assets and a three (3) year lease of an officebuilding in Edgefield, South Carolina. The intended purpose of this transactionis to continue our research and development activities and to provide for thecontinued use of the blast range as a Federal ATF and South Carolina Statelicensed and pre-qualified Department of Defense Explosive Test facility forForce Protection Industries, and selected government/commercial clients

We have begun excavation in the Ladson complex for anew 90,500 square feet facility warehouse that includes an 8,000 square feetcarpentry shop and 8,500 square feet for offices. This new warehouse is beingdesigned to improve material handling efficiencies to support increasedproduction volumes planned. This new facility will allow the redeployment ofthe current warehousing in Building #2 into additional manufacturing space forplanned volume increases.

We are in the process of acquiring a new 60,000 squarefeet facility in Summerville, South Carolina. for the intended purpose ofexpanding research and development operations and to facilitate increasedcustomer training requirements of products and applications. We intend to movethe existing research and development operations housed in Building #3 to thisnew facility. We also intend for the current research and development space inBuilding # 3 to be redeployed into additional manufacturing space.

We have entered into anon-binding letter of intent to lease 120,000 square feet of an existing422,000 square feet manufacturing facility located on approximately 90acres in Florence, South Carolina. The agreement also provides for a survivingRight of First Refusal to match the terms of any offers received for the302,000 square feet balance of the facility. We intend for this property toprovide for additional manufacturing space for future planned products.

**ITEM 3.**                LEGALPROCEEDINGS.

We may be involved fromtime to time in ordinary litigation that will not have a material effect on ouroperations or finances. We are not aware of any pending or threatenedlitigation against the company or our officers and directors in their capacityas such that could have a material impact on our operations or finances.

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

No matters were submittedto security holders during the quarter ended December 31, 2006.

**PART II**

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

*MARKET FOR OURCOMMON STOCK*

Ourcommon stock began trading on the OTC Bulletin Board on December 29, 1998under the symbol “SJET.OB” and subsequently changed to “FRPT.OB.” We list ourcommon stock on the NASDAQ Stock Market effective January 18, 2007 withthe same ticker symbol. Bid and ask quotations for our common shares areroutinely submitted by registered broker dealers who are members of theNational Association of Securities Dealers on the NASD. These quotationsreflect inter-dealer prices, without retail mark-up, markdown or commission andmay not represent actual transactions. The following table shows, for theperiods indicated, the high and low closing sales prices per share of ourcommon stock.

| ** **     | ** ** | **High**                                   | ** ** | **Low**    | ** ** |
|----------------|------------|--------------------------------------------|------------|------------|------------|
| ** **     | ** ** | **Restated for  reverse split*** | ** ** | ** ** | ** ** |
| 2005           |       |                                       |       |       |       |   |   |
| First Quarter  |       |                                       | $          | 3.60       |       |   | $ | 1.75 |   |
| Second Quarter |       |                                       | $          | 2.30       |       |   | $ | 1.28 |   |
| Third Quarter  |       |                                       | $          | 1.80       |       |   | $ | 1.28 |   |
| Fourth Quarter |       |                                       | $          | 1.39       |       |   | $ | 0.69 |   |
| 2006           |       |                                       |       |       |       |   |   |
| First Quarter  |       |                                       | $          | 2.21       |       |   | $ | 0.72 |   |
| Second Quarter |       |                                       | $          | 6.40       |       |   | $ | 1.89 |   |
| Third Quarter  |       |                                       | $          | 9.26       |       |   | $ | 5.44 |   |
| Fourth Quarter |       |                                       | $          | 17.80      |       |   | $ | 6.80 |   |

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*                    EffectiveFebruary 4, 2005, we affected a reverse split of our common stock in theratio of 12 pre-split shares for every 1 post-split share (12:1).

*SHAREHOLDERS*

As of December 31,2006, there were 283 shareholders of record of our common stock.

*DIVIDEND POLICY*

We have never declared or paid a cash dividend on ourcommon stock. We currently intend to retain all of our future earnings, if any,for use in our business and therefore we do not anticipate paying any cashdividends on our common stock in the foreseeable future. Any futuredetermination to pay cash dividends will be at the discretion of our board ofdirectors and will depend upon our financial condition, operating results,capital requirements, restrictions contained in our agreements and otherfactors which our board of directors deems relevant.

On January 21, 2005,we issued 15,800 shares of Series D 6% Convertible Preferred stock. The Series DCertificate of Designation provides for the payment of a dividend at the rateof 6% per annum for so long as the Series D shares are outstanding.Dividend payments are semi-annual due March 1 and September 1 and arepayable in cash or shares of common stock. On March 1, 2006, we made acash dividend payment of $377, 554 and on September 1, 2006, we made acash dividend payment of $159, 386. All Series D 6% 

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Convertible PreferredStock converted to common shares by December 31, 2006 resulting in nofurther dividends being paid.

*RECENT SALES OFUNREGISTERED SECURITIES*

*The following areour issuances of unregistered securities for the quarter ending December 31,2006.*

On October 12, 2006, we issued 22,960 shares ofour common stock for compensation of our board of directors. The shares issuedwere valued at $184,056.

On December 20, 2006, we completed a privateplacement of 13,000,000 shares of our common stock to institutional investorsat $11.75 per share, resulting in gross proceeds of $152,750,000. The proceeds,net of commissions, were $146,640,261.

With respect to the salesof our common stock described above, we relied on the Section 4(2) exemptionfrom securities registration under the federal securities laws for transactionsnot involving any public offering. No advertising or general solicitation wasemployed in offering the shares. The shares were sold to accredited investors.The shares were offered for investment purposes only and not for the purpose ofresale or distribution, and the transfer thereof was appropriately restrictedby us.

*FIVE-YEAR FINANCIALPERFORMANCE GRAPH: 2002-2006*

*Comparison offive-year cumulative return among FPI, S&P 500 and Dow Jones IndustrialAverage*

The annual changes for thefive-year period shown in the graph on this page are based on theassumption that $100 had been invested in FPI stock, the Standard &Poor’s 500 Stock Index and the Dow Jones Industrial Average on December 31,2001, and that all quarterly dividends were reinvested at the average of theclosing stock prices at the beginning and end of the quarter. The totalcumulative dollar returns shown on the graph represent the value that suchinvestments would have had on December 31, 2006.

| ** **  | ** ** | **2001** | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
|-------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| FPI         |       | $        | 100        |     | $          | 171      |       | $        | 93         |     | $          | 391      |       | $ | 87 |   | $ | 2,140 |   |
| S&P 500 |       | 100      |       | 78       |       | 100      |       | 111      |       | 117      |       | 135      |       |
| DJIA        |       | 100      |       | 85       |       | 109      |       | 115      |       | 117      |       | 139      |       |
|             |            |          |            |          |            |          |            |          |            |          |            |          |            |  |  |  |  |  |  |

 

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**ITEM6.**                SELECTED FINANCIALDATA.

| ** **                                    | ** ** | **2006**    | ** **  | **2005**     | ** ** | **2004**     | ** ** | **2003**     | ** ** | **2002**   | ** ** |
|-----------------------------------------------|------------|-------------|-------------|--------------|------------|--------------|------------|--------------|------------|------------|------------|
| ** **                                    | ** ** | ** **  | ** **  | **Restated** | ** ** | **Restated** | ** ** | **Restated** | ** ** | ** ** | ** ** |
| **Results  of Operations**                    |       |        |        |         |       |         |       |         |       |       |       |
| Net Sales                                     |       | $           | 196,017,446 |         | $          | 49,712,829   |       | $            | 10,272,757 |       | $          | 6,247,285 |   | $ | 2,606,634 |   |
| Income (loss) from continuing operations |       | 5,870,452   |        | (14,404,622  | )          | (11,953,803  | )          | (5,155,690   | )          | (5,373,377 | )          |
| Loss from discontinued operations(a)          |       | —      |        | —       |       | —       |       | (2,932,179   | )          | —     |       |
| Deferred tax  benefit(b)                      |       | 12,326,491  |        | —       |       | —       |       | —       |       | —     |       |
| Net Gain/(Loss)                               |       | 18,196,943  |        | (14,404,622  | )          | (11,953,803  | )          | (8,087,869   | )          | (5,373,377 | )          |
| **Per Common  Share**                         |       |        |        |         |       |         |       |         |       |       |       |
| Earnings (Loss) from continuing operations    |       |        |        |         |       |         |       |         |       |       |       |
| Basic(c)                                      |       | 0.37        |        | (0.51        | )          | (0.62        | )          | (0.63        | )          | (1.58      | )          |
| Assuming dilution                             |       | 0.36        |        | (0.51        | )          | (0.62        | )          | (0.63        | )          | (1.58      | )          |
| Common Stock  Dividends                       |       | 0.00        |        | 0.00         |       | 0.00         |       | 0.00         |       | 0.00       |       |
| **Financial  Position at Year-End**           |       |        |        |         |       |         |       |         |       |       |       |
| Property plant and equipment, net        |       | 8,963,901   |        | 2,138,703    |       | 1,036,994    |       | 309,068      |       | 336,523    |       |
| Total assets                                  |       | 274,391,312 |        | 39,776,535   |       | 13,627,196   |       | 1,620,114    |       | 2,615,451  |       |
| Total debt                                    |       | 239,622     |        | 7,500,000    |       | 4,471,707    |       | 745,584      |       | 549,486    |       |
| Convertible  preferred stock(d)               |       | —      |        | 7,901,438    |       | —       |       | —       |       | —     |       |
| Shareholders’ Equity                     |       | 217,854,807 |        | (6,496,761   | )          | 2,558,483    |       | (305,595     | )          | 803,450    |       |
|                                               |            |             |             |              |            |              |            |              |            |            |            |  |  |  |  |  |

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**Notes:**

(a)    Loss resulting from the discontinued operations and disposal ofthe Company’s boat division

(b)   The Company has removed the valuation allowance from the deferredtax assets since it expects to realize future earnings. See financialstatements Note 17—Taxes. 

(c)    Net earnings (loss) available to common shareholders for theyears ending 2006 and 2007 is impacted by dividends and accretion for Series D6% Preferred Stock. See financial statement Note 12—Series D 6% ConvertiblePreferred Stock and Note 18—Earnings (Loss) Per Share.

(d)   The Company has recorded the Series D 6% Convertible Preferred Stockas mezzanine equity on the accompanying balance sheet. See Note 12—Series D 6%Convertible Preferred Stock.  

 

*CAUTIONARYSTATEMENT CONCERNING FORWARD-LOOKING STATEMENTS*

This Report contains forward-looking statements,including, without limitation, statements concerning possible or assumed futureresults of operations and those preceded by, followed by or that include thewords “believes,” “could,” “expects,” “intends,” “anticipates,” or similarexpressions. Our actual results could differ materially from these anticipatedin the forward-looking statements for many reasons including our ability toraise capital when necessary; availability of parts and raw materials for ourproducts; continued customer acceptance of our products; on-going success ofour research and development efforts and other risks described elsewhere inthis report and in our other filings with the Securities and ExchangeCommission. Although we believe the expectations reflected in theforward-looking statements are reasonable, they relate only to events as of thedate on which the statements are made, and our future results, levels ofactivity, performance or achievements may not meet these expectations. We donot intend to update any of the forward-looking statements after the date ofthis document to conform these statements to actual results or to changes inour expectations, except as required by law.

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**ITEM7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

*EXPLANATORY NOTE*

We will be filing anamendment to our Annual Report on Form 10-K for the year ended December 31,2005 to amend and restate financial statements and other information for theyears 2005, 2004 and 2003. The restatement adjusts our accounting for preferredstock and warrants issued to investors, accounting for stock-based compensationto employees and non-employees and accounting for rent expense on a straight-linebasis. The financial information included in this 10-K referring to prioryears ended December 31, 2005, 2004 and 2003 includes each accountingrestatement. Given that we are still in the process of finalizing therestatement with the SEC, there is the potential that the restated numbers maychange pending final resolution. We believe that the restatement did not haveany material impact on our 2006 financial results.

The items identified by usrelate to the valuation method used to account for certain equity issuanceswhich did not properly include a full analysis of the embedded conversionfeature associated with such issuances as required under EITF 98-5,Accounting for Convertible Securities with Beneficial Conversion Features orContingently Adjustable Conversion Ratios, or which were otherwise incorrectlyvalued. As a result, a number of shares of our stock issued as compensation tocertain executives and other third parties and recorded as general andadministrative compensation expense appear to have been valued at less thanfair value.

We believe this issue islimited to a small number of equity issuances made during 2003, 2004 and 2005,with a total combined value of not more than an additional cumulative net lossof approximately $3.75 million for the years 2003 and 2004, and anapproximate realized gain in the range of $2 to $4 million in 2005. We believethat the restatement will not materially impact our 2006 financial results. Ourmanagement and audit committee has discussed the subject matter giving rise tothis conclusion with Jaspers + Hall, PC, its independent accounting firm forthe fiscal year ended December 31, 2005. (Refer to Note 1 to theConsolidated Financial Statements of this 10-K for additional detail)

**RESULTS OF OPERATIONS**

**ConsolidatedStatement of Operations**

| ** **                             | ** ** | **2006**    | ** **  | **2005**     | ** ** | **Change**  | ** ** | **% Change** | ** **  |
|----------------------------------------|------------|-------------|-------------|--------------|------------|-------------|------------|-------------------|-------------|
| ** **                             | ** ** | ** **  | ** **  | **Restated** | ** ** | ** **  | ** ** | ** **        | ** **  |
| Revenues                               |       | $           | 196,017,446 |         | $          | 49,712,829  |       | $                 | 146,304,617 |   |   | 294.30 | % |   |
| Cost of Sales                          |       | 158,994,626 |        | 46,428,615   |       | 112,566,011 |       |              | 242.45      | % |   |
| Gross Profit                           |       | 37,022,820  |        | 3,284,214    |       | 33,738,606  |       |              | 1027.29     | % |   |
| G&A Expense                        |       | 27,183,093  |        | 17,256,359   |       | 9,926,734   |       |              | 57.53       | % |   |
| R&D Expense                        |       | 3,204,165   |        | 1,657,918    |       | 1,546,247   |       |              | 93.26       | % |   |
| Total G&A                          |       | 30,387,258  |        | 18,914,277   |       | 11,472,981  |       |              | 60.66       | % |   |
| Operating Profit  (Loss)               |       | 6,635,562   |        | (15,630,063  | )          | 22,265,625  |       |              | 142.45      | % |   |
| Other  Income/(Expense)                |       | 963,390     |        | 102,941      |       | 860,449     |       |              | 835.87      | % |   |
| Interest Expense                       |       | (1,728,500  | )           | (1,708,291   | )          | (20,209     | )          |              | 1.18        | % |   |
| Realized gain on  derivative liability |       | —      |        | 2,830,791    |       | (2,830,791  | )          |              | -100.00     | % |   |
| Pretax Income (Loss)                   |       | 5,870,452   |        | (14,404,622  | )          | 20,275,074  |       |              | 140.75      | % |   |
| Deferred tax  benefit                  |       | 12,326,491  |        | —       |       | 12,326,491  |       |              | 100         | % |   |
| Net Income (Loss)                      |       | 18,196,943  |        | (14,404,622  | )          | 32,601,565  |       |              | 226.33      | % |   |
|                                        |            |             |             |              |            |             |            |                   |             |  |  |  |  |  |

 

Revenue:   Our netsales grew 294%, over 2005 to $196.0 million. The increase was a result ofstrong demand for blast protected vehicles, increased ability to meet thisdemand and acceptance of our vehicles by customers as well as increasedspare parts revenue.

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Cost of Sales:   Costof sales for the twelve months ended December 31, 2006 was $159.0 million,an increase of 242% percent over 2005 as a result of the increased demand andacceptance of our vehicles. Cost of sales as a percentage of net saleswas 81% in 2006 as compared to 93% in 2005. This improvement in our grossprofit is the result in part of increasing efficiency of our manufacturingoperations. As we continue to expand our production capacity, we expect toachieve increased cost efficiency from volume purchasing, improvements in ourmanufacturing process and all the allocation of indirect costs across a broaderproduction base, resulting in a projected decrease in the cost of sales as apercentage of gross revenue.

General and AdministrativeExpenses:   General and administrative expenses as a percentage of saleswere 15.5% percent in 2006 compared with 38.0% in 2005. General andadministrative expense was $30.4 million in 2006 and $18.9 million in 2005.Although we expect our General and Administrative expenses to increase as wecontinue to expand our production capabilities, it is expected to continue to decreaseas a percentage of Net Sales as we achieve even greater efficiencies in ouroperations.

Deferred Tax Benefit:   Thevaluation allowance for deferred tax assets of $12.3 million was removed in2006, as we expect to realize future earnings sufficient to fully utilize theseaccumulated tax benefits. This change resulted in a net increase in 2006earnings of $12.3 million.

Net Income (Loss):   Netincome for 2006 was $18.2 million as compared to net losses of $14.4 million in2005. The net increase in profitability is primarily due to our higherproduction volumes, increasing cost efficiencies, and the reversal of the previouslyrecorded valuation allowance for deferred tax assets.

**ConsolidatedStatement of Operations**

| ** **                             | ** ** | **2005**    | ** **  | **2004**    | ** ** | **Difference** | ** ** | **% Change** | ** ** | ** ** |
|----------------------------------------|------------|-------------|-------------|-------------|------------|----------------|------------|-------------------|------------|------------|
| Revenues                               |       | $           | 49,712,829  |        | $          | 10,272,757     |       | $                 | 39,440,072 |       |   | 383.9 | % |   |   |
| Cost of Sales                          |       | 46,428,615  |        | 11,266,998  |       | 35,161,617     |       |              | 312.1      | %          |   |   |
| Gross Profit                           |       | 3,284,214   |        | (994,241    | )          | 4,278,455      |       |              | 430.3      | %          |   |   |
| G&A Expense                        |       | 17,256,359  |        | 9,614,052   |       | 7,642,307      |       |              | 79.5       | %          |   |   |
| R&D Expense                        |       | 1,657,918   |        | 1,230,290   |       | 427,628        |       |              | 34.8       | %          |   |   |
| Total G&A                          |       | 18,914,277  |        | 10,844,342  |       | 8,069,935      |       |              | 74.4       | %          |   |   |
| Operating Loss                         |       | (15,630,063 | )           | (11,838,583 | )          | (3,791,480     | )          |              | 32.0       | %          |   |   |
| Other Income                           |       | 102,941     |        | 569,760     |       | (466,819       | )          |              | -81.9      | %          |   |   |
| Interest Expense                       |       | (1,708,291  | )           | (684,980    | )          | (1,023,311     | )          |              | 149.4      | %          |   |   |
| Realized gain on  derivative liability |       | 2,830,791   |        | —      |       | 2,830,791      |       |              | N/M        |       |   |   |
| Net Loss                               |       | $           | (14,404,622 | )           | $          | (11,953,803    | )          | $                 | (2,450,819 | )          |   | 20.5 | % |   |   |

 

Revenue:   Our netsales grew 384% in 2005 over 2004, reaching $49.7 million. This sales growthcame from increased volume of vehicle production and acceptance U.S. defensecustomer as well as increase spare parts revenue.

Cost of Sales:   Costof sales increased 312% to $46.4 million in 2005 from 2004 due to the increasedactivity of vehicle production and the corresponding increased direct andindirect labor and material costs associated with manufacturing activities, aswell as the recording of a warranty provision. Cost of sales as a percentage ofnet sales was 93% in 2005 and 110% in 2004. This improvement in our grossprofit is the result in part of increasing efficiency of our manufacturingoperations.

General and AdministrativeExpenses:   General and administrative expenses as a percentage of saleswere 38% in 2005 and 106% in 2004. General and administrative was $18.9 millionin 2005 and $10.8 million in 2004. It is anticipated that General andAdministrative expenses will increase as we continue to expand our productioncapabilities, it should decrease as a percentage of Net Sales as we achievegreater efficiencies.

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Net Income (Loss):   Netloss was $14.4 million in 2005 and $12.0 million in 2004. The increased netloss was primarily a result of intensive infrastructure development in 2005, aswell as an anticipated decline in vehicle production and delivery during thethird and fourth quarters of 2005. This decline was due to the completion ofcontract backlog and the commencement of production under the JERRV contract.Additionally, there was a nonrecurring expense reserve of $2.0 million relativeto the cost of configuration system upgrades.

*LIQUIDITY AND CAPITAL RESOURCES*

*Current Liquidity:*   Forthe twelve month period ending December 31, 2006, we had a starting cashbalance of $1.2 million and an ending cash balance of $156.3 millionrepresenting a net increase in our cash position for such period of $155.1million. During this period we incurred negative cash flows from operations of$25.9 million due to the increases in accounts receivables and inventories fromincreased production and manufacturing activities as well as spendingassociated with our substantial infra-structure expansion to support ourincreased production capacity. To meet our cash needs during this period, weraised a net total of $188.6 million through various financing activities,including $185.8 million from the sale of 21,277,700 shares of our CommonStock.

*Future Liquidity:*   Duringthe twelve month period ending December 31, 2006, we experienced negativecash flows from operations of $25.9 million and needed to rely on outsidesources of working capital to meet our cash flow requirements. During theupcoming period ending December 31, 2007, we expect the infra-structureexpenses we have incurred in connection with our production ramp-up may remainconstant to provide for further production and manufacturing capabilities andto ensure delivery of expected orders in conjunction, we expect to experiencepositive cash flow from operations as we increase the volume of vehicleproduction.

*Uncertainties:*   Theamount of working capital that we will require depends on several factors,including without limitation, the extent and timing of sales of our products,future inventory costs, the timing and costs associated with the expansion ofour manufacturing, development, engineering and customer support capabilities,the timing and cost of our product development and enhancement activities andour operating results. The realization of a major portion of the assets shownon our balance sheet is dependent upon the success of such future operations.During 2007, we expect to be able to generate cash flows from operationssufficient to satisfy our cash requirements, but if we are unable to do so, wemay need to consider outside sources of financing.

*BACKLOG*

On June 2, 2006, weannounced that on May 31, 2006 the U.S. Army Tank-Automotive and ArmamentsCommand or TACOM awarded BAE Systems Land & Armaments L.P. of York, PAa delivery order in the amount of $180,503,000 as part of a $445,439,000firm-fixed-price contract for the production and delivery of 378 Iraqi LightArmored Vehicles, or ILAV to be delivered to the Iraqi National Army. We havean agreement with BAE pursuant to which we will license to BAE the use of ourCougar vehicle as the basis for the ILAV design, and will act as BAE’sprincipal subcontractor to provide the manpower and other resources needed toproduce 50% of the vehicles in Ladson, South Carolina. Pursuant to the terms ofthe agreement, we will receive a license fee of $8,027 for each ILAV vehiclemanufactured by BAE under the ILAV contract. We will also provide 100% of theafter sales service and support required under the TACOM agreement. As of December 31,2006, we have delivered 55 ILAV vehicles with a backlog of 102 to be producedand delivered in 2007

On May 4, 2006, weannounced that the U.S. Marine Corps awarded us a contract for 79 Cougar JointEOD Rapid Response Vehicles, or JERRV. As of December 31, 2006, wedelivered 71 of these vehicles leaving a backlog of 8 JERRVs to be produced anddelivered in 2007.

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On August 11, 2006,we announced that we had been awarded a contract by the British Ministry ofDefense for more than 85 Cougar explosive ordnance disposal vehicles, alsoknown as Mastiff Protected Patrol Vehicles or Mastiff PPV. The contract alsoincludes associated spares, technical manuals, and field service support. Thecontract, administered through the U.S. Marine Corps System Command, is subjectto price definitization. As of December 31, 2006, we delivered 30 of theMastiffs leaving a backlog of 55 vehicles.

On November 10, 2006,we announced that we had signed a U.S. Marine Corps contract for approximately200 Cougar Joint EOD Rapid Response vehicles, 80 Buffalo mine-protectedclearance vehicles, parts and services. The contract, which will beadministered by the Marine Corps Systems Command, is worth an estimated$214,124,450 subject to contract definitization. As of December 31, 2006,our backlog for this contract was 200 Cougar JERRVs and 59 Buffalo MPCVs.

Thetotal vehicle backlog across all programs as of December 31, 2006 was 369vehicles:

·       Buffalo: 59 vehicles (15-USArmy; 44-USMC)

·       Cougar JERRV: 8 vehicles

·       Cougar MRAP: 200 vehicles

·       ILAVs: 102 vehicles

·       Mastiff (British MOD): 55vehicles

*Supplemental awards:*

On January 15, 2007,the U.S. Marine Corps awarded a firm fixed price contract for 15 Cougar JERRVs.The value of this contract is approximately $9.4 million.

On January 26, 2007, the U.S. Marine Corpsawarded us an Indefinite Delivery, Indefinite Quantity or IDIQ contract for theMRAP vehicle program. This contract allows the U.S. Marine Corps to placedelivery orders for up to 4,100 MRAP vehicles per ordering year for 5 years fora total possible vehicle quantity of 20,500. On January 26, 2007, the U.S.Marine Corps issued a delivery order for 4 MRAP vehicles to be used insurvivability and mobility testing as part of the program. On February 14,2007, the Marine Corps issued a second delivery order for 125 MRAP productionvehicles. The total value of these delivery orders is $74,636,994.

On February 20, 2007,the Mastiff contract was modified to add 22 additional Mastiffs increasing thetotal Mastiffs to be delivered to 108 vehicles.

*TRENDS, RISKS ANDUNCERTAINTIES*

The results of our operations for the period ended December 31,2006 reflect the costs associated with our extraordinary growth, as we continueto evolve into a full scale manufacturing facility. At the same time we wereworking to complete the 2006 backlog, we also undertook the work necessary toincrease our production capacity to meet the expected demand for our vehiclesfor potential follow-on orders. This included substantial vehicle andautomotive engineering work, manufacturing engineering development, hiring andtraining workforce and the expansion of our manufacturing and administrativefacilities. While the 2006 contracts reflects a broader, growing demand for ourvehicles, we continue to face the challenge of expanding our manufacturingcapacity to fully exploit this opportunity. During 2006 we have movedaggressively to meet this challenge by expanding our facilities, improving ouroperating systems and refining our manufacturing processes. These activitieshave required a significant commitment of short term resources, but we expectthe long term benefits will be substantial.

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We recognize there are risks associated with ouron-going expansion activities. We continue to rely upon the U.S. Army and theU.S. Marine Corps for our sales, and if either customer elected not to issuefurther orders to us it would have a dramatic impact upon our financialperformance. In addition, if we are delayed in meeting the deliveryschedule under contracts, we may be obligated to pay liquidated damagesfor any delayed vehicle, and in the event of any substantial failure toperform, the customer could cancel the contract and/or claim additionaldamages. Payment of liquidated damages could negatively impact our futureliquidity, and since we are incurring significant costs associated with ourexpansion program based on the expectation of future contract revenues, loss ofcontracts would have a dramatic impact on both our liquidity and our financialperformance. We currently do not have any reason to expect that our customerswill choose to stop buying our vehicles or that any significant contracts willbe cancelled.

In the past, we haveencountered some difficulties in securing the necessary components for ourvehicles, for example armor steel, truck chassis, axle sets and ballisticglass. To mitigate this risk, we have identified multiple vendors for certaincomponents to ensure we have alternate sources of supply if necessary.Additionally, we have implemented a program of advance purchasing andstockpiling of critical materials. For example, we currently have pre-purchasedsteel and truck parts to ensure availability of material needed for current andpotential future orders. While we do not currently expect the potentialnon-availability of parts or raw materials to materially affect our operations,there is a possibility that delays or increased costs could negatively impactour financial performance if circumstances change. Apart from the foregoing,the main uncertainty about our future operations is whether we will continue toreceive additional orders for our vehicles. It is impossible to predict withcertainty whether such future orders will be placed by existing or newcustomers. If we do not receive future orders, it is unlikely that our businesswill continue. However, we believe our vehicles provide proven blast andballistic protection, and that for so long as there is a risk of bodily harm toservice personnel from explosive blasts, there will be a market for ourproducts. A number of recent market surveys and requests for information issuedby the U.S. military, for armored vehicles with characteristicssubstantially similar to ours, support this view.

*SUMMARY OF CRITICALACCOUNTING POLICIES*

The Securities and Exchange Commission, or SEC, issuedFinancial Reporting release No. 60, “Cautionary Advice Regarding DisclosureAbout Critical Accounting Policies,” or FRR 60, suggesting companies provideadditional disclosure and commentary on their most critical accountingpolicies. In FRR 60, the SEC defined the most critical accounting policies asthe ones that are most important to the portrayal of a company’s financialcondition and operating results, and require management to make its mostdifficult and subjective judgments, often as a result of the need to makeestimates of matters that are inherently uncertain. The methods, estimates andjudgments we use in applying these most critical accounting policies have asignificant impact on the results we report in our financial statements.

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements, as well as the reportedamounts of revenues and expenses during the reporting period. Actual resultscould differ from those estimates.

As a general rule, financial information is accountedfor and based on cost, not current market value. Revenues and gains should bematched using the accrual method with the expenses giving rise to the revenuesand gains to determine earnings for the period. Expenses are necessarilyincurred to produce revenue. Expenses are then “matched” in the same accountingperiod against the revenue generated. Revenues are recognized when they areearned and expenses are recognized in the same period as the related revenue(matching or using a systematic and rational allocation or expensing in theperiod in which they expire), not necessarily in the period in which we receiveor expend cash.

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We believe thefollowing critical accounting policies and procedures, among others, affect ourmore significant judgments and estimates used in the preparation of ourconsolidated financial statements:

·       Revenue recognition;

·       Inventory cost and associated reserves; and

·       Allocation ofdirect and indirect cost of sales.

In December 2004,FASB issued Statement No. 123(R), Share-Based Payment, which establishesaccounting standards for transactions in which an entity receives employeeservices in exchange for (a) equity instruments of the entity or (b) liabilitiesthat are based on the fair value of the entity’s equity instruments or that maybe settled by the issuance of equity instruments. Effective October 1,2005, SFAS 123(R) will require us to recognize the grant-date fairvalue of stock options and equity based compensation issued to employees in thestatement of operations. The statement also requires that such transactions beaccounted for using the fair-value method, thereby eliminating use of theintrinsic method of accounting in APB No. 25. We utilized APB No. 25prior to January 1, 2006.

In November 2004, theFASB issued Statement No. 151, Inventory Costs, to amend the guidance inChapter 4, Inventory Pricing, of the FASB Accounting Research Bulletin No. 43,Restatement and Revision of Accounting Research Bulletins, which becameeffective on January 1, 2006. Statement No. 151 clarifies theaccounting for abnormal amounts of idle facility expense, freight, handlingcosts, and wasted materials. The Statement requires that those items berecognized as current-period charges. Additionally, Statement No. 151requires that allocation of fixed production overhead to the costs ofconversion be based on normal capacity of the production facility. We haveadopted Statement No. 151 and do not believe that Statement No. 151will have a significant impact on our financial condition and results ofoperations.

*Principles ofConsolidation**:*   The consolidated financialstatements include the accounts of Force Protection, Inc., and our twowholly owned subsidiaries, Force Protection Industries, Inc. (formerlyTechnical Solutions Group, Inc.) and Force Protection Technologies, Inc(formerly TSG International, Inc.) for the three and nine month period ended September 30,2006. All inter-company balances and transactions are eliminated inconsolidation.

*Cash Equivalents**:**  *For purposes of reporting cashflows, we consider all highly liquid debt instruments purchased with maturityof three months or less to be cash equivalents.

*Inventories**:***  **Inventories are stated at the lowerof cost or market. The cost is determined under the first-in, first-out,(FIFO) valuation method.

*Property,Plant and Equipment**:***  **Propertyand equipment are stated at cost or at the value of the operating agreement. Wecapitalize additions and improvements which include all material, labor andengineering cost to design, install or improve the asset. Routine repairs andmaintenance are expensed as incurred. Depreciation and amortization arecomputed using the straight-line method over the following estimated usefullives:

| Leasehold improvements  |   | 2 to 5 years |
|-------------------------|--------|--------------|
| Furniture and fixtures  |   | 3 years      |
| Machinery and equipment |   | 7 years      |
| Tooling and molds       |   | 7 years      |
| Vehicles                |   | 5 years      |

 

*Goodwill**:**  *Under SFAS No. 142, Goodwilland other Intangible Assets, all goodwill amortization ceased effective January 1,2002. Rather, goodwill is now subject to annual impairment reviews. A fairvalue test is applied at the reporting level. This test requires variousjudgments and estimates. A goodwill impairment loss will be recorded for anygoodwill that is determined to be impaired. When the carrying value exceeds 

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fair value, theimpairment is the difference between the carrying value of goodwill and thefair value. The fair value of goodwill is defined as the fair value as a wholeless the value of individual assets and liabilities using an estimated purchaseprice, as a whole.

*Estimates**:**  *The preparation of financialstatements in conformity with generally accepted accounting principles requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements, as well as the reported amounts ofrevenues and expenses during the reporting period. Actual results could differfrom those estimates.

*Revenue Recognition**:**  *Our revenue is derived principallyfrom the sale of our vehicles and associated spare parts and training services.Revenue from product sales and spare part sales, net of an allowance forcontractual adjustments, is recognized when the products or spare parts aredelivered to and “formally” accepted by the customer. We define “formalacceptance” as taking place when a representative of the United StatesGovernment signs the United States Form DD250 entitled “MaterialInspection and Receiving Report” which under the Federal AcquisitionRegulations signifies contractual inspection and acceptance of the workperformed by the contractor. It also acts as the contractual invoice creatingpayment liability on the United States Government. In accordance with standardindustry practice, there is a representative from the United States DefenseContractor Manufacturing Agency, (“DCMA”), acting as a contractualrepresentative of the United States Government present at our facilities. ThisDCMA representative inspects each vehicle as it is delivered by us and uponconfirmation of the vehicle’s conformity with the contractual specificationsthe inspector signs the Form DD250 and formally accepts delivery of thevehicle. We only recognize revenues arising from its U.S. Government contractsupon execution of the Form DD250 by the DCMA inspector. Under some of ourU.S. Government contracts, we receive performance based payments based oncompletion of specific milestones stipulated under the contract (for example,delivery of raw material to our Ladson facility). These payments are recordedas “deferred revenue” and carried on our balance sheet until the final deliveryof the products and formal acceptance by the U.S. Government pursuant to the Form DD250.Upon acceptance of the products and the execution of the Form DD250, werecognize the full sale price of the product as revenue.

Revenues from servicesprovided are recorded in accordance with specific contractual terms. Serviceshave historically consisted of us providing on-site personnel on an as-neededbasis in a timely manner, and have generally been provided in foreignlocations.

We negotiate contractswith our customers that may include revenue arrangements with multipledeliverables, as outlined by Emerging Issues Task Force No. 00-21(EITF 00-21). Our accounting policies are defined such that eachdeliverable under a contract is accounted for separately. Historically, we havenegotiated and signed contracts with our customers that outline the contractamount and specific terms and conditions associated with each deliverable.

*Concentration**:*   Our futureoperations and continued expansion are subject to a significant concentrationrisk. For the year 2006 and 2005, our revenues from military units of the U.S.Government accounted for 84% and 90% of total revenues, respectively. Ouraccounts receivable from military units of the U.S. Government for 2006and 2005 amounted to 81% and 60%, of total accounts receivable, respectively.

*Accounts Receivable and “Definitization”**:*   A majority ofour contracts are with the United States Government and as such they are “publicsector” contracts subject to the Federal Acquisition Regulations set outat Title 41 of the United States Code, and may result either from competitivebidding or may be awarded as “sole source” contracts “subject to definitization”as provided under FAR Section 252.217-7027. Following the award of asole source contract, a central component of the definitization process is thenegotiation and finalization of the contract price between the contractor andthe United States contracting officer. As part of this process, the partiesmake a mutual determination of the direct material and labor costs for the workbased upon the bill of materials and other purchasing information and then theparties mutually agree upon “rates” for the indirect labor costs and thegeneral 

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and administrativecosts and upon a “fee” (or profit). While the direct material costs and laborcan be established through objective evidence, the “rates” and fee are moresubjective and are based upon an analysis of multiple factors includinghistorical performance data and projected operational factors. The contractorhas the right to submit proposed rates and fee, but these are subject to finalreview and approval by the contracting officer, who may insist on usingalternate rates and fee. As provided in section 252.217-7027(c):

*(c) If agreement on a definitive contract actionto supersede this undefinitized contract action is not reached by the targetdate in paragraph (b) of this clause, or within any extension of itgranted by the Contracting Officer, the Contracting Officer may, with theapproval of the head of the contracting activity, determine a reasonable priceor fee in accordance with subpart 15.4 and part 31 of the FAR, subject toContractor appeal as provided in the Disputes clause.*

Finally, although bothparties make an effort to definitize the contract as quickly as possible, theprocess is time consuming and can take months (or even years) to complete. Duringthe definitization process the contractor is required to perform the contractwork and to make deliveries under the contract before the final contract pricehas been established. For this reason, as part of the original letter award,the contractor provides a rough order of magnitude (“ROM”) price to be used forinvoicing and accounting purposes pending definitization.

As a result of thepotential adjustments related to the definitization process, we maintain anallowance for contractual adjustments account. This account is reviewed on aregular basis to determine adequate adjustments, if necessary. The allowance isevaluated and deemed adequate based on the analysis of historical data andcalculation of pro-rata percentages of current contracts in place, which remainsubject to the definitization process.

*Dividend Policy**:**  *We have never declared or paid acash dividend on our common stock, and we do not anticipate paying any cashdividends on our common stock in the foreseeable future. Any futuredetermination to pay cash dividends on our common stock will be at the discretionof our board of directors and will depend upon our financial condition,operating results, capital requirements, restrictions contained in ouragreements and other factors which our board of directors deems relevant. Underthe terms of the Certificate of Designation for our Series D ConvertiblePreferred stock, we are obligated to pay a 6% dividend in cash or shares ofcommon stock on the outstanding shares of Series D stock. Such dividend isdue and payable on March 1 and September 1 each year. As of December 31,2006, there are no outstanding Series D shares and we have no furtherobligation to make such dividend payments.

*Off-Balance SheetArrangements**:**  *Asof December 31, 2006, other than operating leases, the company had nooff-balance sheet arrangements. (Refer to Footnote 7 of the FinancialStatements included in this 10-K)

**ITEM7A.**        QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK.

*COMMODITY PRICES**:*   We areexposed to market risk from changes in commodity prices. If the price of steelincreases significantly, the cost of our products could increase. It isunlikely we will be able to pass on this cost under our current contracts. As aresult, if the cost of our raw materials increases, our profitability, if any,could decrease.

*FOREIGN CURRENCY**:*   The majorityof our business is denominated in U.S. dollars and as such, movement in theforeign currency markets will have a minimal direct impact on our business.

*INTEREST RATES**:*   As we do nothave a trading portfolio and our current financing is at a fixed rate, we arenot currently directly at risk of interest rate fluctuations. As our financingneeds change in the future, interest rate risk may become a more significantissue for us.

To date, we have not usedany derivative financial instruments for the purpose of reducing our exposureto adverse fluctuations in interest rates, foreign currency exchange, orcommodity prices. We are not a party to leveraged derivatives nor do we hold orissue financial investments for speculative purposes.

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**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

**To the Board ofDirectors andStockholders of Force Protection, Inc.**

We have audited the accompanying consolidated balancesheets of Force Protection, Inc. and subsidiary as ofDecember 31, 2006, 2005 and 2004, and the related consolidated statementsof income, stockholders’ equity and comprehensive income, and cash flows foreach of the years in the three-year period ended December 31, 2006. Thesefinancial statements are the responsibility of the company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. The company is not required to have, nor were we engaged toperform, an audit of its internal control over financial reporting. Our auditincluded consideration of internal control over financial reporting as a basisfor designing audit procedures that are appropriate in the circumstances, butnot for the purpose of expressing an opinion on the effectiveness of thecompany’s internal control over financial reporting. Accordingly, we express nosuch opinion. An audit also includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements, assessingthe accounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred toabove present fairly, in all material respects, the financial position of ForceProtection Inc., and subsidiary as of December 31, 2006, 2005 and 2004,and the results of its operations and its cash flows for each of the yearsin the three-year period ended December 31, 2006 in conformity withaccounting principles generally accepted in the United States of America.

As discussed in Note 1 tothe financial statements, certain errors resulting in adjustments to the Company’s accountingfor preferred stock and warrants issued to investors, accounting forstock-based compensation to employees and non-employees and accounting for rentexpense on a straight-line basis as of December 31, 2006, 2005 and 2004,were discovered by management of the Company during the current year.Accordingly, the 2006, 2005 and 2004 financial statements have been restated tocorrect these errors.
| /s/ JASPERS + HALL, PC |   |
|------------------------|--------|
| Denver, Colorado       |   |

 

March 2,2007 (except as to the restatement discussed in Note 1 to the consolidatedfinancial statements as to which the date is as of June 5, 2007)

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

**To the Board of Directors andStockholders of Force Protection, Inc.**

We have audited management’sassessment, included in the accompanying Management’s Report on InternalControl over Financial Reporting, that Force Protection Inc. and subsidiarymaintained effective internal control over financial reporting as of December 31,2006, based on criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission (the COSO criteria). Force ProtectionInc.’s management is responsible for maintaining effective internal controlover financial reporting and for its assessment of the effectiveness ofinternal control over financial reporting. Our responsibility is to express anopinion on management’s assessment and an opinion on the effectiveness of thecompany’s internal control over financial reporting based on our audit.

We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether effective internal control overfinancial reporting was maintained in all material respects. Our audit includedobtaining an understanding of internal control over financial reporting,evaluating management’s assessment, testing and evaluating the design andoperating effectiveness of internal control, and performing such otherprocedures as we considered necessary in the circumstances. We believe that ouraudit provides a reasonable basis for our opinion.

A company’s internalcontrol over financial reporting is a process designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles. A company’s internal control over financialreporting includes those policies and procedures that (1) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (3) provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

In our opinion, management’sassessment that Force Protection Inc. and subsidiary maintained effectiveinternal control over financial reporting as of December 31, 2006, isfairly stated, in all material respects, based on the COSO criteria. Also, inour opinion, Force Protection Inc. and subsidiary maintained, in all materialrespects, effective internal control over financial reporting as of December 31,2006, based on the COSO criteria.

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the accompanying consolidatedbalance sheets of Force Protection Inc. and subsidiary as of December 31,2006, 2005 and 2004, and the related consolidated statements of income,stockholders’ equity, and cash flows for each of the three years in the periodended December 31, 2006, and our report dated March 2, 2007,expressed an unqualified opinion thereon.
| /s/ JASPERS  + HALL, PC |
|-------------------------|
| Denver, Colorado        |
| March 2, 2007      |

 

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**FORCE PROTECTION INC. AND SUBSIDIARYCONSOLIDATED STATEMENT OF OPERATIONSFor the Years Ended December 31, 2006, 2005 and 2004**

| ** **                                                 | ** ** | **2006**    | ** **  | **2005**     | ** ** | **2004**     | ** ** |
|------------------------------------------------------------|------------|-------------|-------------|--------------|------------|--------------|------------|
| ** **                                                 | ** ** | ** **  | ** **  | **Restated** | ** ** | **Restated** | ** ** |
| **Net  Sales**                                             |       | $           | 196,017,446 |         | $          | 49,712,829   |       | $ | 10,272,757 |   |
| Cost of sales                                              |       | 158,994,626 |        | 46,428,615   |       | 11,266,998   |       |
| Gross Profit                                               |       | 37,022,820  |        | 3,284,214    |       | (994,241     | )          |
| General and administrative expense                         |       | 27,183,093  |        | 17,256,359   |       | 9,614,052    |       |
| R & D  expense                                    |       | 3,204,165   |        | 1,657,918    |       | 1,230,290    |       |
| **Operating Profit (Loss)**                                |       | 6,635,562   |        | (15,630,063  | )          | (11,838,583  | )          |
| Other income                                               |       | 963,390     |        | 102,941      |       | 569,760      |       |
| Interest expense                                           |       | (1,728,500  | )           | (1,708,291   | )          | (684,980     | )          |
| Realized gain on  derivative liability                     |       | —      |        | 2,830,791    |       | —       |       |
| **Earnings (Loss) from Operations**                        |       | 5,870,452   |        | (14,404,622  | )          | (11,953,803  | )          |
| **Deferred Tax Benefit**                                   |       | 12,326,491  |        | —       |       | —       |       |
| **Net Earnings (Loss)**                                    |       | $           | 18,196,943  |         | $          | (14,404,622  | )          | $ | (11,953,803 | ) |
| Net earnings (loss)                                        |       | $           | 18,196,943  |         | $          | (14,404,622  | )          | $ | (11,953,803 | ) |
| Accretion of  Series D 6% convertible preferred stock |       | (1,297,134  | )           | (2,041,697   | )          | —       |       |
| Preferred  Dividends                                       |       | (325,685    | )           | (778,530     | )          | —       |       |
| Net  Earnings/(Loss) available to common shareholders      |       | $           | 16,574,124  |         | $          | (17,224,849  | )          | $ | (11,953,803 | ) |
| Basic earnings (loss) per common share                     |       | $           | 0.37        |         | $          | (0.51        | )          | $ | (0.62 | ) |
| Diluted earnings (loss) per common share                   |       | $           | 0.36        |         | $          | (0.51        | )          | $ | (0.62 | ) |
| **Weighted-average  shares used to compute:**              |       |        |        |         |       |         |       |
| Basic earnings  (loss) per share                           |       | 44,786,083  |        | 33,926,573   |       | 19,357,939   |       |
| Diluted earnings (loss)  per share                         |       | 50,428,466  |        | 33,926,573   |       | 19,357,939   |       |

 

The accompanying Notes are an integral part of these financial statements.

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**FORCE PROTECTIONINC. AND SUBSIDIARYCONSOLIDATED BALANCE SHEETSDECEMBER 31, 2006, 2005 and 2004**

| ** **                                                                                                                                                                     | ** ** | **2006**    | ** **  | **2005**     | ** ** | **2004**     | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|-------------|--------------|------------|--------------|------------|
| ** **                                                                                                                                                                     | ** ** | ** **  | ** **  | **Restated** | ** ** | **Restated** | ** ** |
| **ASSETS**                                                                                                                                                                     |       |        |        |         |       |         |       |
| Current Assets:                                                                                                                                                                |       |        |        |         |       |         |       |
| Cash                                                                                                                                                                           |       | $           | 156,319,004 |         | $          | 1,217,509    |       | $ | 2,264,406 |   |
| Accounts  receivable, net of allowance for contractual adjustments of $6,068,087  for 2006, $1,018,051 for 2005, and $0 for 2004                                          |       | 36,011,568  |        | 3,666,358    |       | 1,053,973    |       |
| Inventories                                                                                                                                                                    |       | 60,396,297  |        | 32,486,776   |       | 9,029,913    |       |
| Other current  assets                                                                                                                                                          |       | 374,051     |        | 267,189      |       | 241,910      |       |
| Current Portion of  Deferred Taxes                                                                                                                                             |       | 9,562,500   |        | —       |       | —       |       |
| Total current  assets                                                                                                                                                          |       | 262,663,420 |        | 37,637,832   |       | 12,590,202   |       |
| Investment in  Challenger Powerboats Inc, net of valuation allowance                                                                                                           |       | —      |        | —       |       | —       |       |
| Long Term Portion  of Deferred Taxes                                                                                                                                           |       | 2,763,991   |        | —       |       | —       |       |
| Property Plant and  equipment, net                                                                                                                                             |       | 8,963,901   |        | 2,138,703    |       | 1,036,994    |       |
| **Total  Assets**                                                                                                                                                              |       | $           | 274,391,312 |         | $          | 39,776,535   |       | $ | 13,627,196 |   |
| **LIABILITIES & SHAREHOLDERS’ EQUITY**                                                                                                                           |       |        |        |         |       |         |       |
| LIABILITIES                                                                                                                                                                    |       |        |        |         |       |         |       |
| Current Liabilities:                                                                                                                                                           |       |        |        |         |       |         |       |
| Accounts payable                                                                                                                                                               |       | $           | 38,653,813  |         | $          | 14,688,855   |       | $ | 1,867,363 |   |
| Other accrued  liabilities                                                                                                                                                     |       | 2,968,859   |        | 1,898,020    |       | 1,354,466    |       |
| Contract  liabilities                                                                                                                                                          |       | 1,850,000   |        | 1,686,062    |       | 729,461      |       |
| Loans payable                                                                                                                                                                  |       | —      |        | 7,500,000    |       | 360,975      |       |
| Line of Credit                                                                                                                                                                 |       | —      |        | —       |       | 4,000,000    |       |
| Current portion of  long term liabilities                                                                                                                                      |       | 71,685      |        | —       |       | —       |       |
| Deferred revenue                                                                                                                                                               |       | 12,824,211  |        | 12,598,921   |       | 2,645,716    |       |
| Total Current  Liabilities                                                                                                                                                     |       | 56,368,568  |        | 38,371,858   |       | 10,957,981   |       |
| Long-term debt:                                                                                                                                                                |       |        |        |         |       |         |       |
| Other long term  liabilities                                                                                                                                                   |       | 167,937     |        | —       |       | 110,732      |       |
| **Total  Liabilities**                                                                                                                                                         |       | 56,536,505  |        | 38,371,858   |       | 11,068,713   |       |
| Commitment and Contingencies (See Note 7)                                                                                                                                 |       |        |        |         |       |         |       |
| Preferred stock  series D, $0.001 par value, authorized: 20,000 shares, issued and outstanding:  0,13,004, 0 shares; for the years 2006, 2005 and 2004 respectively; |       | —      |        | 7,901,438    |       | —       |       |
| **SHAREHOLDERS’ EQUITY**                                                                                                                                                  |       |        |        |         |       |         |       |
| Preferred stock:  $0.001 par value, authorized: 10,000,000 shares                                                                                                              |       | —      |        | —       |       | —       |       |
| Preferred stock  series B, $0.001 par value, authorized: 25 shares issued and outstanding 0,  0, 19.5 shares; for the years 2006, 2005 and 2004 respectively;                  |       | —      |        | —       |       | —       |       |
| Preferred stock  series C, $0.001 par value, authorized: 150 shares, issued and  outstanding 0,0,0 shares; for the years 2006, 2005 and 2004 respectively;                |       | —      |        | —       |       | —       |       |
| Common stock,  $0.001 par value, authorized: 300,000,000, issued and outstanding: 66,762,  566, 36,114,216, 19,357,938 shares; for the years 2006, 2005 and 2004               |       | 66,763      |        | 36,114       |       | 19,358       |       |
| Warrants                                                                                                                                                                       |       | —      |        | 5,780,952    |       | 2,602,800    |       |
| Shares to be  issued                                                                                                                                                           |       | 31          |        | —       |       | —       |       |
| Beneficial  Conversion Feature                                                                                                                                                 |       | —      |        | —       |       | 19,102,306   |       |
| Additional Paid-in  Capital                                                                                                                                                    |       | 249,694,850 |        | 38,714,893   |       | 35,874,565   |       |
| Accumulated  deficit                                                                                                                                                           |       | (31,906,837 | )           | (51,028,720  | )          | (55,040,546  | )          |
| **Total  Shareholders’ Equity**                                                                                                                                           |       | 217,854,807 |        | (6,496,761   | )          | 2,558,483    |       |
| **Total  Liabilities and Shareholders’ Equity**                                                                                                                           |       | $           | 274,391,312 |         | $          | 39,776,535   |       | $ | 13,627,196 |   |

 

The accompanying Notes are an integral part of these financial statements.

28

----

**FORCEPROTECTION INC. AND SUBSIDIARYCONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITYFor the Years Ended December 31, 2006, 2005 and 2004**

| ** ** | ** ** | **Series B**        | ** ** | **Series C**        | ** ** | ** **            | ** ** | ** **         | ** ** | ** ** | ** ** | ** **         | ** ** | **Shares to** | ** ** | **Additional**  | ** ** | ** ** | ** ** | ** **  | ** ** |
|------------|------------|--------------------------|------------|--------------------------|------------|-----------------------|------------|--------------------|------------|------------|------------|--------------------|------------|--------------------|------------|-----------------|------------|------------|------------|-------------|------------|
| ** ** | ** ** | **Preferred Stock** | ** ** | **Preferred Stock** | ** ** | **Common Stock** | ** ** | ** **         | ** ** | ** ** | ** ** | **be Issued** | ** ** | **Paid-in**        | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
| ** ** | ** ** | **Shares**               | ** ** | **Par $.001**       | ** ** | **Shares**            | ** ** | **Par $.001** | ** ** | **Shares** | ** ** | **Par $.001** | ** ** | **Warrants**       | ** ** | **BCF**         | ** ** | **0**      | ** ** | **Capital** | ** ** | **Deficit** | ** ** | **Total** | ** ** |
|            |            |                          |            |                          |            |                       |            |                    |            |            |            |                    |            |                    |            |                 |            |            |            |             |            |  |  |  |  |

| **Balance, December 31, 2003**                                            |   |   | 10     |   |   |   | $      | 0      |   |   |   | 132    |   |   |   | $      | 0      |       |   | 10,190,021 |   |   | $      | 10,190     |   |        | $      | 4,862,765 |   | $      | 282,890    |       |   | $      | 0           |   |   | $           | 18,805,887 |   |   | $ | (24,267,327 | ) |   | $ | (305,595  | )      |
|--------------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|------------|--------|------------|--------|--------|--------|------------|--------|-------------|--------|-----------|--------|--------|------------|------------|--------|--------|-------------|--------|--------|-------------|------------|--------|--------|---|-------------|---|--------|---|-----------|--------|
| Issuance of common stock for cash                                              |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   | 2,982,717  |   |       | 2,983  |   |   |       |   |        |   |      |   |   |       | 7,200,234  |   |   | 0           |   |   | 7,203,217   |       |
| Issuance of common stock for services—Third Parties                       |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   | 163,501    |   |       | 163    |   |   |       |   |        |   |      |   |   |       | 496,793    |   |   | 0           |   |   | 496,956     |       |
| Issuance of common stock for Compensation—Directors &  Employees |   |   | 0      |   |   |   |   |   |   |   | 0      |   |   |   |   |   |   | 616,682    |   |       | 617    |   |   |       |   |        |   |      |   |   |       | 1,431,187  |   |   |        |   |   | 1,431,804   |       |
| Issuance of common stock for cash (Warrant net change)                    |   |   | 0      |   |   |   |   |   |   |   | 0      |   |   |   |   |   |   | 2,757,618  |   |       | 2,758  |   |   | (2,259,965 | )      |        |   |      |   |   |       | 6,352,054  |   |   |        |   |   | 4,094,847   |       |
| Cancellation of Common shares                                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (304,167   | )      |       | (304   | )      |   |       |   |        |   |      |   |   |       | 304        |   |   |        |   |   | 0           |       |
| Issuance of common shares for Debt                                             |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 20,421     |   |       | 20     |   |   |       |   |        |   |      |   |   |       | 124,956    |   |   |        |   |   | 124,976     |       |
| Conversion of preferred stock to  common stock                                 |   |   | (1     | )      |   |   |   |   |   |   | (80    | )      |   |   |   |   |   | 2,931,145  |   |       | 2,931  |   |   |       |   |        |   |      |   |   |       | (2,931     | )      |   | 0           |   |   | 0           |       |
| Conversion between preferred Series B and  Series C                  |   |   | 11     |   |   |   |   |   |   |   | (105   | )      |   |   |   |   |   | 0          |   |       | 0      |   |   |       |   |        |   |      |   |   |       | 0          |   |   | 0           |   |   | 0           |       |
| Change in Benficial Conversion Feature                                         |   |   | 0      |   |   |   |   |   |   |   | 0      |   |   |   |   |   |   |       |   |       |   |   |   |       |   | 18,819,416  |   |      |   |   |       |       |   |   | (18,819,416 | )      |   | 0           |       |
| Issuance of Preferred Stock for Cash                                           |   |   | 0      |   |   |   |   |   |   |   | 1      |   |   |   |   |   |   | 0          |   |       | 0      |   |   |       |   |        |   |      |   |   |       | 10,000     |   |   | 0           |   |   | 10,000      |       |
| Issuance of preferred stock for compensation                                   |   |   | 0      |   |   |   |   |   |   |   | 38     |   |   |   |   |   |   | 0          |   |       | 0      |   |   |       |   |        |   |      |   |   |       | 1,316,081  |   |   | 0           |   |   | 1,316,081   |       |
| Issuance of preferred stock for conversion of debt                             |   |   | 0      |   |   |   |   |   |   |   | 20     |   |   |   |   |   |   | 0          |   |       | 0      |   |   |       |   |        |   |      |   |   |       | 200,000    |   |   | 0           |   |   | 200,000     |       |
| Rescinded and Redemption of preferred stock                                    |   |   | 0      |   |   |   |   |   |   |   | (6     | )      |   |   |   |   |   | 0          |   |       | 0      |   |   | 0          |   |        |   |      |   |   |       | (60,000    | )      |   | 0           |   |   | (60,000     | )          |
| Net loss                                                                       |   |   | 0      |   |   |   |   |   |   |   | 0      |   |   |   |   |   |   | 0          |   |       | 0      |   |   |       |   |        |   |      |   |   |       |       |   |   | (11,953,803 | )      |   | (11,953,803 | )          |
| **Balance, December 31, 2004**                                            |   |   | 20     |   |   |   | $      | 0      |   |   |   | 0      |   |   |   | $      | 0      |       |   | 19,357,938 |   |   | $      | 19,358     |   |        | $      | 2,602,800 |   | $      | 19,102,306 |       |   | $      | 0           |   |   | $           | 35,874,565 |   |   | $ | (55,040,546 | ) |   | $ | 2,558,483 |   |
| Issuance of common stock for cash                                              |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   | 185,321    |   |       | 185    |   |   | 0          |   |        |   |      |   |   |       | 513,806    |   |   | 0           |   |   | 513,991     |       |
| Issuance of common stock for compensation                                      |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   | 51,616     |   |       | 52     |   |   |       |   |        |   |      |   |   |       | 125,357    |   |   | 0           |   |   | 125,409     |       |
| Issuance of common stock for settlement agreements                             |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   | 53,467     |   |       | 53     |   |   |       |   |        |   |      |   |   |       | 144,842    |   |   | 0           |   |   | 144,895     |       |
| Issuance of common stock for interest                                          |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   | 14,876     |   |       | 15     |   |   |       |   |        |   |      |   |   |       | 20,626     |   |   | 0           |   |   | 20,641      |       |
| Issuance of Common Stock as Series D  dividend shares                     |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   | 281,697    |   |       | 282    |   |   |       |   |        |   |      |   |   |       | 418,148    |   |   | (418,430    | )      |   | 0           |       |
| Issuance of Common Stock to round up post split  shares                        |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   | 3,079      |   |       | 3      |   |   |       |   |        |   |      |   |   |       | 6,075      |   |   | 0           |   |   | 6,078       |       |
| Issuance of common stock for cash-warrants                                     |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   | 114,376    |   |       | 114    |   |   | (122,903   | )      |        |   |      |   |   |       | 334,418    |   |   | 0           |   |   | 211,629     |       |
| Warrant issued for Series D placement                                     |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |       |   |       |   |   |   | 200,071    |   |        |   |      |   |   |       | (200,071   | )      |   |        |   |   | 0           |       |
| Conversion of Series Series D preferred  stock to common stock  |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   | 1,331,429  |   |       | 1,331  |   |   |       |   |        |   |      |   |   |       | 1,440,694  |   |   |        |   |   | 1,442,025   |       |
| Accretion of Series D Preferred Stock                                     |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |       |   |       |   |   |   |       |   |        |   |      |   |   |       | (2,041,697 | )      |   |        |   |   | (2,041,697  | )          |
| Reclassification of Series D Warrants from  Liability                     |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |       |   |       |   |   |   | 5,173,409  |   |        |   |      |   |   |       |       |   |   |        |   |   | 5,173,409   |       |
| Dividends for Series D-cash                                               |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |       |   |       |   |   |   |       |   |        |   |      |   |   |       |       |   |   | (100,020    | )      |   | (100,020    | )          |
| Dividends for Series D-accrued                                            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |       |   |       |   |   |   |       |   |        |   |      |   |   |       |       |   |   | (260,080    | )      |   | (260,080    | )          |
| Conversion of Series B preferred stock to common  stock                   |   |   | (20    | )      |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   | 14,803,750 |   |       | 14,804 |   |   | 0          |   |        |   |      |   |   |       | (14,804    | )      |   | 0           |   |   | 0           |       |
| Benficial Conversion Feature                                                   |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |       |   |       |   |   |   |       |   | (19,102,306 | )      |      |   |   |       |       |   |   | 19,102,306  |   |   | 0           |       |

29

----

 

| Common Share Grants cancelled                                         |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   | (83,333 | )      |   | (83    | )      |   |       |   |   |   |   |   |   |   | (209,916  | )      |   |        |   |   | (209,999    | )      |
|-----------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|---------|--------|--------|--------|--------|--------|------------|--------|--------|--------|--------|--------|--------|--------|-----------|--------|--------|-------------|--------|--------|-------------|--------|
| Stock Based Compensation (FAS 123R)                              |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |   |       |   |   |   |   |   |   |   |      |   |   | 92,671      |   |   | 92,671      |   |
| Warrants-net (expired & issued) not  including Series D |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |    |   |   |   |   |   | (2,072,425 | )      |   |   |   |   |   |   | 2,302,850 |   |   |        |   |   | 230,425     |   |
| Net loss                                                              |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   | 0       |   |   | 0      |   |   |       |   |   |   |   |   |   |   | 0         |   |   | (14,404,621 | )      |   | (14,404,621 | )      |

| **Balance, December 31, 2005**                               |   |   | 0      |   |   |   | $      | 0      |   |   |   | 0      |   |   |   | $      | 0      |       |   | 36,114,216 |   |   | $      | 36,114     |   |   | $      | 5,780,952 |   | $      | 0      |        |   | $      | 0          |   |   | $           | 38,714,893  |   |   | $ | (51,028,720 | ) |   | $ | (6,496,761  | )      |
|-------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|------------|--------|------------|--------|--------|--------|------------|--------|--------|--------|-----------|--------|--------|--------|-------------|--------|--------|------------|--------|--------|-------------|-------------|--------|--------|---|-------------|---|--------|---|-------------|--------|
| Issuance of common stock for cash (PIPE’s)                   |   |   | 0      |   |   |   |   |   |   |   | 0      |   |   |   |   |   |   | 21,250,000 |   |       | 21,250 |   |   | 0          |   | 0      |   |      | 0      |   |   | 185,806,511 |   |   | 0          |   |   | 185,827,761 |        |
| Issuance of common stock for stock options exercised              |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 1,000      |   |       | 1      |   |   | 0          |   | 0      |   |      | 4      |   |   | 5,996       |   |   | 0          |   |   | 6,001       |        |
| Issuance of common stock for compensation                         |   |   | 0      |   |   |   |   |   |   |   | 0      |   |   |   |   |   |   | 313,644    |   |       | 314    |   |   | 0          |   | 0      |   |      | 27     |   |   | 883,248     |   |   | 0          |   |   | 883,589     |        |
| Issuance of common stock for settlement agreements                |   |   | 0      |   |   |   |   |   |   |   | 0      |   |   |   |   |   |   | 30,000     |   |       | 30     |   |   | 0          |   | 0      |   |      | 0      |   |   | 187,470     |   |   | 0          |   |   | 187,500     |        |
| Issuance of common stock for dividends on  Series D          |   |   | 0      |   |   |   |   |   |   |   | 0      |   |   |   |   |   |   | 8,937      |   |       | 9      |   |   | 0          |   | 0      |   |      | 0      |   |   | 48,816      |   |   | (48,825    | )      |   | 0           |        |
| Issuance of Cash for dividends on Series D                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 0          |   |       | 0      |   |   | 0          |   | 0      |   |      | 0      |   |   | 0           |   |   | (276,860   | )      |   | (276,860    | )           |
| Accretion of Series D Preferred Stock                        |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |       |   |       |   |   |   |       |   |   |   |      |   |   |   | (1,297,134  | )      |   |       |   |   | (1,297,134  | )           |
| Issuance of common stock for cash—warrants                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 2,852,140  |   |       | 2,852  |   |   | (5,780,952 | )      | 0      |   |      | 0      |   |   | 16,152,672  |   |   | 0          |   |   | 10,374,572  |        |
| Conversion of Series D preferred stock to common  stock |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 6,192,628  |   |       | 6,193  |   |   | 0          |   | 0      |   |      | 0      |   |   | 9,192,378   |   |   | 0          |   |   | 9,198,571   |        |
| Stock based compensation (FAS 123R)                          |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 0          |   |       | 0      |   |   | 0          |   | 0      |   |      | 0      |   |   | 0           |   |   | 1,250,625  |   |   | 1,250,625   |        |
| Net earnings (loss)                                               |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   |   | 0      |   |   | 0          |   |       | 0      |   |   | 0          |   | 0      |   |      | 0      |   |   | 0           |   |   | 18,196,943 |   |   | 18,196,943  |        |
| **Balance,  December 31, 2006**                              |   |   | 0      |   |   |   | $      | 0      |   |   |   | 0      |   |   |   | $      | 0      |       |   | 66,762,565 |   |   | $      | 66,763     |   |   | $      | 0         |   | $      | 0      |        |   | $      | 31         |   |   | $           | 249,694,850 |   |   | $ | (31,906,837 | ) |   | $ | 217,854,807 |   |

 

The accompanying Notes are an integral part of these financialstatements.

30

----

**FORCE PROTECTIONINC. AND SUBSIDIARYCONSOLIDATED STATEMENTS OF CASH FLOWSYEAR ENDED DECEMBER 31, 2006, 2005 AND 2004(In dollars)**

| ** **                                                                                     | ** ** | **2006**    | ** **  | **2005**     | ** ** | **2004**     | ** ** |
|------------------------------------------------------------------------------------------------|------------|-------------|-------------|--------------|------------|--------------|------------|
| ** **                                                                                     | ** ** | ** **  | ** **  | **Restated** | ** ** | **Restated** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES**                                                      |       |        |        |         |       |         |       |
| Net Earnings (loss) from continuing operations                                                 |       | $           | 18,196,943  |         | $          | (14,404,622  | )          | $ | (11,953,803 | ) |
| **Adjustments to reconcile net loss to net cash  (used in) provided by operating activities:** |       |        |        |         |       |         |       |
| Depreciation and amortization                                                                  |       | 769,454     |        | 386,152      |       | 207,271      |       |
| Deferred Tax Benefit                                                                           |       | (12,326,491 | )           |  — |       |  — |       |
| Realized gain on derivative liability                                                          |       | —      |        | (2,830,791   | )          | —       |       |
| Stock issued for services and compensation                                                     |       | 883,589     |        | (84,590      | )          | 3,244,841    |       |
| Common stock issued for settlement                                                             |       | 187,500     |        | 144,895      |       | —       |       |
| Common stock issued for interest                                                               |       | —      |        | 20,641       |       | —       |       |
| Stock based compensation                                                                       |       | 1,250,625   |        | —       |       | —       |       |
| Change  in assets and liabilities:                                                             |       |        |        |         |       |         |       |
| Decrease (increase) in accounts receivable                                                     |       | (32,345,210 | )           | (2,612,385   | )          | (909,041     | )          |
| Decrease (increase) in inventories                                                             |       | (27,909,521 | )           | (23,456,863  | )          | (8,202,576   | )          |
| Decrease (increase) in other current assets                                                    |       | (106,862    | )           | (25,279      | )          | (181,910     | )          |
| Increase (decrease) in accounts payable                                                        |       | 23,964,958  |        | 12,821,492   |       | 1,152,297    |       |
| Increase (decrease) in other accrued liabilities                                               |       | 1,125,762   |        | 543,554      |       | 1,603,942    |       |
| Increase (decrease) in contract liabilities                                                    |       | 163,938     |        | 956,601      |       | 549,077      |       |
| Deferred Revenue                                                                               |       | 225,290     |        | 9,953,205    |       | 2,436,541    |       |
| **Net cash used in operating activities**                                                      |       | (25,920,025 | )           | (18,587,990  | )          | (12,053,361  | )          |
| **CASH  FLOWS FROM INVESTING ACTIVITIES**                                                      |       |        |        |         |       |         |       |
| Purchase of property and equipment                                                             |       | (7,536,693  | )           | (1,511,337   | )          | (935,197     | )          |
| Proceeds from sale of assets                                                                   |       | —      |        | 155,442      |       | —       |       |
| **Net cash used in investing activities**                                                      |       | (7,536,693  | )           | (1,355,895   | )          | (935,197     | )          |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                                     |       |        |        |         |       |         |       |
| Proceeds from issuance of Private Placement common  stock                                      |       | 185,827,761 |        | —       |       | —       |       |
| Proceeds from issuance of common stock                                                         |       | —      |        | 513,991      |       | 11,298,064   |       |
| Proceeds from issuance of Series D preferred  stock                                       |       | —      |        | 15,305,965   |       | —       |       |
| Redemption of Preferred Stock                                                                  |       | —      |        | —       |       | (50,000      | )          |
| Preferred Stock Dividends paid                                                                 |       | (276,860    | )           | (100,020     | )          | —       |       |
| Issuance of common stock for cash-warrants                                                     |       | 10,374,572  |        | 211,629      |       | —       |       |
| Issuance of common stock for stock options exercised                                           |       | 6,001       |        | —       |       | —       |       |
| Proceeds from (Payments on) loans, net                                                         |       | (7,500,000  | )           | 7,139,025    |       | (175,187     | )          |
| Proceeds from (Payments on) Line of Credit, net                                                |       | —      |        | (4,000,000   | )          | 3,823,039    |       |
| Proceeds from (Payments on) long term liabilities                                              |       | 239,622     |        | (110,732     | )          | 78,271       |       |
| Payments on Capitalized lease                                                                  |       | (112,883    | )           | (62,870      | )          | —       |       |
| **Net cash provided by Financing Activities**                                                  |       | 188,558,213 |        | 18,896,988   |       | 14,974,187   |       |
| **Net increase (decrease) in cash**                                                            |       | 155,101,495 |        | (1,046,897   | )          | 1,985,629    |       |
| **CASH—beginning of period**                                                              |       | 1,217,509   |        | 2,264,406    |       | 278,777      |       |
| **CASH—end of period**                                                                    |       | $           | 156,319,004 |         | $          | 1,217,509    |       | $ | 2,264,406 |   |
| Interest Paid                                                                                  |       | $           | 1,722,119   |         | $          | 1,010,160    |       | $ | 454,512 |   |
| Taxes Paid                                                                                     |       | —      |        | —       |       | —       |       |

 

The accompanying Notes are an integral part of these financial statements.

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**FORCEPROTECTION, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**These notes are an integral part of the Company’sfinancial statements set forth above.**

**NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Restated)**

**2006 Amendment**

The financial informationincluded in this 10-K referring to the year ended December 31, 2006has been amended to include the effect of the updated restatement to thefinancial statements for the year ended 2005 (see Note 1, 2005 and 2004Restatement), and the effect on the basic earning per shares (EPS) of accretionon preferred stock and the calculation of weighted average common shares usedto compute diluted earnings per share.

**Earnings Per Share**

The Company has reviewedthe Financial Accounting Standards Board’s Statement of Financial AccountingStandard No. 128—Earnings Per Share (EPS) and determined that incomeavailable to common shareholders did not include the accretion related topreferred stock and the weighted average number of common shares outstanding usedto calculate diluted earnings per share did not give effect to common sharesissued upon conversion for the entire year.

**Effects ofAmendment**

**Effects on Consolidated Balance Sheet**

| ** **                              | ** ** | **2006** | ** ** |
|-----------------------------------------|------------|----------|------------|
| Increase in  Additional Paid-in-capital | ** ** | 374,309  | ** ** |
| Increase in  Accumulative deficit       | ** ** | 374,309  | ** ** |

 

**Effects on Earnings Per Share**

| ** **                                     | ** ** | **2006** | ** ** |
|------------------------------------------------|------------|----------|------------|
| Decrease in Basic  earnings per common share   | ** ** | $        | (0.03)     | ** ** |
| Decrease in  Diluted earnings per common share | ** ** | $        | (0.03)     | ** ** |

 

**2005 and 2004 Restatement**

**Restatement of Accounting for Preferred Stock andWarrants Issued to Investors**

Force Protection, Inc.(the “Company”) will be filing an amendment to its Annual Report on Form 10-Kfor the year ended December 31, 2005 to amend and restate financialstatements and other information for the years 2005 and 2004. The restatementadjusts the Company’s accounting for preferred stock and warrants issued toinvestors, accounting for stock-based compensation to employees andnon-employees and accounting for rent expense on a straight-line basis. Thefinancial information included in this 10-K referring to prior yearsended December 31, 2005 and 2004 includes each accounting restatement. Giventhat the company is still in the process of finalizing the restatement with theSEC, there is the potential that the restated numbers may change pending finalresolution. The Company believes that the restatement did not have any materialimpact on its 2006 financial results.

The items identified bythe Company relate to the valuation method used to account for certain equityissuances which did not properly include a full analysis of the embeddedconversion feature associated with 

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such issuances as requiredunder EITF 98-5, Accounting for Convertible Securities with BeneficialConversion Features or Contingently Adjustable Conversion Ratios, or which wereotherwise incorrectly valued. As a result, a number of shares of the Company’sstock issued as compensation to certain executives and other third parties andrecorded as general and administrative compensation expense appear to have beenvalued at less than fair value.

TheCompany has reviewed its accounting for preferred stock and warrants issued to investorsas follows:

·       Series B and Series CConvertible Preferred Stock are recorded as equity at fair value using the Black-ScholesMethod at the time of issuance using a one year holding period assumption.

·       A Beneficial ConversionFeature (BCF) treated as equity is created when the value received for eachissuance is less than the fair value from the Black-Scholes calculation. Changesin conversion rates of Preferred Stock into Common Stock also can create aBeneficial Conversion Feature if the Preferred Stock can be converted into morecommon shares than at issuance or last amendment.

·       Series D6% Convertible Preferred Stock is recorded at fair value equaling the net cashproceeds from issuance minus the fair value of warrants issued in conjunctionwith the Series D 6% Convertible Preferred Stock. The Series DPreferred Stock falls outside the scope of SFAS No. 150 but the guidancein Rule 5-02.28 of Regulation S-X, Accounting Series ReleaseNo. 268 (ASR 268) and EITF Topic D-98: “Classification andMeasurement of Redeemable Securities” are applicable. As such, the Company hasrecorded the Series D Preferred Stock as mezzanine equity on theaccompanying balance sheet. Dividends for Series D 6% Convertible PreferredStock were distributed either as Common Stock shares or in cash.

·       The warrants issued inconjunction with the Series D 6% Convertible Preferred Stock were initiallyrecorded at fair value as a liability as liquidating damages were paid as aresult of a late SEC registration of the underlying Common Stock. TheBlack-Scholes Method was used to determine the fair value at issuance using athree year holding period. These warrants are adjusted each reporting period tothe new fair value using the Black-Scholes Method until the registration wasaccepted by the SEC. At that point, the fair value using the Black-ScholesMethod was reclassified into Equity. A realized gain on derivative liability inthe amount of $2,830,791 was recorded in 2005 as a result of the change in fairvalue from issuance to reclassification to equity for these warrants.

·       Other warrants are recordedat fair value using the Black-Scholes Method.

**Restatement of Accounting for Stock-Based Compensationfor Services and Compensation.**

The Company has reviewedits accounting for stock based compensation issued for services andcompensation during 2005, 2004 and 2003 taking into account, where applicable,Financial Accounting Standards Board’s Statement of Financial AccountingStandard No. 123. Stock based compensation issued for services andcompensation were valued at the market price at the time of issuance. As aresult of revaluation, a reduction in expense of $565,035 was recorded in 2005and additional expense of $1,621,985 and $2,946,137 was recorded in 2004 and2003.

The Company has reviewedthe Financial Accounting Standards Board’s Statement of Financial AccountingStandard No. 123(Revised) (“SFAS 123(R)”) and has determined that theCompany will adopt SFAS 123(R) as of July 1, 2005. Stock option expense of$92,671 was recorded for 2005.

**Restatement of Accounting for Operating LeaseCommitments**

The Company has reviewedthe Financial Accounting Standards Board’s Statement of Financial AccountingStandard No. 13 and has determined that in 2005, 2004 and 2003 the Company’saccounting for rent expense was not recorded on a straight-line basis over theterm of the Company’s operating lease commitments. Several of the Company’soperating leases in effect during 2005, 2004 and 2003 included 

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certain terms whichprovided for several months at the beginning of the lease term whereby rentswere not due. Additionally, rent escalation clauses were included withincertain operating leases which previous to this filing had improperly deferredrent expense over the course of the leases. The Company has calculated thenecessary adjustments for 2005, 2004 and 2003 in order to restate its financialstatements and record rent expense associated with operating lease commitmentsfor 2005, 2004 and 2003. Additional rent expense for 2005, 2004 and 2003 wasrecorded in the amount of $12,039, $79,985 and $44,588, respectively.

In light of therestatement, readers should not rely on previously filed financial statementsand other financial information for the years and for each of the quarters inthe years 2005, 2004 and 2003.

**Effects of Restatement**

**Effects on Statements of Earnings**

| ** **                                                         | ** ** | **2005**   | ** ** | **2004**  | ** ** |
|--------------------------------------------------------------------|------------|------------|------------|-----------|------------|
| Increase in cost  of sales                                         |       | 2,012,989  |       | —    |       |
| Increase in  general and administrative expense                    |       | 669,745    |       | 1,701,970 |       |
| Increase in  operating loss                                        |       | 2,682,734  |       | 1,701,970 |       |
| Increase in  unrealized gain                                       |       | 2,830,791  |       | —    |       |
| (Decrease) in non  recurring warranty expense                      |       | (2,012,089 | )          | —    |       |
| Increase/(decrease)  in loss from continuing operations before tax |       | (2,161,046 | )          | 1,701,970 |       |
| Increase/(decrease) in  net (loss)                                 |       | (2,161,046 | )          | 1,701,970 |       |

 

**Effects on Balance Sheet**

| ** **                                                       | ** ** | **2005**    | ** ** | **2004**   | ** ** |
|------------------------------------------------------------------|------------|-------------|------------|------------|------------|
| (Decrease) in  accounts receivable                               |       | (367,233    | )          | —     |       |
| (Decrease) in  total assets                                      |       | (367,233    | )          | —     |       |
| Increase in other  accrued liability                             |       | 279,569     |       | 124,575    |       |
| (Decrease) in  contract liabilities                              |       | (367,233    | )          | —     |       |
| Increase in total  liabilities                                   |       | (87,654     | )          | 124,575    |       |
| Increase in  mezzanine equity—Series D preferred stock |       | 7,901,438   |       | —     |       |
| Increase in  Warrants                                            |       | 5,779,452   |       | 2,601,300  |       |
| Increase/(decrease)  in beneficial conversion feature            |       | (19,102,306 | )          | 19,102,306 |       |
| Increase/(decrease)  in accumulated deficit                      |       | 1,815,639   |       | 23,078,723 |       |
| Increase/(decrease) in  shareholders equity                      |       | (8,181,007  | )          | (124,573   | )          |

 

**Nature of the Business**

Force Protection, Inc.and its subsidiaries (the “Company”) design, manufacture and market blast andballistics armored vehicles for sale to military customers.

**Principles of Consolidation**

The consolidated financialstatements include the accounts of Force Protection, Inc., and its twowholly-owned subsidiaries, Force Protection Industries, Inc. and ForceProtection Technologies, Inc. All inter-company balances and transactionsare eliminated in consolidation.

**General Statement**

The Securities andExchange Commission, or SEC, has issued Financial Reporting Release No. 60,“Cautionary Advice Regarding Disclosure About Critical Accounting Policies,” orFRR 60, suggesting companies provide additional disclosure and commentary on theirmost critical accounting policies. In FRR 60, the SEC defined the most criticalaccounting policies as the ones that are most important to the 

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portrayal of a company’sfinancial condition and operating results, and require management to make itsmost difficult and subjective judgments, often as a result of the need to makeestimates of matters that are inherently uncertain. The methods, estimates andjudgments the Company uses in applying these most critical accounting policieshave a significant impact on the results the Company reports in its financialstatements.

TheCompany believes the following critical accounting policies and procedures,among others, affect its more significant judgments and estimates used in thepreparation of the Company’s consolidated financial statements:

·       Revenue recognition;

·       Inventory cost andAssociated Reserves; and

·       Allocation ofdirect and indirect cost of sales.

**Revenue Recognition**

The Company’s revenue isderived principally from the sale of its vehicles and associated spare partsand training services. Revenue from product sales and spare part sales, net ofan allowance for contractual adjustments, is recognized when the products orspare parts are delivered to and “formally” accepted by the customer. TheCompany defines “formal acceptance” as taking place when a representative ofthe United States government signs the United States Form DD250 entitled “MaterialInspection and Receiving Report” which under the Federal AcquisitionRegulations signifies contractual inspection and acceptance of the workperformed by the contractor. It also acts as the contractual invoice creatingpayment liability on the United States Government. In accordance with standardindustry practice, there is a representative from the United States DefenseContractor Manufacturing Agency (“DCMA”) acting as a contractual representativeof the United States Government present at the Company’s facilities. This DCMArepresentative inspects each vehicle as it is delivered by the Company and uponconfirmation of the vehicle’s conformity with the contractual specificationsthe inspector signs the Form DD250 and formally accepts delivery of thevehicle. The Company only recognizes revenues arising from its U.S. Governmentcontracts upon execution of the Form DD250 by the DCMA inspector. Undersome of the Company’s U.S. Government contracts, it receives performance basedpayments based on completion of specific milestones stipulated under thecontract (for example, delivery of raw material to the Company’s Ladsonfacility). These payments are recorded as “deferred revenue” and carried on theCompany’s balance sheet until the final delivery of the products and formalacceptance by the U.S. Government pursuant to the Form DD250. Uponacceptance of the products and the execution of the Form DD250, theCompany recognizes the full sale price of the product as revenue.

Revenues from servicesprovided are recorded in accordance with specific contractual terms. Serviceshave historically consisted of the Company providing on-site personnel on anas-needed basis in a timely manner, and have generally been provided in foreignlocations.

The Company negotiatescontracts with its customers which may include revenue arrangements withmultiple deliverables, as outlined by Emerging Issues Task Force No. 00-21(EITF 00-21). The Company’s accounting policies are defined such thateach deliverable under a contract is accounted for separately. Historically,the Company has negotiated and signed contracts with its customers whichoutline the contract amount and specific terms and conditions associated witheach deliverable.

**Allowance for Contractual Adjustments**

The Company’s contractswith the U.S. Government are negotiated as a “sole source” or “open competition”bid process. A sole source process is one in which the Company is the solebidder for the contract. An open competition could involve various bidders. Oncea bid is accepted, the U.S. Government expects work to commence immediately. Anopen competition results in a final agreed-upon contract price 

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which the U.S. Governmenthas agreed to. A sole source process results in an agreed-upon contract withthe U.S. Government, subject to an adjustment process at a later date, termedthe “definitization process.” The definitization process commences upondelivery of a product, whereby the U.S. Government completes a detailed reviewof the Company’s costs involved in the manufacturing and delivery process. TheU.S. Government and the Company then work to determine an adequate and fairfinal contract price. As a result of the potential adjustments related to thedefinitization process, the Company maintains an allowance for contractualadjustments account. This account is reviewed on a monthly basis to determineadequate adjustments, if necessary. The allowance is maintained and deemedadequate based on the analysis of historical data and calculation of pro-ratapercentages of current contracts in place, which remain subject to thedefinitization process.

Historically, the Companyhas not encountered sales returns. The Company does not anticipate salesreturns in the future.

**Research and Development**

Research, development, andengineering costs are expensed as incurred, in accordance with SFAS No. 2,*Accounting for Research and DevelopmentCosts*. Research, development, and engineering expenses primarilyinclude payroll and headcount related costs, contractor fees, infrastructurecosts, and administrative expenses directly related to research and developmentsupport.

**Cash Equivalents**

For purposes of reportingcash flows, the Company considers all highly liquid debt instruments purchasedwith maturity of three months or less to be cash equivalents.

**Inventories**

Inventories are stated atthe lower of cost or market. The cost is determined under thefirst-in-first-out (FIFO) valuation method. An allowance for excess or obsoleteinventory is maintained by the Company. The Company determines an appropriatebalance in this account based on historical data and specific identification ofcertain inventory items.

**Property, Plant and Equipment**

Propertyand equipment are stated at cost or at the value of the operating agreement.The Company capitalizes additions and improvements which include all material,labor and engineering cost to design, install or improve the asset. Routinerepairs and maintenance are expensed as incurred. Depreciation and amortizationare computed using the straight-line method over the following estimated usefullives:

| Leasehold Improvements  |   | 2-5 years |
|-------------------------|--------|-----------|
| Furniture and fixtures  |   | 3 years   |
| Machinery and equipment |   | 7 years   |
| Tooling and molds       |   | 7 years   |
| Vehicles                |   | 5 years   |

 

**Impairment ofLong-Lived Assets**

The Company reviewslong-lived assets to be held and used for impairment whenever events or changesin circumstances indicate that the carrying amount of an asset may not berecoverable. If the sum of the expected future cash flows (undiscounted andwithout interest charges) is less than the carrying amount of the asset, theCompany would recognize an impairment loss based on the estimated fair value ofthe asset.

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**Goodwill**

Under SFAS No. 142,*Goodwill and other Intangible Assets*, allgoodwill amortization ceased effective January 1, 2002. Rather, goodwillis now subject to only impairment reviews. A fair-value based test is applied atthe reporting level. This test requires various judgments and estimates. Agoodwill impairment loss will be recorded for any goodwill that is determinedto be impaired. Goodwill is tested for impairment at least annually.

**Foreign Currency Transaction**

Assets and liabilities inforeign currencies are translated at the exchange rate prevailing at thebalance sheet date. Revenues and expenses are translated at the exchange rateprevailing at the transaction date, and the resulting gains and losses arereflected in the statements of operations. Gains and losses arising fromtranslation of a subsidiary’s foreign currency financial statements are shownas a component of stockholders’ equity (deficit) as accumulated comprehensiveincome (loss).

**Income Taxes**

The Company uses the assetand liability method of accounting for income taxes. The asset and liabilitymethod accounts for deferred income taxes by applying enacted statutory ratesin effect for periods in which the difference between the book value and the taxbases of assets and liabilities are scheduled to reverse. The resultingdeferred tax asset or liability is adjusted to reflect changes in tax laws orrates. The company records a valuation allowance for any deferred tax allowancethat it believes will not be realized.

**Stock-Based Compensation**

The Company applied therecognition and measurement principles of Accounting Principles Board Opinion No. 25,*Accounting for Stock Issued to Employees*,and related Interpretations in accounting for those plans through June 30,2005.

In December 2004,FASB issued Statement No. 123(R), *Share-BasedPayment,* which establishes accounting standards for transactions inwhich an entity receives employee services in exchange for (a) equityinstruments of the entity or (b) liabilities that are based on the fairvalue of the entity’s equity instruments or that may be settled by the issuanceof equity instruments. Effective on July 1, 2005, the Company adopted SFAS123(R), which requires the Company to recognize the grant-date fair value ofstock options and equity based compensation issued to employees in thestatement of operations. The statement also requires that such transactions beaccounted for using the fair-value-based method, thereby eliminating use of theintrinsic method of accounting in APB No. 25, *Accounting for Stock Issued to Employees,*which waspermitted under Statement 123, as originally issued.

**Earnings (Loss) per Common Share**

The Company utilizes SFAS No. 128,“Earnings per Share” to calculate earnings/loss per share. Basic earnings/lossper share is computed by dividing the earnings/loss available to commonstockholders (as the numerator) by the weighted-average number of common sharesoutstanding (as the denominator). Diluted earnings/loss per share is computed similarto basic earnings/loss per share except that the denominator is increased toinclude the number of additional common shares that would have been outstandingif all potential common stock (including common stock equivalents) had all beenissued, and if such additional common shares were dilutive. Under SFAS No. 128,if the additional common shares are dilutive, they are not added to thedenominator in the calculation. Where there is a loss, the inclusion ofadditional common shares is anti-dilutive (since the increased number of sharesreduces the per share loss available to common stock holders).

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**Estimates**

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements, as well as the reported amounts of revenues and expenses during thereporting period. Actual results could differ from those estimates. Estimatesand assumptions are periodically reviewed and the effects of revisions arereflected in the consolidated financial statements in the period they aredetermined to be necessary.

**Reclassifications**

Certain reclassificationsto the Company’s income statement have been made in 2006, 2005, and 2004 inorder for the 2006, 2005 and 2004 financial statements to conform to thepresentation of these financial statements. These reclassifications are therestatement of the Research and Development expenses from General andAdministrative expenses.

**Recent Accounting Pronouncements**

In June 2006, theFASB issued FIN No. 48 “Accounting for Uncertainty in Income Taxes—aninterpretation of FASB Statement No. 109.” This interpretation prescribesa comprehensive model for the financial statement recognition, measurement,presentation, and disclosure of uncertain tax positions taken or expected to betaken in income tax returns. FIN No. 48 is effective for Force Protectionin the first quarter of fiscal 2007. The Company is currently assessing theimpact that FIN No. 48 will have on the results of its operations,financial position, or cash flows.

In June 2005, theEmerging Issues Task Force, or EITF, reached a consensus on Issue 05-6,*Determining the Amortization Period forLeasehold Improvements,* which requires that leasehold improvementsacquired in a business combination or purchased subsequent to the inception ofa lease be amortized over the lesser of the useful life of the assets or a termthat includes renewals that are reasonably assured at the date of the businesscombination or purchase. EITF 05-6 is effective for periodsbeginning after July 1, 2005. The Company does not expect the provisionsof this consensus to have a material impact on the financial position, resultsof operations or cash flows.

In May 2005, the FASBissued SFAS No. 154, “Accounting Changes and Error Corrections” (“SFAS 154”)which replaces Accounting Principles Board Opinions No. 20 “AccountingChanges” and SFAS No. 3, “Reporting Accounting Changes in InterimFinancial Statements—An Amendment of APB Opinion No. 28.” SFAS 154provides guidance on the accounting for and reporting of accounting changes anderror corrections. It establishes retrospective application, or the latestpracticable date, as the required method for reporting a change in accountingprinciple and the reporting of a correction of an error. SFAS 154 iseffective for accounting changes and a correction of errors made in fiscalyears beginning after December 15, 2005 and is required to be adopted bythe Company in the first quarter of 2006. The Company is currently evaluatingthe effect that the adoption of SFAS 154 will have on its results ofoperations and financial condition but does not expect it to have a materialimpact.

In March 2005, theFASB issued FASB Interpretation No. 47, “Accounting for Conditional AssetRetirement Obligations” (“FIN 47”). FIN 47 provides guidance relatingto the identification of and financial reporting for legal obligations toperform an asset retirement activity. The Interpretation requires recognitionof a liability for the fair value of a conditional asset retirement obligationwhen incurred if the liability’s fair value can be reasonably estimated.FIN 47 also defines when an entity would have sufficient information toreasonably estimate the fair value of an asset retirement obligation. Theprovision is effective no later than the end of fiscal years ending after December 15,2005. The Company will adopt FIN 47 beginning the first quarter of fiscalyear 2006 and does not believe the adoption will have a material impact on itsconsolidated financial position or results of operations or cash flows.

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**NOTE 2—CONCENTRATIONS**

The Company’s futureoperations and continued expansion is subject to a significant concentrationrisk. During the years ended December 31, 2006, 2005 and 2004, the Company’srevenues from military units of the U.S. Government accounted for 84%, 90% and97% of total revenues, respectively. The Company’s accounts receivable frommilitary units of the U.S. Government at December 31, 2006, 2005 and 2004amounted to 81%, 60% and 95% of total accounts receivable, respectively.

**NOTE 3—ACCOUNTS RECEIVABLES & “DEFINITIZATION”**

The majority of theCompany’s contracts are with the United States Government and as such they are “publicsector” contracts subject to the Federal Acquisition Regulations set out atTitle 41 of the United States Code or “FAR”, and may result either fromcompetitive bidding or may be awarded as “sole source” contracts “subject todefinitization” as provided under FAR Section 252.217-7027.

Following the award of asole source contract, a central component of the definitization process is thenegotiation and finalization of the contract price between the contractor andthe United States contracting officer. As part of this process, the partiesmake a mutual determination of the direct material and labor costs for the workbased upon the bill of materials and other purchasing information and then theparties mutually agree upon “rates” for the indirect labor costs and theGeneral and Administrative costs and upon a “fee” (or profit). While the directmaterial costs and labor can be established through objective evidence, the “rates”and fee are more subjective and are based upon an analysis of multiple factorsincluding historical performance data and projected operational factors. Thecontractor has the right to submit proposed rates and fee, but these aresubject to final review and approval by the contracting officer, who may insiston using alternate rates and fee. As provided in section 252.217-7027(c):

*If agreement on a definitive contract action tosupersede this undefinitized contract action is not reached by the target datein paragraph (b) of this clause, or within any extension of it granted bythe Contracting Officer, the Contracting Officer may, with the approval of thehead of the contracting activity, determine a reasonable price or fee in accordancewith subpart 15.4 and part 31 of the FAR, subject to Contractor appeal asprovided in the Disputes clause.*

Finally, although bothparties make an effort to definitize the contract as quickly as possible, theprocess is time consuming and can take months (or even years) to complete. Duringthe definitization process the contractor is required to perform the contractwork and to make deliveries under the contract before the final contract pricehas been established. For this reason, as part of the original letter award,the contractor provides a rough order of magnitude or “ROM”, price to be usedfor invoicing and accounting purposes pending definitization.

As a result of thepotential adjustments related to the definitization process, the Company maintainsan allowance for contractual adjustments account. This account is reviewed on aregular basis to determine adequate adjustments, if necessary. The allowance isevaluated and deemed adequate based on the analysis of historical data andcalculation of pro-rata percentages of current contracts in place, which remainsubject to the definitization process.

Belowis a table detailing activity within the allowance for contractual adjustmentsaccount for the years ended December 31, 2006, 2005, and 2004 respectively.

| ** **              | ** ** | **Year Ended**         | ** ** | **Year Ended**         | ** ** | **Year Ended**         | ** ** |
|-------------------------|------------|-----------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **              | ** ** | **Dec. 31, 2006** | ** ** | **Dec. 31, 2005** | ** ** | **Dec. 31, 2004** | ** ** |
| Beginning balance       |       | $                           | 1,018,051  |                        | $          | —                      |       |   | $ | — |   |   |
| Additions to  allowance |       | 6,317,077                   |       | 1,018,051                   |       |                        | —     |   |   |
| Reduction to  allowance |       | (1,267,041                  | )          | —                      |       |                        | —     |   |   |
| Ending balance          |       | $                           | 6,068,087  |                        | $          | 1,018,051                   |       |   | $ | — |   |   |

 

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The Company does notmaintain an allowance for doubtful accounts. The Company’s significant salesfor the years ended December 31, 2006, 2005 and 2004 involved contractssigned with the U.S. Government. As of the date of this report all non-directgovernment year-end receivables have been collected. The Company does notbelieve an allowance for doubtful accounts is necessary due to thecredit-worthiness of the U.S. Government.

Historically, the Companyhas not encountered sales returns. The Company does not anticipate salesreturns in the future.

**NOTE 4—INVESTMENT IN CHALLENGER POWERBOATS INC.**

On June 1,2003, and modified on September 15, 2003, the Company sold the assetassociated with its boat business to Rockwell Power Systems, Inc., whichsubsequently merged with Xtreme Companies, Inc, now called ChallengerPowerboats, Inc., a public company traded on the Over the Counter BulletinBoard. As consideration for the sale, the Company received 1/3 of ChallengerPowerboats’ outstanding common stock, which was distributed directly to theCompany’s common stock shareholders. Additionally, the Company was to receive500 shares of Challenger Powerboats Series A preferred stock. The Companyhas been in communications with Challenger Powerboats but has yet to receivethese shares. The Company has elected to account for the investment inChallenger Powerboats’ Series A preferred stock under the cost method andhas provided for a full valuation allowance against the fair market value ofthese shares as of December 31, 2006, 2005 and 2004, respectively.

| ** **                                                      | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Challenger  Powerboats, Inc. Series A preferred stock |       |     | $          | —   |       |     |       | $ | — |   |   |   | $ | — |   |   |
| Valuation  Allowance                                            |       |     | —     |     |       |     | —     |   |   |   | — |   |   |
| Net Investment in  Challenger Powerboats, Inc                   |       |     | —     |     |       |     | —     |   |   |   | — |   |   |

 

**NOTE 5—INVENTORIES**

Inventoriesat December 31, 2006, 2005 and 2004 consisted of the following:

| ** **                                | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Raw materials and  supplies               |       | $          | 45,131,126 |       | $          | 15,222,503 |       | $ | 5,268,798 |   |
| Work in process                           |       | 17,688,784 |       | 17,762,554 |       | 3,756,921  |       |
| Finished Goods                            |       | —     |       | —     |       | 4,194      |       |
| Less: Allowance  for surplus and obsolete |       | (2,423,613 | )          | (498,281   | )          | —     |       |
| Inventories, net                          |       | $          | 60,396,297 |       | $          | 32,486,776 |       | $ | 9,029,913 |   |

 

**NOTE 6—PROPERTY, PLANT AND EQUIPMENT**

Property,Plant and Equipment at December 31, 2006, 2005 and 2004 consisted of thefollowing:

| ** **                          | ** ** | **2006**   | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|-------------------------------------|------------|------------|------------|-----------|------------|-----------|------------|
| Furniture and  fixtures             |       | $          | 1,022,984  |      | $          | 227,613   |       | $ | 252,608 |   |
| Leasehold  improvements             |       | 1,534,057  |       | 59,928    |       | —    |       |
| Machinery and  equipment            |       | 6,534,550  |       | 2,024,436 |       | 983,955   |       |
| Test Equipment                      |       | 16,790     |       | 16,790    |       | 16,790    |       |
| Manuals                             |       | 104,797    |       | 104,798   |       | 104,798   |       |
| Vehicles                            |       | 143,464    |       | 56,464    |       | 10,110    |       |
| Demo vehicles                       |       | 1,095,925  |       | 425,845   |       | 192,530   |       |
| Less depreciation  and amortization |       | (1,488,666 | )          | (777,171  | )          | (523,797  | )          |
| Net property and  equipment         |       | $          | 8,963,901  |      | $          | 2,138,703 |       | $ | 1,036,994 |   |

 

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Depreciation expense forthe years ended December 31, 2006, 2005 and 2004 was $769,454, $386,152and $207,271 respectively.

**NOTE 7—COMMITMENTS AND CONTINGENCIES**

**Other Accrued Liabilities**

TheCompany’s other accrued liabilities include the following:

| ** **                        | ** ** | **2006**  | ** ** | **2005** | ** ** | **2004**  | ** ** |
|-----------------------------------|------------|-----------|------------|----------|------------|-----------|------------|
| Compensation and  benefits        |       | $         | 1,222,143  |     | $          | 1,396,024 |       | $ | 1,195,705 |   |
| Vehicle Fee  Payable              |       | 1,139,250 |       | —   |       | —    |       |
| Liquidated damage  settlement     |       | 607,466   |       | —   |       | —    |       |
| Dividends on  preferred stock     |       | —    |       | 260,080  |       | —    |       |
| Common Stock  shares to be issued |       | —    |       | 212,606  |       | —    |       |
| Other                             |       | —    |       | 29,310   |       | 158,761   |       |
| Total                             |       | $         | 2,968,859  |     | $          | 1,898,020 |       | $ | 1,354,466 |   |

 

**Contract Liabilities**

The Company’s salescontracts generally include a warranty such that the Company’s products arefree from defects in design, material, and workmanship for a period of 1 yearfrom the acceptance date. The warranty does not apply to any damage or failureto perform caused by the misuse or abuse of the vehicle, combat damage, fairwear and tear items (brake shoes, track pads, wiper blades, etc.), or by thecustomer’s failure to perform proper maintenance or service on the supplies.

TheCompany routinely reviews its exposure for warranty costs and determineswarranty and pricing reserves based on historical data and known events. Belowis a table detailing the Company’s accruals for warranty-related costs as of December 31,2006, 2005 and 2004:

| ** **       | ** ** | **2006** | ** ** | **2005** | ** ** | **2004**  | ** ** |
|------------------|------------|----------|------------|----------|------------|-----------|------------|
| General warranty |       | $        | 1,850,000  |     | $          | 1,686,062 |       | $ | 228,130 |   |
| Loss contingency |       | —   |       | —   |       | 501,331   |       |
|             |       | $        | 1,850,000  |     | $          | 1,686,062 |       | $ | 729,461 |   |

 

**Vehicle Fees**

The Company is party to a Memorandum of Understandingwith Mechem, a division of Denel PTY, a South African company pursuant to whichMechem agreed for a period of five years to work exclusively with the Companyand not to cede, dispose or transfer to any third party other than the Companyany of its technology, IPR or other proprietary information relating to itsarmored vehicles systems including, but not limited to, designs, drawings, fulltechnical specifications, test data, hardware and software designs andtechnologies, supplier’s list, know-how and all and every piece of informationand data relevant to such systems. In exchange for such exclusivity the Companyagreed to pay Mechem a “vehicle fee” for every Buffalo, Cougar and Tempest theCompany manufactures and sells. The Company is not obligated to pay a vehiclefee in respect of other vehicles it manufactures and sells. OnSeptember 13, 2006 the Company executed a new Memorandum of Agreement withMechem, extending the period of exclusivity for an additional five years, andadding a provision that Mechem would upon request by the Company provideexpertise and know-how on a “work for hire” basis to advise, assist and supportthe Company in its marketing activities. The Company also agreed to make a onetime payment of $394,500 to Mechem, representing vehicle fees in respect ofCougar vehicles previously delivered and sold by the Company during 2005 and2006. The agreement with Mechem expires in September 2011.

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The Company is also party to an agreement with CSIRDefencetek (a division of the Council for Scientific and Industrial Research) astatutory council established in accordance with the Laws of the Republic ofSouth Africa, pursuant to which the Company is obligated to pay the CSIR asimilar vehicle fee. The agreement with the CSIR expires in March 2007.

Thefollowing table is a summary of the vehicle fees to be paid per vehicle:

| ** ** | ** ** | **Mechem** | ** ** | **CSIR** | ** ** |
|------------|------------|------------|------------|----------|------------|
| Buffalo    |       |       | $5,000     |     |       | $3,000 |   |
| Cougar     |       |       | $1,500     |     |       | $1,500 |   |
| Tempest    |       |       | $3,000     |     |       | $1,500 |   |
| Cheetah    |       |       | $0         |     |       | $0 |   |

 

**Table ofContractual Obligations**

Thefollowing is a table outlining the Company’s actual and projected significantcontractual obligations as of December 31, 2006:

| ** **                      | ** ** | **For the Years Ended** | ** ** |
|---------------------------------|------------|----------------------------------------|------------|
| ** **                      | ** ** | **2007**                               | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **Total** | ** ** |
| Operating Lease Commitments     |       | $1,624,286                             |       | $992,479 |   | $56,609 |   | — |   | — |   | $2,673,374 |   |
| Capital Equipment Note Payments |       | $92,608                                |       | $92,608 |   | $69,456 |   | — |   | — |   | $254,672 |   |
| Mechem—Vehicle  Fees(1)    |       | Variable                               |       | Variable |   | Variable |   | Variable |   | Variable |   | Variable |   |
| CSIR—Vehicle  Fees(2)      |       | Variable                               |       | Variable |   | — |   | — |   | — |   | Variable |   |
| Total                           |       | $1,716,894                             |       | $1,085,087 |   | $126,065 |   | — |   | — |   | $2,928,046 |   |

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(1)          Refer to the Mechemvehicle fee agreement detailed above in Footnote 7, Commitments andContingencies, “Vehicle Fees.”

(2)          Referto the CSIR vehicle fee agreement detailed above in Footnote 7, Commitments andContingencies, “Vehicle Fees.”

**ContractDefinitization**

The Company contracts forthe sale of its vehicles to the U.S. Government under fixed price salescontracts, subject to the provisions of the U.S. Federal AcquisitionRegulations (“FAR”). Under FAR 52.216-25, contract awards may bemade subject to future “Contract Definitization” pursuant to which thecontractor agrees to negotiate with the Government following commencement ofthe contract work to finalize detailed conditions of the contract, includingpricing, scheduling and other applicable requirements. As part of suchnegotiations, the contractor is subject to audit by the U.S. Defense ContractAudit Agency (“DCAA”) of its direct material and labor costs, manufacturingoverhead and margin. Based on such audit and the negotiations with theGovernment, the final “definitized” contract price may be less than the amountoriginally established (see additional discussions within Footnote 1 andFootnote 3).

**Legal Proceedings**

During June, 2006, the Company confirmed that twoformer employees had filed claims under 31 U.S.C. §3730 alleging *inter alia* that the Company had failed tocomply with the terms of the JERRV contract in respect to the allocation anduse of the initial contract milestone payment for such “accelerated deliverycosts.” On August 23, 2006, the Company agreed to settle with the UnitedStates Government and with these former employees all claims relating to orarising under the JERRV contract and the payment of 

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such accelerated delivery costs for a total of$1,905,000 plus interest of $23,000. As of December 31, 2006, the Companyhas paid $1,297,534 under the terms of such settlement agreement and the Companyhas established a provision of $607,466 for the remaining liability.

The Company may beinvolved from time to time in ordinary litigation that will not have a materialeffect on our operations or finances. Other than the litigation describedabove, we are not aware of any pending or threatened litigation against thecompany or our officers and directors in their capacity as such that could havea material impact on our operations or finances.

**NOTE 8—DEFERREDREVENUE**

The Company onlyrecognizes revenue from the sales of its vehicles upon formal acceptance by itscustomers. However, the Company does receive performance based payments inaccordance with agreed milestones under some of its government contracts. TheCompany records such performance based payments as deferred revenue and carriesthem on its balance sheet until formal acceptance by the customer. As of December 31,2006, 2005 and 2004 the Company had $12,824,211, $12,598,921 and $2,645,716,respectively as deferred revenue resulting from its contracts with the U.S.Army and the U.S. Marines.

**NOTE 9—DEBT**

On November 18, 2005, Longview Fund, LP andLongview Equity Fund, LP (collectively, “Longview”) issued secured promissorynotes (the “Notes”) to the Company for gross proceeds of $7,500,000. The Notesmatured on February 18, 2006. Interest is payable on the Notes at theannualized rate of 24%. The Company also executed a Security Agreement thatgranted Longview a first preferred UCC-1 security interest in all of theCompany’s assets and property.

On February 18, 2006, the Company entered into aModification and Assignment Agreement with Longview pursuant to which theCompany paid $1,250,000 against the principle balance of the Notes and extendedthe maturity date of the Notes for an additional 60 days. In addition, theCompany consented to the assignment of $2,500,000 of the Notes to Fort AshfordFunds LLC (the “Ashford Note”). Frank Kavanaugh, a director of the Company, isthe principal owner of Fort Ashford Funds and a substantial shareholder of theCompany’s common stock. Mr. Kavanaugh’s relationship to Fort Ashford FundsLLC was fully disclosed to the Company and Mr. Kavanaugh did notparticipate in the negotiations or decision process in respect of theModification and Assignment Agreement. The Company paid $87,510 to Longview and$50,000 to Fort Ashford in cash as compensation for the extension of thematurity dates of the Notes.

On April 20, 2006, the Company paid $1,000,000against the principle balance of the Notes and extended the maturity date onthe Notes and the Ashford Note for an additional 60 days, through June 20,2006. The Company paid $55,000 to Longview and $50,000 to Fort Ashford in cashas compensation for this extension.

On June 20, 2006, the Company paid off theprinciple balance and all applicable accrued interest under the Notes.Additionally, the Company extended the maturity date of the Ashford Note for anadditional 30 days, through July 20, 2006. The Company paid $50,000to Fort Ashford in cash as compensation for the extension of the Ashford Note.

On August 9, 2006, the Company paid off theprinciple balance of the Ashford Note, and all applicable accrued interestunder the Ashford Note.

In October 2006 theCompany acquired capital equipment valued at $234,875 using a note with impliedinterest of 11.25% from the supplier with a repayment based on usage ofmaterials used with the 

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equipment. It is expectedthat based on usage estimates the note payments in 2007, 2008, and 2009 will be$92,608, $92,608 and $69,456, respectively.

**NOTE 10—FACTORINGOF ACCOUNTS RECEIVABLE**

The Company entered into an agreement with GCFinancial Services, Inc. on June 29, 2005, pursuant to which theCompany agreed to sell accounts receivables under our JERRV Contract (M67854-05-D-5091)in an amount not to exceed $63,000,000. Under the terms of such agreement, theCompany received 98.1% of the value of receivables sold to the Factor within 24-48hours of delivery of the invoice. During June 2006, the Company exceededthe agreed maximum value of receivable to be factored under the FactoringAgreement. On June 22, 2006, the Factoring Agreement was terminated and nofurther obligation remained between the Company and GC Financial Services, Inc.

The Company entered into an agreement with GCFinancial Services, Inc. on June 28, 2004, pursuant to which theCompany agreed to sell accounts receivables under our Buffalo contracts withthe U.S. Army. Under the terms of such agreement, the Company receivesapproximately 98% of the value of receivables sold to the Factor within 24-48hours of delivery of the invoice. The Factor was granted a security interest inthe Company’s assets and retained the right of full recourse against theCompany. The Company terminated such agreement in January 2005.

TheCompany’s factoring transactions in 2006, 2005 and 2004 are summarized below:

| ** **                     | ** ** | **Year Ended**             | ** **  | **Year Ended**             | ** ** | **Year Ended**             | ** **  |
|--------------------------------|------------|---------------------------------|-------------|---------------------------------|------------|---------------------------------|-------------|
| ** **                     | ** ** | **December 31, 2006** | ** **  | **December 31, 2005** | ** ** | **December 31, 2004** | ** **  |
| Sale of  Receivables to Factor |       |                            | $           | 44,692,632                      |       |                            |        | $ | 17,170,086 |   |   |   | $ | 11,895,363 |   |   |
| Payments to Factor             |       |                            | (45,482,504 | )                               |       |                            | (16,380,214 | ) |   |   | (11,294,319 | ) |   |
| Balance at end of  period      |       |                            | $           | —                          |       |                            |        | $ | 789,872 |   |   |   | $ | 601,044 |   |   |
| Charges by Factor              |       |                            | $           | 849,160                         |       |                            |        | $ | 311,443 |   |   |   | $ | 237,907 |   |   |

 

**NOTE 11—STOCKHOLDERS’EQUITY**

The Company was originally incorporated onNovember 27, 1996 as a Colorado corporation. The Company incorporatedForce Protection, Inc, a Nevada corporation on December 13, 2004 andeffected a merger with Force Protection, Inc., a Colorado corporation, onJanuary 1, 2005. The Colorado Corporation was dissolved upon the merger.The Company has continued its operations as the Nevada Corporation fromJanuary 1, 2005 forward. The Company has the authority to issue310,000,000 shares, in aggregate, consisting of 300,000,000 shares of commonstock and 10,000,000 shares of preferred stock, of which 1,600 have beendesignated “Series A,” 25 of which have been designated as“Series B,” 150 of which have been designated as “Series C” and20,000 of which have been designated as “Series D.” At all times throughDecember 31, 2004, the Company’s stock was all issued at “no par value.”By shareholder’s resolution effective January 1, 2005, all classes ofstock were declared to have a par value of $0.001 per share. For furtherinformation regarding Series D 6% Convertible Preferred Stock, pleaserefer to the separate footnote disclosure in Note 12.

The preferred stock has the following characteristics:

Dividends—Each holder of preferred stock shall beentitled to receive dividends in cash, stock or otherwise, if, when and as declaredby the Company’s board of directors, with the exception of the preferred stockdesignated as Series A, which shall not be entitled to receive dividends.However, the Company will not declare or pay a dividend to common stockholderswithout first declaring and paying a dividend to the preferred shareholders.Each share of Series D Preferred Stock is specifically entitled to 6%cumulative dividends, payable semi-annually in cash or common stock. See Note12 for further details regarding Series D 6% Convertible Preferred Stock.

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Liquidation—In theevent of any voluntary or involuntary liquidation, dissolution or winding-up ofthe Company, the assets of the Company available for distribution to itsstockholders shall be distributed as follows:

(a)           Series A PreferredStock shall rank senior to Series B Preferred Stock, Series CPreferred Stock, Series D 6% Convertible Preferred Stock and common stock;

(b)          Series B PreferredStock shall rank junior to Series A Preferred Stock, senior toSeries C Preferred Stock, Series D 6% Convertible Preferred Stock andcommon stock;

(c)           Series C PreferredStock shall rank junior to Series A Preferred Stock, Series BPreferred Stock and senior to Series D 6% Convertible Preferred Stock andcommon stock;

(d)          Series D 6% ConvertiblePreferred stock shall rank junior to Series A Preferred StockSeries B Preferred Stock, Series C Preferred Stock and senior tocommon stock; and

(e)           Common stock shall rankjunior to Series A, B, C and D 6% Convertible Preferred Stock.

Additionally, upon a liquidation event, holders ofSeries A Preferred Stock will receive $1,000 per share of Series APreferred Stock. Holders of Series B Preferred Stock will receive thegreater of $2,500 or the pro-rata share of the Company’s remaining net assetsto be distributed, after rank considerations. Holders of Series CPreferred Stock will receive a 150% return on the face value of the share ofSeries C Preferred Stock, or $1,500, after rank considerations. In anyevent whereby the preceding distributions are unable to be met, the rankconsiderations outlined above shall be considered and the distribution of theCompany’s net assets shall be determined according to rank and on a pro-ratabasis.

Conversion—Series A Preferred Stock shall convertinto common stock at a rate of $4.00 per share, as adjusted accordingly. Eachshare of Series B Preferred Stock shall convert into 759,167 shares ofcommon stock. Each share of Series C Preferred Stock shall convert into75,917 shares of common stock. Each share of Series D 6% ConvertiblePreferred Stock shall convert into common stock at $2.10 per share.

In connection with the private placement sale of theCompany’s common stock on January 19, 2005, the Company and the holders ofSeries B and Series C Preferred Stock agreed to convert all shares ofthe Series B and Series C Preferred Stock outstanding to shares ofthe Company’s common stock. As a result, all shares of Series B andSeries C Preferred Stock were converted into common effective January 19,2005. The Series D 6% Convertible Preferred Stock issued in connectionwith the January 19, 2005 private placement remained outstanding followingthe conversion of the Series B and Series C Preferred Stock. Alloutstanding shares of the Series D 6% Convertible Preferred Stock wereconverted in full in 2006, and no shares of the Series D 6% ConvertiblePreferred Stock remain outstanding as of September 30, 2006. Series D6% Convertible Preferred Stock has been classified as Mezzanine Equity by theCompany. Please refer to Note 12 for further details regarding Series D 6%Convertible Preferred Stock.

On January 18, 2005, the Company’s board ofdirectors, acting pursuant to a resolution of the Company’s shareholders,approved a reverse split of the Company’s stock whereby each 12 shares ofcommon stock outstanding on the date of record, February 4, 2005, would beexchanged for 1 new share of common stock. All references to common stock inthe Company’s public filings refers to “post reverse split” shares.

The followingdisclosures reference accounting guidelines and certain accounting treatmentswhich the Company has used throughout 2006, 2005 and 2004. The Companyconsiders the following terms and definition significant in ensuring the readerof these financial statements understands the accounting treatments applied bythe Company:

·       TheEmerging Issues Task Force (“EITF”) provides accounting guidance andinterpretations on emerging issues in business and accounting.

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·       Statementson Financial Accounting Standards (“SFAS”) are a primary source of accountingguidance under which many of the Company’s accounting policies are based.

·       Beneficialconversion feature is a topic addressed in EITF 98-5, *Accounting for Convertible Securities with Beneficial ConversionFeatures or Contingently Adjustable Conversion Ratios*, EITF 00-19*Accounting for Derivative Financial InstrumentsIndexed to, and Potentially Settled in , a Company’ s Own Stock* and EITF 00-27*Application of Issue No. 98-5 to CertainConvertible Instruments*, is an accounting term defined in EITF 98-5that represents a situation in which a convertible security (debt or equity) isconvertible into the Company’s common stock at a price which is at a discountto the market, at the time the convertible security is issued.

·       TheBlack-Scholes option pricing model (Black-Scholes) is an analytical model usedto value an option to purchase a security based on certain market fundamentalssuch as the volatility of a security, the market for effective interest ratesover a period of time and constraints placed on the option to purchase thesecurity such as time horizons or the expiration of the option to purchase thesecurity. The Company utilizes Black-Scholes to value stock options issued toemployees, preferred stock issued to employees and service providers, preferredstock purchased by investors and warrants issued to investors.

***During the year ended December 31, 2006, theCompany recorded the following transactions within its stockholders’ equityaccounts:***

*COMMON STOCKTRANSACTIONS*

·       On July 24, 2006, theCompany closed a private placement sale and issued 8,250,000 shares of commonstock to investors for gross proceeds of $41,250,000. Net proceeds receivedafter expenses were $39,187,500.

·       On December 20, 2006, the Company closed aprivate placement sale and issued 13,000,000 shares of common stock toinvestors for gross proceeds of $152,750,000. Net proceeds received afterexpenses were $146,640,261.

The followingissuances of the Company’s common stock during 2006 were valued by the Companyusing the Company’s closing bid price of its common stock as quoted on the OTCBulletin Board market as of the date of the associated contract or the issuancedate if no contract existed:

·       Effective January 1, 2006, the Company’sboard of directors granted the Company’s Chief Executive Officer 300,000 sharesof the Company’s unregistered common stock valued at $216,000. The shares werefully vested upon issuance.

·       On April 21, 2006, theboard of directors adopted a resolution approving payment of annualcompensation to each member of the Company’s board of directors. Each member isto receive annual cash compensation of $24,000. In addition, each memberreceived a guarantee of an annual grant of 15,353 shares of the Company’sunregistered common stock. The shares of the Company’s unregistered commonstock are required to be held until the individual’s service as a member of theCompany’s board of directors is complete. The Company awarded 96,149 and issued69,360 shares of the Company’s common stock to the members of the Company’sboard of directors in 2006. A total of 26,789 shares of the Company’s commonstock were included in shares to be issued in the stockholders’ equity table asof December 31, 2006 relating to this award. The value for the 96,149shares of common stock awarded to the members of the board of directors wasrecorded as stock based compensation of $445,990.

·       On June 2, 2006, theCompany granted and issued 12,500 shares of its unregistered common stock to amember of the Company’s board of directors, valued at $40,500 as compensationdue under a previous employment contract with the Company. During 2006, theCompany granted and issued 165,202 shares of its unregistered common stockvalued at $405,786 under various employment agreements. Included withinthese issuances were common stock issuances related to certain employeeagreements which were 

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modified during 2006. Atotal of 233,418 shares of common stock were rescinded as a result of themodifications to employee agreements. These transactions resulted in areduction of the total stock-based compensation for 2006 of $224,688.

·       On August 8, 2006, theCompany agreed to issue 30,000 shares of common stock under a settlementagreement with Atlantis Partners, Inc. The shares issued were valued at$187,500.

·       During 2006, employeesexercised stock options to purchase 5,348 shares of the Company’s common stockvalued at $6,001. A total of 4,348 shares of the Company’s common stock wereincluded in shares to be issued in the stockholders’ equity table as of December 31,2006 related to employee exercised stock options.

·       The Company adopted SFAS123R as if July 1, 2005. Total stock option expense for 2006, which isinclusive of stock grants in 2006 was $1,250,625.

*PREFERRED STOCKTRANSACTIONS*

*Series D 6% ConvertiblePreferred Stock:*

·       During the year ended December 31,2006, 13,004 shares of Series D Preferred Stock were voluntarily convertedto 6,192,628 shares of common stock. The fully accreted conversion value ofthese shares of common stock at the time converted was $9,198,571. SeeNote 12—Series D 6% Convertible Preferred Stock.

·       During the three monthperiod ended June 30, 2006, 586 shares of common stock were issued in lieuof cash dividends for the holders of Series D Preferred Stock. The sharesissued were valued at $2,377 which was 85% of the average of the lowest marketvalue for 3 of the prior 10 trading days.

·       During the three monthperiod ended September 30, 2006, 8,351 shares of common stock were issuedin lieu of cash dividends for the holders of Series D Preferred Stock. Theshares issued were valued at $46,448 which was 85% of the average of the lowestmarket value for 3 of the prior 10 trading days.

*WARRANTTRANSACTIONS*

·       During 2006, warrantsassociated with Series D Preferred Stock were exercised and the Companyissued 2,633,333 shares of common stock for gross proceeds of $9,874,999.

·       During 2006, variouswarrants were exercised and the Company issued 218,807 shares of common stockfor gross proceeds of $499,573.

·       As of December 31,2006, all warrants were exercised or expired. No warrants remained outstandingas of December 31, 2006.

*SHARES TO BE ISSUED*

·       During the three monthperiod ended December 31, 2006, 26,789 shares of common stock were grantedfor compensation to the Company’s board of directors. The shares were valued at$210,408 but were not issued as of December 31, 2006.

***During the year ended December 31, 2005, theCompany recorded the following transactions within its stockholders’ equityaccounts:***

*COMMON STOCKTRANSACTIONS*

In January 2005, the Company issued a total188,400 shares of the Company’s common stock at an average price of $2.76 pershare, generating $520,069 in net proceeds pursuant to the Investment Agreementbetween the Company and Dutchess Private Equities Fund, L.P., datedJanuary 26, 2004.

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The followingissuances of the Company’s common stock during 2005 were valued by the Companyusing the Company’s closing bid price of its common stock as quoted on the OTCBulletin Board market as of the date of the associated contract or the issuancedate if no contract existed.

·       41,666shares of the Company’s common stock valued at $112,499 were issued to adirector, a member of the board of directors, for services rendered to theCompany. An expense of $112,499 was classified as compensation of directors andwas recorded in 2005.

·       9,950shares of the Company’s common stock valued at $12,910, to the Company’s formerPresident, for services rendered to the Company. An expense of $12,910 wasclassified as officer compensation and was recorded in 2005.

·       TheCompany issued 53,467 shares of the Company’s common stock pursuant to theterms of the Company’s agreement with certain third parties and were valued at $144,895.An expense of $144,895 was classified as settlement expense and was recorded in2005.

·       TheCompany issued 14,876 shares of the Company’s common stock pursuant to theterms of the Company’s agreement with GC Financial Services, Inc. whichwere valued at $20,641. An expense of $20,641 was classified as interestexpense and was recorded in 2005.

·       TheCompany’s former Chief Executive Office, agreed to rescind 83,333 shares ofcommon stock issued in 2004 valued at $209,999.

A total of 114,376 shares of common stock were issuedby the Company for net proceeds of $211,629 in connection with the exercise ofwarrants issued through a PIPE offering completed on April 10, 2002.

The Company issued a warrant to purchase 65,833 sharesof the Company’s common stock on January 19, 2005 to HPC Company. Thewarrant was valued at $200,071 using Black-Scholes. The Company recorded areduction of stockholders’ equity associated with services provided as aplacement agent for the Company’s Series D 6% Convertible Preferred Stockoffering, which closed on January 19, 2005. The inputs for this warrant inBlack-Scholes are consistent with the inputs for the warrants issued with theSeries D 6% Convertible Preferred Stock.

The Company issuedwarrants to purchase 75,000 shares of the Company’s common stock that can beexercised for $3.75 per share in a settlement agreement with H.C.Wainwright & Co. The value as determined by Black-Scholes was expensedas settlement expense in the amount of $158,071. The Company also issued awarrant to purchase 41,667 shares of the Company’s common stock that can beexercised for $3.96 per share in a settlement agreement with Westor Online. Thevalue as determined by Black-Scholes was expensed as settlement expense in theamount of $72,354. The warrants were exercised in 2006. Below is a tabledepicting the valuation attributes used in Black-Scholes calculations relatedto these warrants issued in 2005:

**Warrant ValuationInformation**

| Valuation Assumptions                           |   | —  |       |
|-------------------------------------------------|--------|---------|------------|
| Stock price on grant date                       |   | $       | 2.05-$3.00 |   |
| Number of shares of common stock convertible to |   | 116,667 |       |
| Conversion price                                |   | $       | 3.75-$3.96 |   |
| Expected option term (in years)                 |   | 1       |       |
| Vesting term (in years)                         |   | N/A     |       |
| Expected volatility                             |   | 177.06  | %          |
| Risk-free interest rate                         |   | 4.26    | %          |
| Expected forfeiture rate                        |   | 0       | %          |
| Estimated corporate tax rate                    |   | 0       | %          |
| Expected dividend yield                         |   | 0       | %          |

 

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Outstanding warrants to purchase 2,143,085 commonstock shares expired or were cancelled during 2005. The warrant valuation of$2,302,850 was added to Additional Paid in Capital accordingly in 2005.

The Company issued14,803,750 shares of unregistered common stock resulting for the mandatoryconversion on February 8, 2005 of all the outstanding shares of theCompany’s Series B Convertible Preferred Stock. At the time of conversion,the conversion rate for the Series B Convertible Preferred Stock was 2% offully diluted common stock. The beneficial conversion feature related to theSeries B Convertible Preferred Stock in the amount of $19,102,306 wasrelieved in full on February 8, 2005.

*PREFERRED STOCKTRANSACTIONS*

*Series D 6%Convertible Preferred Stock:*

·       OnJanuary 19, 2005, the Company issued 15,800 shares of the Company’sSeries D 6% Convertible Preferred Stock for net cash of $15,305,966. Theissuance of the Company’s Series D 6% Convertible Preferred Stock wasrecorded at $7,301,766 which is the net value of the cash received of$15,305,966 less the fair value of the associated warrants of $8,004,200. TheCompany classified the Series D 6% Convertible Preferred Stock as MezzanineEquity. Refer to Note 12 for further information regarding Series D 6%Convertible Stock.

·       OnMay 23, 2005, 2,796 shares of the Series D Preferred Stock werevoluntarily converted into 1,331,429 shares of Common Stock. The conversionvalue of these shares of common stock at the time of conversion was $1,442,025.

***During the year ended December 31, 2004, theCompany recorded the following transactions within its stockholders’ equity accounts:***

*COMMON STOCKTRANSACTIONS*

The Company closedon a private investment in public equity (“PIPE”) offering on March 23,2004. The PIPE, sold to numerous accredited investors, consisted of thefollowing:

·       Commonstock issuances, 1,771,874 shares of common stock were issued for $4,245,000 innet proceeds.

·       Issuanceof “A” warrants, 1,771,874 warrants to purchase common stock were issued in2004, with an original exercise price of $1.44 per warrant. A total of 219,792shares of common stock were issued by the Company for net proceeds of $316,497,in connection with the exercise of “A” warrants in 2004. The remaining “A”warrants expired on December 31, 2004.

·       Issuanceof “Green Shoe” warrants, 1,771,874 warrants to purchase common stock wereissued in 2004, with an original exercise price of $2.40 per warrant. A totalof 674,058 shares of common stock were issued by the Company for net proceedsof $1,677,713, in connection with the exercise of “Green Shoe” warrants in2004. The remaining ”Green Shoe” warrants expired on December 31,2004.

In November and December 2004, the Companyissued a total 1,210,843 common shares generating $2,958,217 in net proceedspursuant to the Dutchess Equity agreement.

A total of 1,863,768 shares of common stock wereissued by the Company for net proceeds of $2,100,637 in connection with theexercise of warrants issued through a private investment in public equity(“PIPE”) offering dated April 10, 2002 for Regulation D Section 506Private Placement Memorandum issued in 2003 to numerous accredited investors.

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The followingissuances of the Company’s common stock during 2004 were valued by the Companyusing the Company’s closing bid price of its common stock as quoted on the OTCBulletin Board market as of the date of the associated contract or the issuancedate if no contract existed.

·       163,501shares of the Company’s common stock valued at $496,956 were issued to a thirdparty for services rendered to the Company. An expense associated with thisissuance of $496,956 was recorded in 2004.

·       70,833shares of the Company’s common stock valued at $127,500 were issued to a memberof the board of directors, for services rendered to the Company. An expense of$127,500 was classified as compensation of directors and was recorded in 2004.

·       91,667shares of the Company’s common stock valued at $231,000 were issued to a memberof the board of directors, for services rendered to the Company. An expense of$231,000 was classified as compensation of directors and was recorded in 2004.

·       208,333shares of the Company’s common stock valued at $495,000 to the Company’s formerChief Executive Officer, for services rendered to the Company. An expense of$495,000 was classified as officer compensation and was recorded in 2004.

·       125,000shares of the Company’s common stock valued at $255,000 to the Company’s formerChief Financial Officer, for services rendered to the Company. An expense of$255,000 was classified as officer compensation and was recorded in 2004.

·       41,682shares of the Company’s common stock valued at $145,054 to an employee, forservices rendered to the Company. An expense of $145,054 was classified asstock-based compensation and was recorded in 2004.

·       79,167shares of the Company’s common stock valued at $178,250, to various employeesfor services rendered to the Company. An expense of $178,250 was classified asstock-based compensation and was recorded in 2004.

304,167 shares of common stock issued in error inDecember 2003 were cancelled in the first week of January 2004.

The Company issued 20,421 sharesof common stock to third parties upon the conversion of existing debts in theamount of $124,976.

*PREFERRED STOCKTRANSACTIONS*

For information regarding Series D 6% ConvertiblePreferred Stock, please refer to the separate footnote disclosure in Note 12.

Series B and Series C Convertible PreferredStock are in the form of shares, and have no conditional or unconditionalmandatory redemption provisions obligating the Company in the future other thanliquidation or company wind-up provisions. Under SFAS 150—*Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity*, the issuances ofSeries B and Series C Preferred stock have been classified as equity.The conversion options are not considered derivative liabilities which must bevalued at fair value under SFAS 133 or EITF 00-19. The conversion options areindexed to the Company’s own stock and the host instrument is classified asequity thus meeting the paragraph 11a scope exception under SFAS No. 133—Accountingfor Derivative instruments and hedging activities. The Company determined thatthere is no intrinsic value of the conversion options for the Series B andSeries C Preferred Stock under EITF 00-27.

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In accordance with EITF 98-5, “Accounting forConvertible Securities with Beneficial Conversion Features or ContingentlyAdjustable Conversion Rates,” the Company records “beneficial conversionfeature expense” when and if the Company issues debt or equity instrumentswhich are convertible into shares of the Company’s common stock, at aconversion price which is favorable to the holder of the debt or equityinstrument. Valuation of this favorable conversion feature is based on thecircumstances of each debt or equity issuance but is generally based on theactual or estimated difference between the fair market value of the underlyingcommon stock less the cost of acquiring the common stock or a beneficialincrease in conversion rates of preferred shares into common stock.

The Company issuedpreferred stock shares for services provided as follows:

·       4shares of the Company’s Series C Convertible Preferred Stock were issuedto a member of the board of directors, for services rendered. The Company usedBlack-Scholes to determine the value of the shares as $137,583.

·       20shares of the Company’s Series C Convertible Preferred Stock were issuedto the Company’s former Chief Executive Office, for services rendered. TheCompany used Black-Scholes to determine the value of the shares as $692,996.

·       4shares of the Company’s Series C Convertible Preferred Stock were issuedto the Company’s former Chief Financial Officer, for services rendered. TheCompany used Black-Scholes to determine the value of the shares as $138,976.

·       10shares of the Company’s Series C Convertible Preferred Stock were issuedto a member of the board of directors, for services rendered. The Company usedBlack-Scholes to determine the value of the shares as $346,526.

The Company issued 20 shares of Series CConvertible Preferred Stock in exchange for existing debt in the amount of$200,000. The Company used Black-Scholes and calculated the value of shares atissuance. A beneficial conversion feature was generated as the value of theissuance using Black-Scholes was greater than the value of the debt convertedin the amount of $385,530.

The Company issued 1 share of the Company’sSeries C Convertible Preferred Stock for proceeds of $10,000. The value ofthis issuance was calculated using Black-Scholes and was greater than the valueof the proceeds in the amount of $22,612. The Company recorded a BeneficialConversion Feature for this difference.

Belowis a table depicting the valuation attributes used in Black-Scholescalculations related to the Series C Preferred Stock issued in 2004:

**Series CPreferred Stock Valuation Information for the Year Ended December 31, 2004**

| Valuation  Assumptions                           |   | —         |   |
|--------------------------------------------------|--------|----------------|--------|
| Stock price on  grant date                       |   | $1.80-$4.08    |   |
| Number of shares  of common stock convertible to |   | 2,198,276      |   |
| Conversion price                                 |   | $1.80-$4.08    |   |
| Expected option  term (in years)                 |   | 1              |   |
| Vesting term (in  years)                         |   | N/A            |   |
| Expected  volatility                             |   | 90.29%-177.06% |   |
| Risk-free  interest rate                         |   | 4.00%-4.29%    |   |
| Expected  forfeiture rate                        |   | 0%             |   |
| Estimated  corporate tax rate                    |   | 0%             |   |
| Expected dividend  yield                         |   | 0%             |   |

 

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The followingtransactions of the Company’s preferred stock during 2004 were recorded:

·       TheCompany had 5 Shares of Series C Convertible Preferred Stock voluntarilyredeemed for $60,000. A loss on redemption of $10,000 was recorded. Additionally,the Company recorded a gain on debt extinguishment related to the recapture ofbeneficial conversion feature expensed in connection with the issuance of thepreferred stock in 2002 of $7,272.

·       1,330,865shares of the Company’s common stock were issued upon the voluntary conversionof 51 shares of Series C Convertible Preferred Stock. The conversionrate at the time of conversion was 0.2% of outstanding common stock. TheCompany recorded a gain on debt extinguishment related to the recapture of beneficialconversion feature expensed in connection with the issuance of the preferredstock in the amount of $243,690. 

·       1share of the Company’s Series C Convertible Preferred Stock wasvoluntarily rescinded. A gain was recognized in the amount of $83,577 as aresult. The gain was calculated using the Company’s closing bid price of itscommon stock as quoted on the OTC Bulletin Board market as of the date theshares were rescinded and the number of shares of common stock for which thepreferred stock was convertible into. Additionally, the Company recorded a gainon debt extinguishment related to the recapture of beneficial conversionfeature expensed in connection with the issuance of the preferred stock in theamount of $3,234.

·       1share of the Company’s Series B Convertible Preferred Stock wasvoluntarily converted to 10 Series C Convertible Preferred Stock. TheCompany used Black Scholes and calculated a beneficial conversion feature of$269,044, associated as a result of differences between conversion ratesbetween the two preferred stock classes.

·       416,667shares of the Company’s common stock were issued upon the conversion of 1 shareof Series B Convertible Preferred Stock. The conversion rate at the timeof conversion was 2% of fully diluted common stock. The Company recorded a gainon debt extinguishment related to the recapture of beneficial conversionfeature expensed in connection with the issuance of the preferred stock in of$16,324.

The conversion rate forSeries C Convertible Preferred Stock changed to 0.2% of fully dilutedstock on September 14, 2004. At that time, there were 144 Series CPreferred Stock shares outstanding. The Company used Black-Scholes to calculatethe value of this change as $18,558,870, which represents the beneficial conversionfeature for this conversion rate increase for all outstanding Series CPreferred Stock Shares on September 14, 2004. After which, 14,263 sharesof the Company’s common stock were issued upon the voluntary conversion of 1share of Series C Convertible Preferred Stock. During October 2004,all outstanding shares of the Company’s Series C Preferred Convertiblestock were either mandatory converted to Series B Convertible Preferredstock or into shares of common stock. The conversion rate was 10 shares ofSeries C Convertible Preferred stock for 1 share of Series BConvertible Preferred Stock or 0.2% of fully diluted common stock. In total,115 shares of Series C Convertible Preferred stock were redeemed for 11.5shares of Series B Convertible Preferred Stock. 1,169,350 shares of commonstock were issued for the conversion of the remaining 28 Series CConvertible Preferred Stock. These transactions resulted in the Company recordedrecording a gain on debt extinguishment related to the recapture of beneficialconversion feature expensed in connection with the issuance of the preferredstock in the amount of $146,120.

**NOTE 12—Series D6% Convertible Preferred Stock**

On January 19, 2005, the Company issued 15,800shares of Series D 6% Convertible Preferred Stock (“Series DPreferred) at $1,000 per share pursuant to a purchase agreement (the “PurchaseAgreement”) for gross proceeds of $15,800,000. Issuance costs of $494,034 wereincurred and treated as a discount 

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toreduction of the carrying value which netted to$15,305,966. The Series D Preferred may convert at any time, at theholder’s discretion, into shares of Common Stock. The conversion price is $2.10per share. Each share of the Series D Preferred converts into the numberof shares of Common Stock equal to $1,000 divided by the conversion price whichis approximately 467.19 shares. Additionally, the Company pays 6% dividends onthe Series D Preferred in cash or Common Stock. The Series DPreferred Stock, if not converted to Common Stock, is redeemable for $1,000 perSeries D Preferred share on January 19, 2008.

In the same private placement, the Company issuedWarrants to purchase 2,633,333 shares of Common Stock at an exercise price of$3.75 per share. The Warrants expire on January 19, 2008. These warrantsare further disclosed below.

The Series D Preferred falls outside the scope ofSFAS No. 150 but the guidance in Rule 5-02.28 of Regulation S-X,Accounting Series Release No. 268 (ASR 268) and EITF Topic D-98:“Classification and Measurement of Redeemable Securities” are applicable. Assuch, the Company has recorded the Series D Preferred as mezzanine equityon the accompanying balance sheet. 

The differencebetween the initial recorded amount and redemption value, the discount, isaccreted to retained earnings or, in the absence of retained earnings,additional paid-in capital, over the period from the date of issuance to theearliest redemption date of the security using the interest method thusreducing net income attributable to common shareholders. This accretion istreated like a dividend on preferred stock. The accretion from the initialvalue to the redemption amount has been determined using T-Value based on thefollowing inputs:

1.                 Rate—8.00%(reasonable rate of interest)

2.                 Number of paymentperiods—36 (three years)

The following tablesummarizes the transactions of the Series D Preferred: 

| Series D 6% Convertible Preferred stock at  issuance                                         |   | $         | 15,800,000 |   |
|---------------------------------------------------------------------------------------------------|--------|-----------|------------|--------|
| Less:                                                                                             |   |      |       |
| Issuance costs                                                                                    |   | 494,034   |       |
| Fair value of warrants at issuance (see “Warrants”)                                     |   | 8,004,200 |       |
| Subtotal Carrying Value at issuance                                                               |   | $         | 7,301,766  |   |
| Plus:                                                                                             |   |      |       |
| Cumulative accretion of discount to redemption value  first quarter 2005                          |   | 420,695   |       |
| Cumulative accretion of discount to redemption value  second quarter 2005                         |   | 593,609   |       |
| Cumulative accretion of discount to redemption value  third quarter 2005                          |   | 508,577   |       |
| Cumulative accretion of discount to redemption value  fourth quarter 2005                         |   | 518,816   |       |
| Less:                                                                                             |   |      |       |
| Carrying Value of 2,796  Series D Preferred converted into Common Stock second  quarter 2005 |   | 1,442,025 |       |
| Carrying Value at December 31, 2005                                                          |   | $         | 7,901,438  |   |
| Plus:                                                                                             |   |      |       |
| Cumulative accretion of discount to redemption value  first quarter 2006                          |   | 484,750   |       |
| Cumulative accretion of discount to redemption value  second quarter 2006                         |   | 448,815   |       |
| Cumulative accretion of discount to redemption value  third quarter 2006                          |   | 363,569   |       |
| Less:                                                                                             |   |      |       |
| Carrying Value of 4,526 Series D Preferred  converted into Common Stock first quarter 2006   |   | 2,872,466 |       |
| Carrying Value of 3,601  Series D Preferred converted into Common Stock second  quarter 2006 |   | 2,456,119 |       |
| Carrying Value of 4,877 Series D Preferred  converted into Common Stock third quarter 2006   |   | 3,869,987 |       |
| Carrying Value at December 31, 2006                                                          |   | $         | —     |   |

 

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The Series BPreferred has the following rights, preferences and privileges: 

***Registration Rights***

The Company and theholders of Series D Preferred entered into a “Registration RightsAgreement” on January 19, 2005. Among other things, the Company wasobligated to file a registration statement on Form S-3 within 75 daysof the agreement and use its commercially reasonable efforts to cause suchregistration statement to become effective. The Securities & ExchangeCommission accepted the Registration Statement on Form S-3 on May 11,2005, pursuant to which the shares of Common Stock issuable upon conversion ofthe Series D Preferred, as well as the shares of Common Stock issuableupon the exercise of warrants, were registered for resale. The agreementprovides for any liquidated damages by the Company to the Series DPreferred holders if the Company is unable to complete the registration, notfiling in timely manner or maintain such effectiveness. 

***Voting Rights***

Each holder of shares ofSeries D Preferred shall have no voting rights so long as the Companyshall not, without the affirmative vote of the holders of Series DPreferred then outstanding, alter or change the powers, preferences or rightsof the holders of Series D Preferred, authorize or create any class ofstock ranking as to dividends, redemption, or distribution of assets uponliquidation senior to Series D Preferred, amend corporate documents so asto affect adversely any rights of holders or increase the authorized number ofshares of Preferred Stock. 

***Dividends***

Cumulative Dividends arepayable to all holders of Series D Preferred on March 1 andSeptember 1 beginning with the first such date after the original issuedate and on any conversion date. Dividends can be paid in cash unless certaincriteria are met (mainly no cash available fro for payment) which allows theCompany to issue shares of Common stock equivalent to the amount due at 85% ofthe average stock price of the preceding 10 trading days to the dividendpayment date. Series D Preferred dividends are recorded as a reduction (increase) toretained earnings (accumulated deficit) and net income (loss) available tocommon shareholders. Dividends, whether declared or not, are payable at a rateof six percent (6%) of the Stated Value per annum.

In the event dividends arepaid on any shares of other Preferred Sstock or cCommon sStock, the Companyshall pay any amounts due to Series D Preferred holders before suchdividend can be paid. 

| **Dividend Transactions (per equity table)**       | ** ** | ** ** | ** ** | **Amount** | ** ** |
|------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| Dividend Payment  March 1, 2005  57,186 common shares issued      |       | $     | 100,075    |       |
| Dividend Payment  September 1, 2005  224,511 common shares issued |       | 318,355    |       |
| Cash payment                                                           |       | 100,020    |       |
| Total Dividend for September 1, 2005                              |       | 418,375    |       |
| Dividend Accrued as of December 31, 2005                          |       | 260,080    |       |
| Dividend Payment March 1,  2006  586 common shares issued         |       | $     | 2,377      |       |
| Cash payment                                                           |       | 117,464    |       |
| Total Dividend for March 1, 2006                                  |       | 119,841    |       |
| Dividend Payment  September 1, 2006  8,351 common shares issued   |       | 46,448     |       |
| Cash payment                                                           |       | 159,396    |       |
| Total Dividend for September 1, 2006                              |       | 205,844    |       |

 

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***Conversion***

The Series DPreferred may convert at any time, at the holder’s discretion, into shares ofCommon Stock. The conversion price is $2.10 per share. Each share of theSeries D Preferred converts into the number of shares of Common Stockequal to $1,000 divided by the conversion price which is approximately 467.19shares. The Company shall not effect any conversion of the Series DPreferred and the Holder shall not have the right to convert any portion ofSeries D Preferred to the extent that after giving effect to suchconversion, the Holder (including it’s affiliates) would beneficially own inexcess of 4.99% of the number of shares of common stock outstanding immediatelyafter giving effect to such conversion. The Company must reserve and keepavailable out of its authorized and unissued shares of common stock for thepurpose of issuance upon conversion of the Series D Preferred and paymentsof dividends on the Series D Preferred. The Company may force a conversionof Series D Preferred if the market value of the common stock for 20consecutive trading days exceeds 180% of the conversion price effective at thattime.

***Redemptions***

On the third anniversary of the original issue date,the corporation shall redeem all remaining outstanding Series D Preferredwhich are not yet converted into common stock at a price equal to the StatedValue. Each holder of Series D Preferred to be so redeemed may, in lieu ofredemption, convert such holder’s shares of Series D Preferred Stock inwhole or in part into shares of Common Stock.

The Company may beobligated to redeem the outstanding shares of Series D Preferredimmediately prior to a change of control, failure to file the registrationstatement on or prior to 210 days after the original issue date, lapsing of theRegistration Statement for more than 60 calendar days in aggregate or failureto have available the sufficient number of authorized and unreserved shares ofcommon stock to issue upon conversion of a holder.

***Warrants***

The Warrantsrepresent a liability under EITF 00-19 in that the registration rightsagreement contains a liquidated damages clause requiring the Company to paycash to the holder of the instrument if the Company fails to obtain aneffective registration statement timely, an event that is out of the Company’scontrol. (Note: On April 11, 2005, the Company paid $237,000 in liquidateddamages for not filing its registration statement timely). The Warrants wouldnot be classified as equity until the effective registration statement wasobtained. As such, in accordance with EITF 00-19, the Warrant Liability ismeasure at its fair value at the reporting date, with the change in its fairvalue from issuance date reporting in the statement of operations. The fairvalue of the warrants has been determined using the Black-Scholes model usingthe following inputs:

1.                 Number of Warrantshares—2,633,333

2.                 Stock price atissuance date—$3.12 per share

3.                 Exercise price—$3.75per share

4.                 Term—3 years

5.                 Discount rate—3.42%,representing the three* year Treasury at the date of issuance

6.                 Volatility—259%,based on the stock prices during three* years prior to issuance

These inputs yield a fair value of $8,004,200.

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(*coincides with the term of the Warrants)

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The warrants aremeasured at fair value both initially and in subsequent periods until theregistration statement has been accepted by the Security and ExchangeCommission. Subsequent changes in the fair value of the warrants until thattime are recognized in current earnings under “other income (expense)” in theconsolidated statements of operations. The decrease in fair value for the threemonth period ended March 31, 2005 is $3,431,206. The fair value of thewarrants at March 31, 2005 has been determined using the Black-Scholes modelusing the following inputs:

1.                 Number of Warrantshares—2,633,333

2.                 Stock price atreporting date—$1.84 per share

3.                 Exercise price—$3.75per share

4.                 Term—2.75 years

5.                 Discount rate—3.96%,representing the three year Treasury at the reporting date

6.                 Volatility—245%,based on the stock prices during three years prior to the reporting date

These inputs yield a fair value of $4,572,984 atMarch 31, 2005.

On May 11,2005, the Company filed received Form 424B3 from the SEC confirming theregistration of 17,008,655 common shares. As a result, the warrant liability isreclassified to equity on this date. The fair value of the warrants has beendetermined using the Black-Scholes model using the following inputs:

7.                 Number of Warrantshares—2,633,333

8.                 Stock price at reportingdate—$2.08 per share

9.                 Exercise price—$3.75per share

10.          Term—2.70 years

11.          Discount rate—3.96%,representing the three year Treasury at the reporting date

12.          Volatility—245%, basedon the stock prices during three years prior to the reporting date

These inputs yield a fairvalue of $5,173,409. The $5,173,409 was reclassified from warrant liability (Series D)to equity. The Unrealized Gain on Financial Instruments was reduced by $600,425.

**NOTE 13—STOCKOPTIONS AND STOCK GRANTS**

***Stock Options***

The Company does not have a formal stock option plan.However, the Company has offered its employees stock options. During 2006 and2005, the Company issued options to purchase 1,508,125 and 652,833 shares ofits unregistered common stock, respectively, to certain employees.

The Company adopted Statement of Financial AccountingStandards No. 123(R) (“SFAS 123(R)) as of July 1, 2005. SFAS 123(R) providesfor mandatory expensing of the estimated value of stock options granted to theCompany’s employees over the period of time the stock options vest. The Companymeasures the total cost of each stock option grant at the date of grant usingthe Black Scholes option trading model. We recognize the cost of each stockoption on a straight line basis over the applicable vesting period.

All stock options issued in 2005 do not carry adesignated expiration date and vest over a 1 year period.

Stock option expense recorded for 2006, 2005 and 2004amounted to $701,124, $92,671 and $0, respectively.

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The Company adopted SFAS 123(R) as of July 1,2005. Had the Company adopted SFAS 123(R) as of January 1, 2005, thepro forma impact on the 2005 net loss would have been an increase in the netloss reported by the Company of $39,128.

The following table summarizesstock options activity for the years ended December 31, 2006, 2005 and2004:

**Stock Option Activity**

| ** **                         | ** ** | **Average per share** | ** ** |
|------------------------------------|------------|---------------------------------|------------|
| ** **                         | ** ** | **Shares subject**         | ** ** | **Exercise** | ** ** | **Market** | ** ** |
| ** **                         | ** ** | **to option**              | ** ** | **price** | ** ** | **price** | ** ** |
| Balance at  December 31, 2003 |       |                            | —     |   |   | — |   |   | (a) |
| Options granted                    |       |                            | —     |   |   | — |   |   | (a) |
| Options exercised                  |       |                            | —     |   |   | — |   |   | (a) |
| Options  terminated                |       |                            | —     |   |   | — |   |   | (a) |
| Balance at  December 31, 2004 |       |                            | —     |   |   | — |   | — |   |
| Options granted                    |       |                            | 652,833    |   |   | $ | 1.50 |   | $ | 1.50 |   |
| Options exercised                  |       |                            | —     |   |   | — |   |   | (a) |
| Options  terminated                |       |                            | (196,167   | ) |   | $ | 1.50 |   |   | (a) |
| Balance at  December 31, 2005 |       |                            | 456,666    |   |   | $ | 1.50 |   | $ | 1.50 |   |
| Options granted                    |       |                            | 1,508,125  |   |   | $ | 0.72-$7.48 |   | $ | 0.77-$7.48 |   |
| Options exercised                  |       |                            | (5,348     | ) |   | $ | 1.38-$1.50 |   |   | (a) |
| Options  terminated                |       |                            | —     |   |   | — |   |   | (a) |
| Balance at  December 31, 2006 |       |                            | 1,959,443  |   |   | $ | 2.53 |   | $ | 17.98 |   |

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(a)           Not applicable

The following tablesummarizes the attributes used in the Company’s valuation of stock optiongrants during 2006, 2005 and 2004:

**Option Valuation Information**

| ** **                                                  | ** ** | **2006**     | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------|------------|--------------|------------|----------|------------|----------|------------|
| Valuation Assumptions                                       |       |         |       |     |       |     |       |   |   |
| Stock price on  date of grant                               |       | $            | 0.77-$7.48 |     | $          | 1.50     |       |   |   |   |   |
| Expected option  term (in years)                            |       | 2            |       | 2        |       |     | —     |   |   |
| Expected duration  from grant to expiration date (in years) |       | 4 and 5      |       | 5        |       |     |       |   |   |
| Option vesting  term (in years)                             |       |         | (a)        | 1        |       |     |       |   |   |
| Expected  volatility                                        |       | 45.82%-70.31 | %          | 48.61    | %          |     | —     |   |   |
| Risk-free  interest rate                                    |       | 4.40%-4.97   | %          | 3.42     | %          |     | —     |   |   |
| Expected  forfeiture rate                                   |       | 5.00         | %          | 5.00     | %          |     | —     |   |   |
| Estimated  corporate tax rate                               |       | 40.00        | %          | 40.00    | %          |     | —     |   |   |
| Expected dividend yield                                     |       | 0.00         | %          | 0.00     | %          |     | —     |   |   |
|                                                             |            |              |            |          |            |          |            |  |  |  |  |

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(a)           Options issued in 2006vest between 1 day and 14 months

(b)          Notapplicable

57

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**Stock Grants**

The Company awarded stockgrants to certain employees during 2006. The stock grants consisted of 191,016shares of the Company’s common stock valued at $1,047,501, subject to certainvesting provisions. The stock grants vest on a schedule as shown below:

| **Stock grant vesting dates** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------------------------------|------------|------------|------------|------------|------------|
| January 1,  2007                        |       | 50,000     |       |
| May 4, 2007                             |       | 20,513     |       |
| Total for 2007                               |       | 70,513     |       |
| January 1, 2008                         |       | 50,000     |       |
| May 4, 2008                             |       | 20,513     |       |
| Total for 2008                               |       | 70,513     |       |
| January 1, 2009                         |       | 50,000     |       |
| Total for 2009                               |       | 50,000     |       |

 

**NOTE 14—ACQUISITIONAND SALE OF ASSETS**

In September 2004,the Directors of TSGI agreed to exchange all shares held by it of TechnicalSolutions Group Inc for the TSGI shares held by the Company, as a result ofwhich the Company reacquired 100% of the shares of Technical Solutions Group asa wholly owned subsidiary.

**NOTE 15—CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS**

The Company’s Chief Executive Officer, Mr. McGilton,is a principle of APT Leadership, a consulting firm the Company hired toprovide various business consulting services, training seminars and certainbusiness software. APT Leadership billed the Company $606,817, $225,400 and$21,017 for the years ended December 31, 2006, 2005 and 2004,respectively.

On February 18, 2006, the Company entered into aModification and Assignment Agreement with Longview pursuant to which theCompany paid $1,250,000 against the principle balance of the Notes and extendedthe maturity date of the Notes for an additional 60 days. In addition, theCompany consented to the assignment of $2,500,000 of the Notes to Fort AshfordFunds LLC (“Fort Ashford”). Frank Kavanaugh, a director of the Company, is theprincipal owner of Fort Ashford and a substantial shareholder of the Company’scommon stock. Mr. Kavanaugh’s relationship to Fort Ashford Funds LLC wasfully disclosed to the Company and Mr. Kavanaugh did not participate inthe negotiations or decision process with respect to the Modification andAssignment Agreement. The Company paid $87,510 to Longview and $50,000 to FortAshford in cash as compensation for the extension of the maturity dates of theNotes.

On April 20, 2006, the Company paid $1,000,000against the principle balance of the Notes and extended the maturity date onthe Notes and the Note with Fort Ashford for an additional 60 days, through June 20,2006. The Company paid $55,000 to Longview and $50,000 to Fort Ashford in cashas compensation for this extension.

On June 20, 2006, the Company paid off theprinciple balance and all applicable accrued interest under the Notes.Additionally, the Company extended the maturity date of the Ashford Note for anadditional 30 days, through July 20, 2006. The Company paid $50,000to Fort Ashford in cash as compensation for the extension of the Ashford Note.

On August 9, 2006,the Company paid off the principle balance of the Ashford Note, and allapplicable accrued interest under the Ashford Note.

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**NOTE 16—OTHER COMPREHENSIVE LOSS (Restated)**

Other comprehensiveearnings/(loss) consists of the following:

| ** **                                | ** ** | **2006**   | ** ** | **2005**     | ** ** | **2004**     | ** ** |
|-------------------------------------------|------------|------------|------------|--------------|------------|--------------|------------|
| ** **                                | ** ** | ** ** | ** ** | **Restated** | ** ** | **Restated** | ** ** |
| **Net  Earnings (Loss)**                  |       | $          | 18,196,943 |         | $          | (13,458,599  | )          | $ | (11,953,803 | ) |
| Other  Comprehensive Earnings, net of tax |       |       |       |         |       |         |       |
| **Comprehensive Earnings (Loss)**         |       | $          | 18,196,943 |         | $          | (13,458,599  | )          | $ | (11,953,803 | ) |

 

**NOTE 17—TAXES**

The Financial AccountingStandards Board (FASB) has issued Statement of Financial Accounting StandardsNumber 109 (“SFAS 109”). “Accounting for Income Taxes”, which requires theasset and liability method of accounting for income taxes. Under the asset andliability method, deferred income taxes are recognized for the tax consequencesof “temporary differences” by applying enacted statutory tax rates applicableto future years to differences between the financial statement carrying amountsand the tax basis of existing assets and liabilities.

TheCompany’s net deferred tax asset as of December 31, 2006, 2005, and 2004consisted of the following:

| ** **                                                                     | ** ** | **12/31/2006** | ** ** | **12/31/2005** | ** ** | **12/31/2004** | ** ** |
|--------------------------------------------------------------------------------|------------|----------------|------------|----------------|------------|----------------|------------|
| Deferred tax assets                                                            |       |           |       |           |       |           |       |
| Inventory reserves and inventory tax law (uniform  capitalization) differences |       | $              | 2,544,527  |           | $          | 894,392        |       | $ | 401,336 |   |
| Allowance for  uncollectible accounts                                          |       | 328,224        |       | 248,942        |       | —         |       |
| Difference in  recognition of rent expense                                     |       | 52,254         |       | 52,254         |       | 47,649         |       |
| Warranty and  contract provisions                                              |       | 2,477,165      |       | 785,382        |       | 64,241         |       |
| Difference in recognition of stock based  compensation expense                 |       | 285,232        |       | 35,447         |       | —         |       |
| Payroll accruals                                                               |       | 57,906         |       | 364,761        |       | 345,859        |       |
| Deferred tax assets                                                            |       | 5,745,308      |       | 2,381,178      |       | 859,085        |       |
| Deferred tax  liability                                                        |       |           |       |           |       |           |       |
| Depreciation  differences                                                      |       | (268,110       | )          | (204,486       | )          | (168,722       | )          |
| Net deferred tax assets before net operating loss  carryforwards               |       | 5,477,198      |       | 2,176,692      |       | 690,363        |       |
| Net operating loss carryforwards—SC                                       |       | 371,923        |       | 1,080,527      |       | 493,963        |       |
| Future benefit of  offset of Alternative Minimum Tax                           |       | 288,943        |       |           |       |           |       |
| Net operating  loss carryforwards—US                                      |       | 6,188,427      |       | 10,928,919     |       | 7,068,047      |       |
| Net deferred tax assets                                                        |       | 12,326,491     |       | 14,186,138     |       | 8,252,373      |       |
| Less valuation allowance                                                       |       | —         |       | (14,186,138    | )          | (8,252,373     | )          |
| Deferred tax  benefit                                                          |       | $              | 12,326,491 |           | $          | —         |       | $ | — |   |

 

The Company has removed the valuation allowance forthe deferred tax assets since it expects to realize future earnings to beoffset by future tax benefits. In 2005 and 2004 the company recorded avaluation allowance for all of its net deferred tax assets. The Company’svaluation allowance decreased for the year ended December 31, 2006, $14,186,138and increased for the years ended December 31, 2005, and 2004 $5,933,765 and$3,713,302, respectively.

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As of December 31, 2006, 2005 and 2004, theCompany has available Federal operating loss carry-forwards of $18,611,810,$32,868,929, and $21,257,284, expiring through 2025, respectively, and stateoperating loss carry-forwards of $7,438,470, $21,610,537, and $9,879,269,expiring through 2025, respectively.

The followingis a reconciliation of the provision for income taxes at the U.S. federalincome tax rate to the income taxes reflected in the Statement of Operations:

| ** **                                      | ** ** | **December 31,  2006** | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------------------|------------|-----------------------------|------------|------------------------|------------|-----------------------------|------------|
| Tax expense (credit) at  statutory rate-federal |       |                        | (35.00     | )%                     |       |                        | (35.00     | )% |   |   | (35.00 | )% |   |
| State tax expense net of  federal tax           |       |                        | (3.25      | )%                     |       |                        | (3.25      | )% |   |   | (3.25 | )% |   |
| Changes in valuation  allowance                 |       |                        | (209.98    | )%                     |       |                        | (38.25     | )% |   |   | (38.25 | )% |   |
| Tax expense at actual rate                      |       |                        | 209.98     | %                      |       |                        | 0          | % |   |   | 0 | % |   |

 

**NOTE 18—EARNINGS/LOSS PER SHARE**

TheCompany utilizes SFAS No. 128, “Earnings per Share” to calculate gain/lossper share. Basic earnings/loss per share is computed by dividing theearnings/loss available to common stockholders (as the numerator) by theweighted-average number of common shares outstanding (as the denominator).Diluted earnings/loss per share is computed similar to basic earning/loss pershare except that the denominator is increased to include the number ofadditional common shares that would have been outstanding if all potentialcommon stock (including common stock equivalents) had all been issued, and ifsuch additional common shares were dilutive. 

| **Basic Earning Per Share Computation** | ** ** | ** ** | ** ** | **2006** | ** ** |
|-------------------------------------------------------------|------------|------------|------------|----------|------------|
| Net Earnings                                                |       | $          | 18,196,943 |     |
| Accretion of  Series D 6% convertible preferred stock  |       | (1,297,134 | )          |
| Preferred dividends                                         |       | (325,685   | )          |
| Net earnings available  to common shareholders              |       | $          | 16,574,124 |     |
| **Basic  Earnings per common share**                        |       | $          | 0.37       |     |
| **Weighted-average  shares used to compute:**               |       |       |       |
| Basic Profit/(loss) per share                               |       | 44,786,083 |       |

 

| **Diluted Earning Per Share Computation:**           | ** ** | ** ** | ** ** | **2006** | ** ** |
|--------------------------------------------------------------------------|------------|------------|------------|----------|------------|
| Earnings available to  common shareholders                               |       | $          | 16,574,124 |     |
| Add Back:                                                                |       |       |       |
| Accretion of  Series D 6% convertible preferred stock               |       | 1,297,134  |       |
| Preferred Dividends                                                      |       | 325,685    |       |
| Profit/(Loss) available  to common shareholders plus assumed conversions |       | $          | 18,196,943 |     |
| Weighted-average number  of common shares outstanding                    |       | 44,786,083 |       |
| Dilutive effect of:                                                      |       |       |       |
| Series D preferred  stock                                           |       | 2,369,259  |       |
| Warrants                                                                 |       | 1,631,822  |       |
| Stock options                                                            |       | 1,543,458  |       |
| Stock grants                                                             |       | 97,844     |       |
| **Weighted-average shares used to compute:**                             |       |       |       |
| Diluted Earnings/(loss)  per share                                       |       | 50,428,466 |       |
| **Diluted Earnings per common share**                                    |       | $          | 0.36       |     |

 

UnderSFAS No. 128, where there is a loss, the inclusion of additional commonshares is anti-dilutive (since the increased number of shares reduces the pershare loss available to common stock holders), and 

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if theadditional common shares are anti-dilutive, they are not added to thedenominator in the calculation. For periods where the additional common sharesare anti-dilutive, the following common stock equivalents have been excludedfrom the calculation of diluted loss per share:

| ** **                                 | ** ** | **2005**  | ** ** | **2004**   | ** ** |
|--------------------------------------------|------------|-----------|------------|------------|------------|
| Convertible Preferred  Stock Series B |       | —    |       | 10,493,939 |       |
| Convertible Preferred  Stock Series C |       | —    |       | —     |       |
| Convertible Preferred  Stock Series D |       | 6,288,428 |       | —     |       |
| Warrants                                   |       | 2,104,863 |       | 1,725,942  |       |
| Options                                    |       | 323,420   |       | —     |       |
| Total                                      |       | 8,716,711 |       | 12,219,881 |       |

 

| **Basic Earning Per Share Computation** | ** ** | ** **   | ** **  | **2005**     | ** ** | **2004**    | ** ** |
|-------------------------------------------------------------|------------|--------------|-------------|--------------|------------|-------------|------------|
| ** **                                                  | ** ** | **Restated** | ** **  | **Restated** | ** ** |
| Net Loss                                                    |       | $            | (14,404,622 | )            | $          | (11,953,803 | )          |
| Accretion of  Series D 6% convertible preferred stock  |       | (2,041,697   | )           | —       |       |
| Preferred Dividends                                         |       | (778,530     | )           | —       |       |
| (Loss) available to  common shareholders                    |       | $            | (17,224,849 | )            | $          | (11,953,803 | )          |
| **Basic  Loss per common share**                            |       | $            | (0.51       | )            | $          | (0.62       | )          |
| **Weighted-average  shares used to compute:**               |       |         |        |         |       |
| Basic loss per share                                        |       | 33,926,573   |        | 19,357,939   |       |

 

| **Diluted Earning Per Share Computation:** | ** ** | ** ** | ** **  | **2005**   | ** ** | **2004**    | ** ** |
|----------------------------------------------------------------|------------|------------|-------------|------------|------------|-------------|------------|
| (Loss) available to  common shareholders                       |       | $          | (17,224,849 | )          | $          | (11,953,803 | )          |
| **Diluted  Loss per common share**                             |       | $          | (0.51       | )          | $          | (0.62       | )          |
| **Weighted-average  shares used to compute:**                  |       |       |        |       |       |
| Diluted loss per share                                         |       | 33,926,573 |        | 19,357,939 |       |

 

**NOTE 19—VALUATION ANDQUALIFYING ACCOUNTS AND RESERVES**

The following tablesummarizes information about accounts and reserves:

| ** **                         | ** ** | ** **            | ** ** | **Additions**       | ** ** | ** **   | ** ** | ** **    | ** ** | ** **          | ** ** |
|------------------------------------|------------|-----------------------|------------|---------------------|------------|--------------|------------|---------------|------------|---------------------|------------|
| ** **                         | ** ** | **Balance at**   | ** ** | **Charged to** | ** ** | ** **   | ** ** | ** **    | ** ** | **Balance at** | ** ** |
| ** **                         | ** ** | **Beginning of** | ** ** | **Costs and**  | ** ** | ** **   | ** ** | ** **    | ** ** | **End of**     | ** ** |
| **Description**                    | ** ** | ** **            | ** ** | **Period**          | ** ** | **Expenses** | ** ** | **Writeoffs** | ** ** | **Other**           | ** ** | **Period** | ** ** |
| **Revenue  Based Provisions**      |       |                  |       |                |       |         |       |          |       |                |       |   |   |
| 2006                               |       | $                     | 1,018,051  |                | $          | 6,317,077    |       | $             | 1,267,041  |                |       | $ | — |   |   | $ | 6,068,087 |   |
| 2005(A)                            |       | $                     | —     |                | $          | 1,018,051    |       | $             | —     |                |       | $ | — |   |   | $ | 1,018,051 |   |
| 2004                               |       | $                     | —     |                | $          | —       |       | $             | —     |                |       | $ | — |   |   | $ | — |   |
| **Allowance for Inventory Losses** |       |                  |       |                |       |         |       |          |       |                |       |   |   |
| 2006                               |       | $                     | 498,281    |                | $          | 1,925,332    |       | $             | —     |                |       | $ | — |   |   | $ | 2,423,613 |   |
| 2005                               |       | $                     | —     |                | $          | 498,281      |       | $             | —     |                |       | $ | — |   |   | $ | 498,281 |   |
| 2004                               |       | $                     | —     |                | $          | —       |       | $             | —     |                |       | $ | — |   |   | $ | — |   |
| **Warranty Reserve**               |       |                  |       |                |       |         |       |          |       |                |       |   |   |
| 2006                               |       | $                     | 1,686,062  |                | $          | 163,938      |       | $             | —     |                |       | $ | — |   |   | $ | 1,850,000 |   |
| 2005(B)                            |       | $                     | 729,461    |                | $          | 1,764,264    |       | $             | 807,663    |                |       | $ | — |   |   | $ | 1,686,062 |   |
| 2004                               |       | $                     | 180,384    |                | $          | 728,595      |       | $             | 179,518    |                |       | $ | — |   |   | $ | 729,461 |   |
|                                    |            |                       |            |                     |            |              |            |               |            |                     |            |  |  |  |  |  |  |  |  |  |

----

(A)       Consists of the Allowancefor Contractual Adjustments, as presented on the Company’s balance sheet andexplained in Footnote 7 to the financial statements.

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(B)        Inclusiveof the general warranty reserve as well as the Twin Disc Warranty Reserve of$1,306,018 recorded in 2005.

**NOTE 20—SUMMARIZEDQUARTERLY UNAUDITED FINANCIAL DATA**

| ** **                                  | ** ** | **2006**  | ** ** |
|---------------------------------------------|------------|-----------|------------|
| ** **                                  | ** ** | **Q1**    | ** ** | **Q2** | ** ** | **Q3** | ** ** | **Q4** | ** ** |
| **Net  Sales**                              |       | $         | 34,802,585 |   | $ | 56,074,537 |   | $ | 42,160,858 |   | $ | 62,979,466 |   |
| Gross Profit                                |       | 6,637,769 |       | 10,156,786 |   | 7,918,508 |   | 12,309,757 |   |
| Operating Income                            |       | 12,826    |       | 1,771,136 |   | 592,150 |   | 4,259,450 |   |
| **Net  Earnings (Loss)**                    |       | (767,449  | )          | 973,024 |   | 602,698 |   | 17,388,670 |   |
| **Basic  Earnings (loss) per common share** |       | $         | (0.04      | ) | $ | 0.01 |   | $ | 0.00 |   | $ | 0.40 |   |
| **Diluted loss per common share**           |       | $         | (0.04      | ) | $ | 0.01 |   | $ | 0.00 |   | $ | 0.39 |   |

 

| ** **                                    | ** ** | **2005 Restated** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|
| ** **                                    | ** ** | **Q1**                 | ** ** | **Q2** | ** ** | **Q3** | ** ** | **Q4** | ** ** |
| **Net  Sales**                                |       | $                      | 5,853,423  |   | $ | 18,295,357 |   | $ | 9,303,526 |   | $ | 16,260,523 |   |
| Gross Profit                                  |       | (541,896               | )          | 4,036,672 |   | 1,314,823 |   | (1,525,385 | ) |
| Operating Loss                                |       | (3,528,382             | )          | (473,325 | ) | (5,321,045 | ) | (6,307,311 | ) |
| **Net Loss**                                  |       | (936,306               | )          | (647,344 | ) | (5,666,483 | ) | (7,154,489 | ) |
| **Basic  Earnings (loss) per common share**   |       | (0.05                  | )          | (0.04 | ) | (0.19 | ) | (0.23 | ) |
| **Diluted Earnings (loss) per  common share** |       | (0.05                  | )          | (0.04 | ) | (0.19 | ) | (0.23 | ) |
|                                               |            |                        |            |  |  |  |  |  |  |  |  |  |  |

 

**NOTE 21—SUBSEQUENTEVENTS**

On January 9, 2007, NASDAQ approved the Company’sapplication to list its common stock on the NASDAQ Stock Market. The Companywill retain its FRPT trading symbol and the listing was effective January 18,2007.

On January 11, 2007, the Company received aletter contract from the United States Marine Corps for 15 of its CougarJoint Explosive Ordnance Disposal Rapid Response Vehicles (JERRV). The lettercontract for the vehicles, spare parts and sustainment services has a totalvalue of approximately $9,379,370.

On January 19, 2007, the Company’s Board ofDirectors appointed Michael S. Durski to the position of Chief FinancialOfficer.

On January 25, 2007, the Company received afour-vehicle letter contract from the U.S. Marine Corps for testing, productionand sustainability for its Mine Resistant Ambush Protected (MRAP) vehicleprogram. The work under this contract will be performed by Force Dynamics, LLC,the Company’s joint venture with General Dynamics Land Systems, Inc.

On February 14, 2007, the Company received acontract award from the U.S. Marine Corps for 125 vehicles as part of theMine Resistant Ambush Protected (MRAP) vehicle program. The work under thecontract will be performed by Force Dynamics, LLC, the Company’s joint venturewith General Dynamics Land Systems, Inc. The contract award has a totalvalue of approximately $67 million. Under the contract award, Force Dynamicswill produce 65 vehicles for Category I and 60 vehicles for Category II of theMRAP program. The vehicles are to be delivered within 120 days from thedelivery of the contract and will be used by all branches of the U.S. armedforces.

On February 20, 2007, the Company’s Mastiffcontract with the British Ministry of Defense was modified to add 22 additionalMastiff vehicles increasing the total to be delivered to 108.

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On March 9, 2007, the Company received a deliveryorder from the U.S. Marine Corps for an additional 19 Buffalomine-protected vehicles worth an estimated $16.2 million. Under aNovember 2006 contract award administered by the Marine Corps SystemsCommand, the Company expects to deliver the 19 Buffalo vehicles byDecember 2007.

On March 9, 2007, theCompany purchased the Research and Developmental Testing Facility of NEWTECServices Group, Inc., located near Edgefield, SC. The facility will beused to expand the Company’s research and development activities and supportthe verification and quality control validation of the Company’s armoredvehicles used to protect military personnel against explosive threats.

**ITEM 9.**                CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIALDISCLOSURE.

At a meeting of the Audit Committee held on November 10,2006, the Audit Committee approved the engagement of Elliott Davis, LLC toserve as our independent registered accounting firm for the fiscal year ending December 31,2007. In addition, the Audit Committee dismissed Jaspers + Hall, P.C. as ourindependent registered accounting firm effective upon completion of the auditof our consolidated financial statements as of and for the fiscal year ending December 31,2006.

During the years ended December 31, 2005 and2004, and through November 16, 2006, we did not consult Elliott Davis, LLCregarding the application of accounting principles to a specified transaction,either completed or proposed, the type of audit opinion that might be renderedon our financial statements or any matter that was either the subject of adisagreement (as defined in Item 304(a)(1)(iv) and the relatedinstructions to Item 304 of Regulation S-K) or a reportable event (asdefined in Item 304(a)(1)(v) of Regulation S-K).

The reports of Jaspers + Hall, P.C. on ourconsolidated financial statements for the years ended December 31, 2005and 2004 did not contain an adverse opinion or a disclaimer of opinion and werenot qualified or modified as to uncertainty, audit scope or accountingprinciple.

During the years ended December 31, 2005 and2004, and through November 16, 2006, there were no disagreements withJaspers + Hall, P.C. on any matter of accounting principles or practices,financial statement disclosure or auditing scope or procedure, whichdisagreements, if not resolved to the satisfaction of Jaspers + Hall, P.C.,would have caused Jaspers + Hall, P.C. to make reference thereto in its reportson our consolidated financial statements for such years. During the years endedDecember 31, 2005 and 2004, and through November 16, 2006, there wereno reportable events (as defined in Item 304(a)(1)(v) of RegulationS-K) with respect to us.

We requested Jaspers +Hall, P.C. to furnish a letter addressed to the Securities and ExchangeCommission stating whether or not it agrees with the above statements. A copyof such letter is filed as Exhibit 16.1 to the Form 8-K filed on November 16,2006.

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**ITEM 9A.**        CONTROLS ANDPROCEDURES

**Management’s Reporton Internal Control Over Financial Reporting**

Our management isresponsible for establishing and maintaining adequate internal control overfinancial reporting as defined in Rules 13a-15(f) and 15d-15(f) underthe Securities Exchange Act of 1934. Our internal control over financialreporting is a process designed to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statementsfor external purposes in accordance with generally accepted accounting principles.Our internal control over financial reporting includes those policies andprocedures that:

(i)             pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of our assets;

(ii)         provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of our management and directors; and

(iii)     provide reasonable assuranceregarding prevention or timely detection of unauthorized acquisition, use ordisposition of our assets that could have a material effect on the financialstatements.

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

Management assessed the effectiveness of our internalcontrol over financial reporting as of December 31, 2006. In making thisassessment, management used the criteria set forth by the Committee ofSponsoring Organizations of the Treadway Commission (COSO) in *Internal Control*—*Integrated Framework.*

Based on this assessment, management determined thatwe maintained effective internal control over financial reporting as of December 31,2006.

Management’s assessment ofthe effectiveness of our internal control over financial reporting as of December 31,2006 has been audited by Jaspers + Hall, PC, an independent registered publicaccounting firm, as stated in their report which is included in “Item 8.Financial Statements and Supplementary Data.”

**ITEM 9B:**      OTHER INFORMATION

None.

**PART III**

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

The information requiredto be set forth herein will be included in our Proxy Statement, which isincorporated herein by reference.

**ITEM 11.**         EXECUTIVECOMPENSATION.

The information requiredto be set forth herein will be included in our Proxy Statement, which isincorporated herein by reference.

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

The information requiredto be set forth herein will be included in our Proxy Statement, which isincorporated herein by reference.

**ITEM 13.**         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.

The information requiredto be set forth herein will be included in our Proxy Statement, which isincorporated herein by reference

**ITEM 14.**         PRINCIPALACCOUNTANT FEES AND SERVICES

*AUDIT FEES*

We paid Jaspers + Hall,P.C., an independent accounting firm, $40,000 for audit fees in 2005. In 2006,we paid $55,000 in audit fees.

*AUDIT-RELATED FEES*

None.

*TAX FEES &ACCOUNTING SERVICES*

We paid Bryan, Truesdale,Adkins & Williams, PA, an independent accounting firm $97,703 forservices in 2006.

*OTHER FEES*

None.

**PART IV**

**ITEM 15.**         EXHIBITS,FINANCIAL STATEMENT SCHEDULES.
| NUMBER | ** ** | ** **                                                                                                                                                                                                                 | ** ** | **DESCRIPTION** |
|--------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 2.1    |       | Agreement and Plan of  Merger (included as Attachment A to Exhibit 99.2 to the Form DEF 14A  filed November 19, 2004, and incorporated herein by reference).                                                     |
| 3.1    |       | Articles of  Incorporation (included as Attachment B to Exhibit 99.2 to the Form DEF 14A  filed November 19, 2004, and incorporated herein by reference).                                                   |
| 3.2    |       | By-Laws (included  as Attachment C to Exhibit 99.2 to the Form DEF 14A filed  November 19, 2004, and incorporated herein by reference).                                                                          |
| 3.3    |       | Amended Articles  of Incorporation (included as Attachment D to Exhibit 99.2 to the  Form DEF 14A filed November 19, 2004, and incorporated herein by  reference).                                               |
| 4.1    |       | Certificate of  Designation for Series D Convertible Preferred Stock, dated  January 19, 2005 (included as Exhibit 4.1 to the Form 8-K filed  January 27, 2005, and incorporated herein by reference). |
| 4.2    |       | Form of Common  Stock Purchase Warrant, dated January 19, 2005, (included as  Exhibit 4.2 to the Form 8-K filed January 27, 2005, and  incorporated herein by reference).                         |
| 4.3    |       | Securities  Purchase Agreement, dated January 19, 2005 (included as Exhibit 4.3  to the Form 8-K filed January 27, 2005, and incorporated herein by  reference).                                       |

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| 4.4  |   | Registration  Rights Agreement, dated January 19, 2005 (included as Exhibit 4.4  to the Form 8-K filed January 27, 2005, and incorporated herein by  reference).                                                                                                                      |
|------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.5  |   | Amended and  Restated Certificate of Designation for Series B Convertible Preferred  Stock (included as Exhibit 4.1 of the Form 8-K filed February 15,  2005, and incorporated herein by reference).                                                                                       |
| 4.6  |   | Amended and  Restated Certificate of Designation for Series C Convertible Preferred  Stock (included as Exhibit 4.2 of the Form 8-K filed February 15,  2005, and incorporated herein by reference).                                                                                       |
| 4.7  |   | Bridge Facility  between the Company and GC Financial Services, Inc., dated  September 29, 2005 (included as Exhibit 4.1 to the Form 8-K  filed July 8, 2005, and incorporated herein by reference).                                                                             |
| 4.8  |   | Demand Note  between the Company and GC Financial Services, Inc., dated  September 29, 2005 (included as Exhibit 4.2 to the Form 8-K  filed July 8, 2005, and incorporated herein by reference).                                                                                 |
| 10.1 |   | Series B Convertible Preferred Stock Purchase  Agreement between the Company and Ashford Capital, LLC, dated  December 27, 2001 (included as Exhibit 10.1 to the Form 8-K filed  January 7, 2002, and incorporated herein by reference).                                              |
| 10.2 |   | Series C Convertible  Preferred Stock Purchase Agreement between the Company and eFund Capital  Partners, LLC, dated December 27, 2001 (included as Exhibit 10.2 to the  Form 8-K filed on January 7, 2002, and incorporated herein by  reference).                                   |
| 10.3 |   | Letter Agreement  between the Company and Ashford Capital, LLC, dated April 15, 2003  (included as Exhibit 4.9 to the Form 10-QSB filed November 18,  2003, and incorporated herein by reference).                                                                                         |
| 10.4 |   | Industrial Lease  between the Company and Aerospace/Defense, Inc., dated September 2,  2003 (included as Exhibit 10.12 to the Form 10-QSB filed  August 13, 2004, and incorporated herein by reference).                                                                         |
| 10.5 |   | Modification of  Business Asset Sale, License Agreement & Assignment of Rights  between the Company and Rockwell Power Systems, Inc., dated  September 15, 2003 (included as Exhibit 2.3 to the Form 10-QSB  filed November 18, 2003, and incorporated herein by reference). |
| 10.6 |   | Non-Employee  Directors and Consultants Retainer Stock Plan, dated March 31, 2003  (included as Exhibit 4 to the Form S-8 filed November 7, 2003, and  incorporated herein by reference).                                                                                                  |
| 10.7 |   | Investment  Agreement between the Company and Dutchess Private Equities Fund, L.P., dated  January 26, 2004 (included as Exhibit 10.8 to the SB-2 filed  January 27, 2004, and incorporated herein by reference).                                                                               |
| 10.8 |   | Registration  Rights Agreement between the Company and Dutchess Private Equities Fund,  L.P., dated January 26, 2004 (included as Exhibit 10.9 to the SB-2 filed  January 27, 2004, and incorporated herein by reference).                                                                      |
| 10.9 |   | Placement Agent  Agreement between the Company, Charleston Capital, LLC, and Dutchess Private  Equities Fund, L.P., dated January 27, 2004 (included as Exhibit 10.10  to the SB-2 filed on January 27, 2004, and incorporated herein by  reference).                                           |

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| 10.10 |   | Form of  Subscription Agreement between the Company and Gamma Opportunity Capital  Partners, LP, Longview Fund, LP, Alpha Capital Aktiengesellschaft, Domino  International Ltd, Magellan International Ltd, and Mountain Ridge Capital  LLC, dated March 23, 2004 (included as Exhibit 4 to the Form 8-K  filed on March 26, 2004, and incorporated herein by reference). |
|-------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.11 |   | Royalty Agreement  between the Company and J.J. van Eck, dated April 1, 2004 (included as Exhibit  10.13 to the Form 10-QSB filed August 13, 2004, and incorporated  herein by reference).                                                                                                                                                                                      |
| 10.12 |   | Contract between  the Company and the U.S. Marines, dated April 21, 2004 (included as Exhibit  10.14 to the 10-QSB filed August 13, 2004, and incorporated herein by  reference).                                                                                                                                                                                                    |
| 10.13 |   | Term Sheet  between the Company and GC Financial Services, Inc., dated  September 16, 2004 (included as Exhibit 10.14 to the 10-QSB filed  November 15, 2004, and incorporated herein by reference).                                                                                                                                                                            |
| 10.14 |   | Employment  Agreement between the Company and Thomas Thebes (included as Exhibit 10.10  to the Form 10-QSB filed August 13, 2004, and incorporated herein  by reference).                                                                                                                                                                                                       |
| 10.15 |   | Letter re:  Industrial Lease Agreement between the Company and  Aerospace/Defense, Inc., dated July 13, 2004 (included as  Exhibit 10.11 to the Form 10-QSB filed August 13, 2004,  and incorporated herein by reference).                                                                                                                                            |
| 10.16 |   | Employment  Agreement between the Company and Frank Kavanaugh, dated November 15,  2004 (included as Exhibit 10.15 to the 10-QSB filed November 15, 2004,  and incorporated herein by reference).                                                                                                                                                                                    |
| 10.17 |   | Letter Contract  awarded to the Company by the Department of the Army dated November 18,  2004 (as described in the 8-K filed November 24, 2004, and incorporated  herein by reference).                                                                                                                                                                                             |
| 10.18 |   | Promissory Note  between the Company and Dutchess Private Equity Fund, II, LP dated  December 3, 2004 (included as Exhibit 10.1 to the Form 8-K  filed December 8, 2004, and incorporated herein by reference).                                                                                                                                                       |
| 10.19 |   | Employment  Agreement between the Company and Gordon McGilton, dated January 27,  2005 (included as Exhibit 10.22 to the Form 10-KSB/A filed  April 22, 2005, and incorporated herein by reference).                                                                                                                                                                       |
| 10.20 |   | Employment  Agreement between the Company and Ted McQuinn, dated February 4, 2005  (included as Exhibit 10.23 to the Form 10-KSB/A filed  April 22, 2005, and incorporated herein by reference).                                                                                                                                                                           |
| 10.21 |   | Order for  Supplies or Services between the Company and U.S. Department of Defense,  dated May 13, 2005 (included as Exhibit 10.1 to the Form 8-K  filed May 18, 2005, and incorporated herein by reference).                                                                                                                                                              |
| 10.22 |   | Order for  Supplies or Services between the Company and U.S. Department of Defense,  dated May 18, 2005 (included as Exhibit 10.1 to the Form 8-K  filed May 23, 2005, and incorporated herein by reference).                                                                                                                                                              |
| 10.23 |   | Order for  Supplies or Services and Delivery Order between the Company and U.S.  Department of Defense, dated September 23, 2005 (included as  Exhibit 10.1 to the Form 8-K filed September 27, 2005,  and incorporated herein by reference).                                                                                                                              |

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| 10.24 |   | Purchase and Sale  Agreement the Company and GC Financial Services, Inc., dated  September 29, 2005 (included as Exhibit 10.1 to the Form 8-K  filed July 8, 2005, and incorporated herein by reference).                                                                                                               |
|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.25 |   | Security  Agreement the Company and GC Financial Services, Inc., dated  September 29, 2005 (included as Exhibit 10.2 to the Form 8-K  filed July 8, 2005, and incorporated herein by reference).                                                                                                                        |
| 10.26 |   | Purchase Order  between the Company and Ricardo Engineering, dated September 29, 2005  (included as Exhibit 10.1 to the Form 8-K filed July 19, 2005,  and incorporated herein by reference).                                                                                                                                |
| 10.27 |   | Solicitation/Contract/Order  for Commercial Items and Delivery Order between the Company and the United  States Marine Corps, dated September 7, 2005 (included as  Exhibit 10.1 to the Form 8-K filed September 9, 2005, and  incorporated herein by reference).                                                            |
| 10.28 |   | Engineering  Services Agreement between the Company and TecStar, dated August 22,  2005 (included as Exhibit 10.31 to the Form 10-QSB filed  November 11, 2005, and incorporated herein by reference).                                                                                                                       |
| 10.29 |   | Contract between the Company and the United States  Army (included as Exhibit 10.36 to the Form 10-K filed  April 13, 2006, and incorporated herein by reference).                                                                                                                                                                |
| 10.30 |   | Form of  Common Stock Purchase Agreement dated July 24, 2006 (included as Exhibit 10.1  to the Form 8K filed on July 25, 2006, and incorporated herein by  reference).                                                                                                                                                  |
| 10.31 |   | Production  License Agreement between the Company and BAE Systems Land &  Armaments, LP, dated June 13, 2006 (included as Exhibit 10.1 to the  Form 10-Q filed August 14, 2006, and incorporated herein by  reference).                                                                                             |
| 10.32 |   | Logistic Support  Agreement between the Company and BAE Systems Land & Armaments, LP,  dated June 13, 2006 (included as Exhibit 10.2 to the Form 10-Q  filed August 14, 2006, and incorporated herein by reference).                                                                                                |
| 10.33 |   | Contract between  the Company and the British Ministry of Defense, dated August 11, 2006  (included as Exhibit 10.1 to the Form 8-K filed August 17,  2006, and incorporated herein by reference).                                                                                                                           |
| 10.34 |   | Memorandum of  Agreement and Cooperation between the Mechem, a division of Denel (PTY),  Ltd., and the Company, dated September 28, 2006 (included as  Exhibit 10.1 to the Form 8-K filed September 28, 2006, and  incorporated herein by reference).                                                                        |
| 10.35 |   | Memorandum of  Understanding between the Company and General Dynamics Land Systems, Inc.,  dated November 9, 2006 (included as Exhibit 10.1 to the  Form 8-K filed November 17, 2006, and incorporated herein by  reference).                                                                                           |
| 10.36 |   | Memorandum of  Understanding between the Company and Stewart & Stevenson Tactical  Vehicle Systems LP d/b/a Tactical Vehicle Systems, a Division of Armor  Holdings, Inc., dated November 10, 2006 (included as  Exhibit 10.1 to the Form 8-K filed November 20, 2006, and  incorporated herein by reference). |
| 10.37 |   | Form of  Securities Purchase Agreement, dated December 20, 2006 (included as  Exhibit 10.1 to the Form 8-K filed December 21, 2006, and  incorporated herein by reference).                                                                                                                                             |
| 10.38 |   | Certificate of  the Company’s Corporate Secretary, dated January 10, 2007 (included as  Exhibit 10.2 to the Form S-8 filed January 12, 2007, and  incorporated herein by reference).                                                                                                                                    |

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| 10.39 |   | Common Stock  Purchase Option issued by the Company to Gordon McGilton, dated  January 10, 2006 (included as Exhibit 10.2 to the Form S-8  filed January 12, 2007, and incorporated herein by reference).         |
|-------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.40 |   | Common Stock  Purchase Warrant issued by the Company to Gordon McGilton, dated  October 31, 2006 (included as Exhibit 10.3 to the Form S-8  filed January 12, 2007, and incorporated herein by reference).        |
| 10.41 |   | Letter contract  issued to the Company by the U.S. Marine Corps, dated January 11, 2007  (included as Exhibit 10.1 to the Form 8-K filed January 18,  2007, and incorporated herein by reference).                |
| 10.42 |   | Employment Offer  Letter between the Company and Michael S. Durski, dated January 19, 2007  (included as Exhibit 10.1 to the Form 8-K filed January 25,  2007, and incorporated herein by reference).             |
| 10.43 |   | Letter Contract issued to the Company by the United  States Marine Corps, dated January 25, 2007 (included as  Exhibit 10.1 to the Form 8-K filed February 5, 2007, and  incorporated herein by reference).       |
| 10.44 |   | Letter Contract  issued to the Company by the United States Marine Corps dated  February 14, 2007 (included as Exhibit 10.1 to the Form 8-K  filed February 20, 2007, and incorporated herein by reference).      |
| 10.45 |   | Letter Contract  issued to the Company by the U. S. Marine Corps dated March 9, 2007  (included as Exhibit 10.1 to the Form 8-K filed March 15,  2007, and incorporated herein by reference).                     |
| 10.46 |   | Purchase and Sale  Agreement between the Company and NEWTEC Services Group, Inc. dated  March 9, 2007 (include as Exhibit 10.2 to the Form 8-K filed  March 15, 2007, and incorporated herein by reference). |
| 23.1  |   | Consent of  Jaspers + Hall, PC                                                                                                                                                                                                        |
| 31.1  |   | Certification of  the Chief Executive Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                        |
| 31.2  |   | Certification of  the Chief Financial Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                        |
| 32.1  |   | Certification of  Officers pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                       |

 

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**SIGNATURES**

Inaccordance with the requirements of the Exchange Act, the registrant causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.
|                      | **FORCE  PROTECTION, INC.** |
|----------------------|-----------------------------|
| Date: July 12,  2007 | By:                         | /s/ GORDON MCGILTON |
|                 |                        | Gordon McGilton |
|                 |                        | *Chief Executive Officer* |
| Date: July 12,  2007 | By:                         | /s/ MICHAEL DURSKI |
|                 |                        | Michael Durski |
|                 |                        | *Chief Financial Officer* |
|                 |                        | *Principal Accounting Officer* |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant and in thecapacities and on the dates indicated.

**Signatures**
|                               | **Name** | ** **                     | ** ** | ** **    | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|-------------------------------|----------|--------------------------------|------------|---------------|-----------|------------|------------|------------|----------|------------|
| /s/ GORDON  MCGILTON          |     | Director, and  Chief Executive |       | July 12, 2007 |
| Gordon  McGilton              |     | Officer                        |       |          |
| /s/ MICHAEL  MOODY            |     | Director                       |       | July 12, 2007 |
| Michael  Moody                |     |                           |       |          |
| /s/ ROGER  THOMPSON, JR. |     | Director                       |       | July 12, 2007 |
| Roger  Thompson, Jr.     |     |                           |       |          |
| /s/ JACK  DAVIS               |     | Director                       |       | July 12, 2007 |
| Jack Davis                    |     |                           |       |          |

 

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