** **

**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

**FORM 10-KSB**

**x**                              Annual Reportpursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for thefiscal year ended September 30, 2006

**o**                                 TransitionReport pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934for the transition period from    to   

**Commission File Number  0-15318**

**BALLISTIC RECOVERY SYSTEMS, INC.**

**(Exactname of issuer as specified in its charter)**

| **Minnesota**                                                   |       | **41-1372079**                     |
|-----------------------------------------------------------------|------------|------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |       | (IRS Employer  Identification No.) |
|                                                            |       | ** **                         |
| **300  Airport Road, South St. Paul, Minnesota**                | ** ** | **55075-3541**                     |
| (Address of  Principal Executive Offices)                       |       | (Zip Code)                         |

 

**(651) 457-7491**

**(Issuer’stelephone number)**

**Securities registered pursuant to Section 12(b) of theExchange Act:**

**None**

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

**CommonStock, par value $0.01 per share**

**Check whether the issuer: (1) filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the past 12 months (or for such shorter period that the issuer wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.Yes**x  No o

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

**Check if there is no disclosure of delinquent filerspursuant to Item 405 of Regulation S-B is not contained herein, and nodisclosure will be contained, to the best of registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in PartIII of this Form 10-KSB or any amendment to this Form 10-KSB.  **o

**The issuer’s revenues for the fiscal year endedSeptember 30, 2006 were $9,191,729.**

**As of December 15, 2006 there were 9,930,059outstanding shares of common stock, par value $0.01 per share.**

**The aggregate market value of the voting commonstock of the issuer held by non-affiliates of the issuer on December 15, 2006based on the closing price of the common stock as quoted by the NASDOver-the-Counter Bulletin Board on such date was $9,861,577.**

**TransitionalSmall Business Disclosure Format: Yes**o  No x

 

----

**TABLE OFCONTENTS**
| ** **   | ** **                                                                            | ** ** |
|--------------|---------------------------------------------------------------------------------------|------------|
| **PART I**   |                                                                                  |       |
| Item 1       | Description of Business                                                               |       |
| Item 2       | Description of  Property                                                              |       |
| Item 3       | Legal Proceedings                                                                     |       |
| Item 4       | Submission of  Matters to a Vote of Security Holders                                  |       |
| **PART II**  |                                                                                  |       |
| Item 5       | Market for Common  Equity and Related Stockholder Matters                             |       |
| Item 6       | Management’s  Discussion and Analysis or Plan of Operation                       |       |
| Item 7       | Consolidated  Financial Statements                                                    |       |
| Item 8       | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure |       |
| Item 8A      | Controls and  Procedures                                                              |       |
| Item 8B      | Other Information                                                                     |       |
| **PART III** |                                                                                  |       |
| Item 13      | Exhibits                                                                              |       |
| Item 14      | Principal  Accountant Fees and Services                                               |       |
|         | Index to  Consolidated Financial Statements                                           |       |
|         | Certifications                                                                        |       |

** **

DOCUMENTSINCORPORATED BY REFERENCE

Portions of theCompany’s Definitive Proxy Statement to be used in connection with the electionof directors at the 2007 annual shareholders meeting (the “Proxy Statement”)are incorporated by reference into Part III, Items 9-12 as follows:

** **
|    | Part of Form 10KSB                                                                                                |   | Portion of 2007 Proxy Statement                                        |
|---------|-------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------|
| Item 9  | Directors,  Executive Officers, Promoters and Control Persons; Compliance with Section  16(a) of the Exchange Act |   | PROPOSAL 1. ELECTION OF  DIRECTORS and OWNERSHIP OF SECURITIES

  |
| Item 10 | Executive  Compensation                                                                                           |   | EXECUTIVE COMPENSATION                                                 |
| Item 11 | Security  Ownership of Certain Beneficial Owners and Management                                                   |   | OWNERSHIP OF SECURITIES                                                |
| Item 12 | Certain  Relationships and Related Transactions                                                                   |   | CERTAIN RELATIONSHIPS  AND RELATED TRANSACTIONS                        |

 

1

----

**REFERENCES**

**References to “BRS,” the “Company,” the “Registrant,”“we,” “us,” or “our” in this Annual Report on Form 10-KSB refer to BallisticRecovery Systems, Inc., a Minnesota corporation.**

**FORWARD-LOOKINGSTATEMENTS**

**This Annual Report on Form 10-KSB containsstatements that are forward-looking in nature, including statements regardingthe expectations, beliefs, intentions or strategies regarding the future.  In particular, the “Management’s Discussionand Analysis or Plan of Operation” section in Item 6 of this annual reportincludes forward-looking statements that reflect our current views with respectto future events and financial performance. We use words such as we “expect,” “anticipate,” “believe,” and “intend”and similar expressions to identify forward-looking statements.  Investors should be aware that actual resultsmay differ materially from our expressed expectations because of risks anduncertainties inherent in future events, including, but not limited to, theCompany’s dependence on Cirrus Design Corporation (Cirrus), potential productliability claims and payment if such claims are successful, federaltransportation rules and regulation which may negatively impact the Company’sability to ship its products in a cost efficient manner, the elimination offunding for new research and development projects, the decline in registeredand unregistered aircraft sales, dependence on discretionary consumer spending,dependence on existing management, general economic conditions, and changes infederal or state laws or regulations. Investors should not unduly rely on these forward looking statements.**

**PART I**

**ITEM 1.**                             BUSINESS

**Introduction**

Ballistic Recovery Systems, Inc. (Ticker: “BRSI.OB”)is one of the leading aviation safety companies in the United States.  Founded in 1980 and based in South St. Paul,Minnesota, BRS is engaged in the business of developing and commercializingwhole-aircraft emergency recovery parachute systems for use primarily withgeneral aviation and recreational aircraft.

The parachute systems are designed to safely descendthe entire aircraft and its occupants in the event of an in-air emergency.  The parachute system is designed for in-airemergencies that include mid-air collisions, structure failure, engine failure,pilot incapacitation, and unstable meteorological conditions, among otherthings.  The Company believes it is thelargest manufacturer of whole aircraft recovery systems in the world.  Since its inception 26 years ago, the Companyhas delivered over 23,000 systems that have been installed on general aviationaircraft (including over 2,800 on Federal Aviation Administration (FAA)certified aircraft) and recreational aircraft throughout the world.

The Company currently operates in three marketsegments that comprise all of the Company’s current revenues:

·                  General aviation aircraft as certified bythe FAA.  The general aviation market isour largest consumer, comprising approximately 74% of our revenue.

·                  Light Sport Aircraft (LSA) which aresmaller two-seat aircraft.  The FAAmonitors and regulates this segment under different regulations andrestrictions than the general aviation aircraft.

2

----

·                  Recreational aviation (commonly calledultralight aircraft).  The recreationalaviation market is the oldest market segment that we service.  Our first products were developed for thissegment over 26 years ago.

In recent years, the Company’s growth has come fromits general aviation market, primarily from sales to Cirrus.  The Company sees its future growth comingfrom the following areas:

·                  Expansion of the general aviation marketbeyond Cirrus to other general aviation manufacturers;

·                  Continued growth in the LSA market;

·                  Growth in the emerging VLJ market;

·                  Development of the repack market forgeneral aviation aircraft; and

·                  Utilize its manufacturing expertise andexcess capacity for non-aviation cut and sew production in its Mexicoproduction facility.

The Company maintains its corporate headquarters andmain manufacturing facility in South St. Paul, Minnesota, on the grounds ofFleming Field.  The Company also has afacility in Mexico that is used for manufacturing parachutes for BRSproducts.  The Company employs 50 peoplebetween its operations in Minnesota and its parachute manufacturing facility inMexico.

**Businessof the Company**

Principal Products

The Company’s principal product is whole-aircraftemergency parachute recovery systems. The product, when utilized in an in-air emergency and at the appropriatealtitude, may be activated by the pilot releasing a parachute that is designedto open quickly, slow the descent of the aircraft, and lower the aircraft andits occupants safely to the ground to prevent or reduce injury and damage tothe aircraft. Possible parachute usage scenarios include:  Mid-air collision (loss of integrity orcontrol); severe weather upset (wind shear, turbulence); power loss with poorvisibility (night or instrument flight conditions); loss of control (componentfailure or malfunction); engine out over hostile (unlandable) terrain; structuralfailure (age-weakened parts); pilot medical trauma (heart attack, allergicreaction, stroke); overstress (violent weather); and/or pilot error.

General Aviation Products

The Company entered the general aviation market in themid 1980’s when it developed an emergency parachute recovery system for theCessna 150/152 series of aircraft.  In1993, this system, known as the GARD-150 (now called the “BRS-150”), received aSupplemental Type Certificate, or STC, from the FAA that allowed owners ofCessna 150/152 model aircraft to install the system.  Media attention for this new product resultedin domestic and international television and radio broadcasts as well ascoverage in domestic and international aviation and non-aviation print media.Although the BRS-150 did not sell in significant volumes, the Company believesthat it helped in the development of the Company’s current products.

In 1994, the Company entered into an agreement withCirrus, a privately held company to develop and certify a four-place all compositegeneral aviation aircraft.  The FAAcertified the aircraft, known as the Cirrus Design SR20, in October 1998.  This was the first FAA certified aircraft tooffer one of the Company’s recovery systems as required standardequipment.  The Company began deliveringsystems for the SR20 in fiscal year 1999. During fiscal year 2000, Cirrus began development and

3

----

certification efforts fortheir next generation aircraft called the SR22. The SR22 is a heavier and faster version of the SR20 and utilizes muchof the same parachute technology developed for the SR20.  The SR22 received FAA certification inNovember 2000 and was certified with the Company’s parachute system as astandard component of the aircraft. Deliveries of SR22 parachute systems by the Company began in December2000.

In fiscal year 2001 the Company began development of aparachute system for the Cessna 172 model aircraft.  During fiscal year 2001, the Company received$200,000 in funding from a third party investor, which took the form of equityand project specific funding, to develop and test such a recovery system.  The development and testing was completed infiscal year 2002 and the Company received FAA certification for the BRS-172recovery system in July 2002.  TheCompany made its first customer delivery in September 2002 with 19 totalsystems installed through the end of fiscal year 2006.

Near the end of fiscal year 2004, the Companyfinalized development of a parachute recovery system for the Cessna 182 modelaircraft, which is called the BRS-182. The system utilizes many of the same components used in the recoverysystems for the Cirrus aircraft models and the Cessna 172.  The Company received the Supplemental TypeCertificate or STC from the FAA in June 2004, allowing the product to beinstalled on certified Cessna 182 series aircraft.  The first customer delivery and installationwas completed in July 2004.  A total of25 BRS-182 units have been installed through the end of fiscal year 2006.

Light Sport Aircraft

LSA are smaller two-seat aircraft which are subject tofederal regulations approved in December 2004 regulating airplanes weighingless than 1,320 lbs.  The regulations andrestrictions relating to LSA are less onerous than that relating to generalaviation aircraft.  Management believesthat these lesser restrictions may have a positive effect on the LSA market inthe United States, and that the Company has a significant market opportunity ifit can develop and manufacture compatible products.  The Company delivered 87 LSA units in fiscalyear 2006.

No assurances can be made that such plans, ifimplemented, will have a material impact on the Company’s LSA aircraft productsales.

Recreational Aviation Products

Recreational aviation products include productsdesigned and manufactured for use on unregistered aircraft such as ultralightsand aircraft registered with the FAA as experimental.  Like the Company’s general aviation products,these recreational aviation products are designed to prevent or reduce humaninjury and damage to the aircraft.  TheCompany manufactures these products and sells direct and through dealers anddistributors who also market and sell the aircraft and related products.  The Company currently works withapproximately 30 dealers and distributors worldwide.

Contract Research and Development

Previously, the Company has performed research anddevelopment funded by, and on behalf of, airplane manufacturers, which hasallowed the Company to expand its product line and expertise in whole-aircraftrecovery systems.  Currently, the Companyhas no such contracts, but it has been and will continue to be a goal of theCompany to enter into such relationships and receive outside funding for itsresearch and development activities to supplement its own financial commitment.  There is no assurance the Company will enterinto such contracts.

4

----

**Industry Overview**

General Aviation Market

In fiscal year 2006, the Company’s general aviationproduct lines accounted for approximately 74% of the Company’s revenues.  According to the General AviationManufacturers Association (“GAMA”), the general aviation market experienced 27%growth in 2005.    The Company’s primarygeneral aviation product has been used on the Cirrus SR20 and SR22 aircraftmanufactured by Cirrus.  For fiscal year2006, sales to Cirrus account for approximately 71% of the Company’srevenues.  One of the Company’s growthstrategies addresses customer concentration by pursuing more general aviationbusiness from other manufacturers.

*Cirrus —*Based in Duluth, Minnesota,Cirrus is presently the world’s largest manufacturer of single engine 4-seatcertified aircraft, according to General Aviation Manufacturers Association(GAMA) reports.  Both models of Cirrusaircraft utilize the Company’s parachute system as required standardequipment. As standard equipment, the Company’s parachute is included in theaircraft’s Type Certificate, or TC, issued by the FAA (for more information onthe TC, please see the section entitled “Government Regulation” on page 10).

The Company’s relationship with Cirrus dates back to1994, when the Company and Cirrus developed and obtained FAA certification fora four-place, all composite general aviation aircraft.  One feature that made the first Cirrus plane,the SR20, unique was that it was the first FAA certified aircraft to require aparachute recovery system as standard equipment.  The partnership with Cirrus continued asCirrus developed and certified the SR22 in 2000, a heavier and faster versionof the SR20, which also included the Company’s parachute as standard equipment

Sales of Cirrus aircraft have recently flourished,with 600 aircraft shipped in 2005, an increase of approximately 8.5% over the553 aircraft shipped by Cirrus in 2004. In 2004, Cirrus became the leading US based manufacturer of generalaviation aircraft, passing longtime industry leaders such as Cessna, Piper andMooney.  According to GAMA, Cirrus is themarket leader in high performance, single-engine piston, four-place airplanes.

In November 2005, Cirrus announced that it intended todesign a new “personal jet,” and that it intended to include a parachute onthis model as well.

The Company currently operates under a Purchase andSupply Agreement with Cirrus, dated as of September 1999 and amended February2006 (the “Cirrus Supply Agreement”). Under the Cirrus Supply Agreement, BRS is the non-exclusive supplier ofthe parachute recovery system to Cirrus. The current term of the Cirrus Supply Agreement expires in July 2007,but the Agreement is subject to rolling automatic renewal terms of 18 months,unless terminated by either party upon 18 months advance notice.  The recent amendment to the Agreement alsoprovides that Cirrus will maintain product liability insurance on the parachutesystem whose components are directly or indirectly supplied by BRS.  Additionally, Cirrus has agreed to indemnifyBRS for all related product liability claims involving the BRS parachute system(except for claims for economic losses or damage related solely to theaircraft).  The Cirrus Supply Agreementalso gives Cirrus limited exclusivity for an increased gross weight (3,600pound) system for a period of one year after introduction.

Cirrus continues to make enhancements and advancementsto both the SR20 and SR22 and has new aircraft designs currently underdevelopment.  BRS intends to approachCirrus regarding the use of

5

----

the Company’s product insuch new aircraft, and anticipates that its products will continue to beoffered on Cirrus aircraft as standard equipment.

*Other General Aviation —*TheCompany develops and sells aftermarket FAA certified parachute systems for theCessna 172 and 182 aircraft.  Where theCompany’s parachute is offered as optional equipment, the product is given aSupplemental Type Certificate, or STC, by the FAA, allowing the installation ofthe product but not requiring it for operation of the aircraft (for moreinformation on the STC, please see the section entitled “Government Regulation”on page 10).  The Company made its firstCessna 182 customer delivery and installation in July 2004, and has sold 54Cessna units, to date, of which 24 were sold in the last two years.  These products are primarily sold by theCompany’s sales staff directly to Cessna aircraft owners.  According to GAMA, Cessna delivered 525 Cessna182 and 172 units in the first three quarters of 2006 compared to 447 Cessna182 and 172 units in the first three quarters of 2005.

The Company continues to explore opportunities to haveits products be standard certified equipment or a factory installed option withseveral other general aviation manufacturers.

Light Sport Aircraft Market

The new LSA market segment is the result of recentfederal regulations that were approved in December 2004.  LSA aircraft resemble traditional two-seatgeneral aviation aircraft, but weigh less than 1,320 pounds, and aircraftprices start as low as $20,000.  LSAaircraft have relatively less restrictive regulatory requirements than generalaviation aircraft.  The FAA has projectedthis market to be over 3,000 aircraft in the next 2-3 years.  The Company believes there is significantmarket potential for LSA aircraft where its products would be offered as eitherstandard equipment or a factory option.

The LSA market currently has 34 approved airplanetypes and the Company is in development of designs and has orders to developparachute recovery systems for 13 of these aircraft types.  Many of the existing LSA aircraft weredeveloped around existing European designs, some of which, but not all, utilizethe Company’s products.  The Company hasdeveloped solid relationships with US-based

Recreational Market

For fiscal year 2006, the Company’s recreationalproduct lines accounted for approximately 26% of the Company’s revenues.  Recreational aviation products includeproducts designed and manufactured for use on unregistered aircraft (such asultralights) and aircraft registered with the FAA as experimental.  Like the Company’s general aviation products,these recreational aviation products are designed to prevent or reduce bodilyinjury to the human occupant in the event of an in-air emergency.  Sales to international customers accountedfor approximately 47.5% of the Company’s recreational aviation product sales in2006.

6

----

distributors andmanufacturers of LSA aircraft, such as Flight Star and Sport AircraftWorks.  While the Company is optimisticthat the LSA market will continue to develop, no assurance can be given thatthe Company’s products will be successfully marketed within the LSA market.

Very Light Jet Market

The newest market segment, and one in which theindustry and the Company believe has great potential, is the VLJ market.  VLJs are being developed by several generalaviation manufacturers, including Cirrus, Piper and Diamond (as identifiedbelow).  A VLJ is a smaller version of alarger jet that, in general, seats up to five persons, weighs less than 10,000pounds (maximum take off weight) and will retail for between $1,000,000 and$2,500,000.  This market is designed tobe the transition from high performance piston and turbo-charged aircraft to ajet which is easy to fly and more affordable than their costliercounterparts.  The VLJ is of a weightclass and a performance class that the Company believes it can successfullymanufacture and market its products, capitalizing on what the Company believesis a significant market potential. According to published reports, nearly 3,000 VLJ orders are on the booksof manufacturers, including a backlog of 123 single Diamond D-Jets.

In July 2006, the Diamond Aircraft Industries (“Diamond”),a Toronto-based manufacturer of general aviation and light jet aircraftannounced that a parachute would be an option on the newly announced Djet.  The Company has not entered into a definitiveagreement with Diamond.  However, thecurrent working arrangement is that the Company will be the exclusive supplierof any parachute system used on a Diamond D-JET aircraft.  The Company intends to enter into adefinitive agreement with Diamond.  The Companyintends to be free to supply other light jet manufacturers during the term ofany agreement. The Company’s parachute recovery system would be offered as afactory option on the D-JET.

In June 2006, Cirrus announced that it intends tomanufacture a personal jet.  The Companyis in discussion with Cirrus about the possibility of including the Company’sproducts on its proposed personal jet. Cirrus has committed that they will include a parachute on everyaircraft as standard equipment.

All single engine VLJ manufacturers known to theCompany have expressed some interest in including a whole airplane emergencyrecovery parachute as either standard equipment or an option.  The Company intends to continue discussionswith some or all of these manufacturers, and believes the VLJ market provides asignificant market opportunity to the Company.

Repack Market

All of the Company’sunits require repack, or refurbishment, for continued service.  The average refurbishment cycle onrecreational aircraft is six years, and ten years for general aviationaircraft.  On FAA certified Cirrusaircraft, the Company’s parachute assembly must be repacked at ten-yearintervals in order to maintain its airworthiness certificate.  Currently, we believe only the Company isable to complete repacking.  The repackentails:

a)              replacement of theextraction rocket;

b)             inspectionof the parachute assembly including replacement of certain time change itemsand other parts that have reached the end of their service life; and

c)              repacking of theparachute.

7

----

If the product is not repacked in accordance with theFAA regulations, any aircraft to which it is required equipment will not retainits certification of airworthiness.  TheCompany expects that the repack business may become a substantial business lineas all Cirrus aircraft are required to have the parachute repacked in 10 yearintervals.

Non-Aviation and Department of Defense Market

The Company is actively seeking new non-aviationproduct lines from a variety of safety-related firms to manufacture in itsMexican facility of a “cut-and-sew” nature. These opportunities require highquality, precise assembly processes in a customizable and quick-changeenvironment.  The Tijuana facilityfulfills these requirements precisely with its trained and highly skilledworkforce familiar with sewing techniques which can translate seamlessly tothese diversified product lines.  TheCompany is currently finalizing plans with three such vendors for “build-to-print”activities requiring high quality standards, yet with quick-reaction-timeability to conform to end-user specific desires.  The Company expects these contracts willreach approximately 10% of total sales revenues within the next two years.

The Company is actively seeking opportunities toincorporate its parachute recovery systems aboard current and future plannedaerial combat systems (both unmanned and manned) for the US DoD and foreignMoDs.  A number of inquires have beenmade by industry to this end, and the Company is preparing proposals to competefor these.  The Company has alsopartnered with a domestic OEM desiring to sell its newly developedsingle-engine piston aircraft as a replacement basic trainer for the USAF andUSN whereby each aircraft would have the Company’s parachute recovery systemsinstalled as standard equipment in lieu of individual ejection seats orpersonnel parachutes. The Company expects these contracts to encompassapproximately 7% of total sales revenues over the new three years.

**Manufacturing**

Parachute Manufacturing

The Company’s products are primarily assembled in itsSouth St. Paul, Minnesota facility from products manufactured by the Company orsupplied by third parties.  In September2005, the Company acquired the manufacturing facility of Paranetics Technology,Inc. (“Paranetics”), located in Tijuana, Mexico, for the purpose ofmanufacturing parachutes and related components for its general aviation andrecreational market segments.  TheCompany currently has two recreational product lines produced in its Mexicofacility, and intends to manufacture approximately 70% of its total parachuteproduction in Mexico commencing in fiscal year 2007.

The Company also outsources some parachute componentmanufacturing in China.  The Companyestimates that a portion of the parachute manufacturing (up to 30%) will becompleted in China by the end of fiscal year 2007.  This outsourcing is expected to provide theCompany with cost reductions and a dual source for its parachute needs.

Other Components

The Company manufactures its own ballistic devices andcurrently receives its rocket propellant from a single source. During fiscalyear 2007, the Company entered into a supply agreement with a secondmanufacturer of rocket propellant.  TheCompany believes there are alternate sources for propellant in the event thateither source becomes unavailable.  Othercomponents are purchased from a variety of suppliers or internally produced.

8

----

The Company also attempts to hold reasonable inventoryof key components to provide time to secure alternate suppliers should the needarise.

**Patentsand Intellectual Property**

It is the Company’s policy to actively seek to obtainwhere appropriate, the broadest protection possible for its products,proprietary information and proprietary technology through a combination ofcontractual arrangements and patents, both in the United States and elsewherein the world.

The Company also depends upon the skills, knowledgeand experience of its personnel, some of which may not be patentable.  To help protect its proprietary know-howwhich is not patentable, and for inventions for which patents may be difficultto enforce, the Company relies on trade secret protection and confidentialityagreements to protect its interests.  Tothis end, as appropriate, the Company requires employees, consultants, andother contractors to enter into confidentiality agreements which prohibit thedisclosure of confidential information and, where applicable, requiredisclosure and assignment to the Company of the ideas, developments,discoveries and inventions important to its business.

To date, the Company has not been involved in anypatent infringement or trade secret actions.

Patents

The Company owns two filed patents:  1) a patent relating to a “Parachute ReefingDevice,” also known as the “slider,” and 2) a patent related to “thin filmparachute fibers.”  The patent relatingto the slider, a device that delays the deployment of the parachute until theaircraft slows to an appropriate speed (United States Patent No. 4,863,119), was issued in September 1989 onbehalf of two of the Company’s employees, and expires in September 2008.  The two employees assigned the patent to theCompany, for which the Company is required to make continuing payment ofmaintenance fees until September 2008. The slider is currently utilized in the Company’s general aviation line,as well as in its recreational aviation products.  Current development projects also utilize thereefing device as an integral design component. The Company does not believe that the expiration of this patent willhave a material adverse impact on the Company or its products.

The second patent, Patent No. 6,056,241, was issued tothe Company in May 2000 on behalf of one of the Company’s employees for a “ThinFilm Parachute with Continuous Lateral Reinforcement Fibers.” The employeeassigned the patent to the Company, for which the Company is required to makecontinuing payment of maintenance fees until August 2018. The Company developedthis process as a result of a NASA Small Business Innovative Research grantprogram that was completed during the fiscal year 1999. The Company does nothave an application for this patented process within its current product line.However, military and civilian markets are both being explored for potentialapplications of this technology, which. This patent is not actively utilized in the Company’s technology.

The Company further anticipates obtaining patentprotection for components to one or more of its VLJ products that are currentlyin development.

Trademark Protection

The U.S. Trademark Office has acknowledged trademarkof the Company’s service mark, principle register of “DEFINING AVIATION SAFETY”application, and advises that the application has been assigned on October 10,2006, bearing Registration No. 3,152,604.

9

----

**GovernmentRegulation**

In the general aviation market, some aircraft are FAAcertified.  As it relates to FAAcertified general aviation aircraft and the incorporation of the Company’sproducts into these aircraft, there are two types of certifications that areavailable, a Type Certificate, or TC, and a Supplemental Type Certificate, orSTC.  With respect to the Cirrus SR20 andSR22, Cirrus obtained a TC, whereby Cirrus obtained FAA certification of theCirrus aircraft with the inclusion of the Company’s parachute recovery system —effectively making the Company’s product required standard equipment for theCirrus aircraft.

The STC is a certification that is obtained toconstitute FAA approval of a modification to an already certifiedaircraft.  For example, the Companyobtains an STC to include its parachute recovery system onto an aircraft thathas already obtained a Type Certificate without the Company’s product. This STCenables the manufacturer or any distributor of the aircraft to sell the Company’sproduct as an option.  The Company haspreviously obtained STCs for the Cessna 150/152, the Cessna 172, the Cessna182, and more recently, the Symphony 160.

**Seasonality**

Typically, the Company experiences seasonality in itsrecreational line.  The second and thirdfiscal quarters have the highest sales as this product line is marketed torecreational pilots who tend to fly their aircraft during the warmer months andequip their aircraft with a recovery system near the beginning of the flyingseason.  The Company’s expansion in thegeneral aviation market through the production of systems for the Cirrus SR20and SR22 has lessened the impact of seasonality on the Company.  This trend is expected to continue as the Companyincreases its deliveries in the general aviation market over the next severalyears.

**Dependenceon a Single Customer**

During the fiscal years ended September 30, 2006 and2005, the Company was dependent on one customer, Cirrus, for 70.7% and 74.7%, respectively,of the Company’s total sales.  TheCompany supplies parachute recovery systems to Cirrus from its general aviationproduct line.  Cirrus also owns 14.22% ofcommon stock of the Company as of September 30, 2006 and maintains a seat onthe Board of Directors.

**Dealer/DistributorNetwork**

The Company’s recreational aviation product sales areprimarily through dealers and distributors who sell to the end consumer.  The Company believes that in the event thatany individual dealers or distributors cease to represent the Company’srecreational aviation products, alternative dealers or distributors can beestablished.  The Company does not haveformal written agreements with all its dealers and distributors andaccordingly, such dealers and distributors are not prohibited from sellingproducts competitive with the Company’s products.

**Backlogof Orders**

As of September 30, 2006 and 2005, the Company had abacklog of orders totaling approximately $9,941,000 and $940,000,respectively.  The backlogs included over$9,764,000 and $850,000 of orders for the Cirrus aircraft for the respectiveperiods.  This increase in backlog isrelated to the timing of the receipt of purchase orders from Cirrus withrespect to the Company’s fiscal year end and is unrelated to the volume ofthose orders received or anticipated on-going volumes from Cirrus.  The 2006 backlog is expected to be filledwithin 12 months.  Due to the backlogperiod involved, however, it is possible that there could be cancellations of aportion of the currently backlogged orders. The Company expects to

10

----

fund the build out andsale of the backlogged orders through cash flow provided by the sale of thoseorders.  The Company cautions investorswho may utilize published bookings and backlog information as tools to forecastthe Company’s revenue during a given timeframe since certain purchase ordersmay be subject to cancellation and/or delivery schedule revision.

**Researchand Development**

In fiscal year 2006, the Company expendedapproximately $465,415 in research and development, compared to $357,702expended in fiscal year 2005. Additionally, the BRS board recently elected to fund an internalResearch & Development program that will be modeled after the Company’srecently completed NASA contract.

**Competition**

As referenced above, the Cirrus SR20 and SR22 are FAAcertified with a TC.  These are the firstwhole aircraft recovery systems ever certified by the FAA as standardequipment.  The Company also holds STCsfor the recovery systems for the Cessna 150/152, Cessna 172, Cessna 182 andSymphony 160 model aircraft.  There areno other manufacturers requiring STCs to install a recovery system in thegeneral aviation market.  The Company isunaware of any other manufacturer performing contract or self-funded researchand development activities attempting to obtain TCs or STCs for any other FAAcertified aircraft.  As such, the Companybelieves that any potential competitor in the general aviation market will havea substantial barrier to entry.

The Company believes it is the only manufacturer ofwhole-craft emergency parachute systems in the general aviation market and isthe only US-based manufacturer in the domestic recreational aviationmarket.  Currently, the Company is awareof four foreign competitors in the international recreational aviation marketand the LSA market. One of the foreign competitors has entered the US market asa standard component on a newly designed LSA airplane.  While data is not publicly available, theCompany believes these competitors are smaller than BRS.

Competition for the recreation market is strong in theInternational market, where purchase decisions are mainly based on price.  The Company believes it currently hasapproximately 80% of the domestic market share of the “all-sport” market, whichconsists of the recreational and LSA markets, and approximately 40% of theInternational all-sport market.   TheCompany further believes that its acquisition and implementation of the Mexicofacility will enable it to lower the price of its products, including those inthe International market, and make it better able to compete on a price basis.

Many other companies could develop, manufacture andmarket a parachute recovery system competitive with that of the Company,although the Company believes that such development and approval could take oneor more years to complete due to the technical challenges associated withperformance and regulatory issues.

**Insuranceand Product Liability**

As a manufacturer of products, the Company has beenexposed to products liability litigation on both its general aviation andrecreational products.  The Companyhistorically has not maintained products liability insurance.  The Company does not intend to pursueproducts liability insurance for the recreational market where the number ofincidents have been few and damages minimal. In the past five years, the Company has had only two product liabilityclaims relating to the recreational markets. One of those claims has been settled by the Company for an immaterialamount and the other claim is still pending.

11

----

Prior to February 2006, the Company did not haveproduct liability coverage for any of its products.  The Company recently obtained products liabilitycoverage for its Cirrus products in the Company’s general aviation market.  Pursuant to the Cirrus Supply Agreementamended in February 2006, Cirrus has agreed to maintain products liabilityinsurance coverage on the parachute system whose components are directly orindirectly supplied by the Company. Additionally, Cirrus has agreed to indemnify the Company for losses, forall related product liability claims involving the BRS parachute system (exceptfor claims for economic losses or damage solely incidental to theaircraft).  This coverage/indemnificationis limited to claims arising after February 2006 related to Cirrus aircraft,and will not affect certain claims for products liability relating to Cirrusaircraft that arose prior to February 2006. Please see Item 3 — Legal Proceedings below for a discussion of suchclaims.

With respect to products liability insurance for othergeneral aviation (i.e., non-Cirrus) products, the Company expects to securesuch insurance coverage in fiscal year 2007 or early 2008.

**EnvironmentalCompliance**

The Company believes that it is in compliance with allcurrent federal and state environmental laws.

**Employees**

As of September 30, 2006, the Company had 27 full-timeemployees at its South St. Paul facility. No employees are represented by a labor union and we consider ourrelations with employees to be good.

As of September 30, 2006, the Company had 23 full-timeemployees at its BRS de Mexico SA de CV facility in Tijuana, Mexico.  The employees are represented by a laborunion and we consider our relations with these employees to be good.

**ITEM 2.**                             DESCRIPTIONOF PROPERTY

The Company leases a stand-alone 13,000 square footoffice and production facility located at Fleming Field Airport in South St.Paul, Minnesota.  The building is a WorldWar II training hangar, which the Company has renovated.  This lease expires December 31, 2007.  The Company also leases office space in asecond building on Fleming Field.  Thislease expires April 30, 2008.  TheCompany maintains all of its equipment in good working order and has securedadequate insurance for the facilities and its contents.

The Company leases a stand-alone 25,000 square footoffice (two floors) and production facility located at Calle Uno PonienteNo. 115-A,  Tijuana, Baja California, Mexico for parachutemanufacturing.  The building leaseexpires November 14, 2007.  This facilityis used to manufacture the certain canopies and various other parts used in theCompany’s products.  The Companymaintains all of its equipment in good working order and has secured adequateinsurance for the facilities and its contents.

The Company believes that the current facilities areadequate for the current level of business activities, but is searching foralternatives for expansion to meet the continued sales increases.  In the event that the Company requiresadditional facilities, the Company believes it could procure acceptablefacilities.  The Company does not own anyreal estate.

12

----

**ITEM 3.**                             LEGALPROCEEDINGS

InAugust 2003, the Company was served in two related actions, Kathleen F.Fischer and Susan Sedgwick in U.S. District Court for the Northern District ofNew York.  These actions arise from thecrash of a Cirrus Design Corp. SR22 airplane in April 2002 near Parish,New York.  The Plaintiffs have broughtclaims for strict products liability, negligence and breach of warranty againstCirrus Design, the airplane’s manufacturer, the Company, which manufactures theCAPS (Cirrus Airframe Parachute System), a parachute system which is a requiredcomponent of the plane, and Wings Aloft, Inc., which provided training on theSR22 to the decedents.

In June and August2006, the Company settled with such plaintiffs without any liability to the Company.

On April 17, 2004,an action was commenced against the Company by Aerospace Marketing, Inc. andCharles Parsons v. Ballistic Recovery Systems, Inc., U.S. District Court,Middle District of Florida, File No. 04-CV-242. The action resulted from the Company’s notification to Charles F.Parsons in April 2004 of its intent to terminate the sales and marketingcontract between the Company and Mr. Parsons relating to the BRS-172 andBRS-150 products for lack of performance.

In 2005, a juryawarded damages to Parsons and Aerospace Marketing in the combined amount ofapproximately $3.4 million for breach of contract. The Company has settled thismatter directly with Parsons and Aerospace on September 19, 2005 by agreeing topay $1.9 million pursuant to terms described in the settlement agreement.  An initial payment of $700,000 plus interestwas made on September 19, 2005.  Theremainder of the settlement amount was to be paid by the Company over a term of8 years, although the Company had the right to pre-pay remaining amountsdue at any time.  On November 16,2006, the Company prepaid $721,219 of such sum. The current balance is $315,000, which requires interest only paymentsthrough September 2010, and principal and interest payments from October 2010through September 2013.

In April 2005, anaction was commenced against the Company by Sue Jean McGrath, individually andas successor in interest to Charles W. McGrath, deceased, Charles W. McGrathIII, Tanya Sue McGrath, Janny Sue McGrath, individually v. Cirrus DesignCorporation, Ballistic Recovery Systems, Inc., and Aerospace Systems andTechnologies, Inc., U.S. District Court, Northern District of California, FileNo. C05-1542.  The plaintiffs havealleged vicarious liability, strict product liability, negligence and breach ofwarranty against the defendants arising from the crash of a Cirrus Design Corp.SR22 airplane near Sugar Bowl, California. The case is currently in the early stages of discovery.  At this time the Company cannot state withany degree of certainty what the outcome of the matter or the amount or rangeof potential damages will be.

On September 16,2005, an action was commenced against the Company by Robert Treat Rayner, inthe Circuit Court of the 5th Judicial Circuit in and from Lake County, Florida,File No. 04 CA 1749.  The Complaintalleges that plaintiff was injured when his ultralight aircraft crashed whilebeing towed by another ultralight. Plaintiff alleges that he deployed his BRS system, but that it failed todeploy properly.  BRS is undertaking aninvestigation of the claim and has responded to the suit.  At this time, the Company cannot state withany degree of certainty what the outcome of these matters will be or the amountor range of potential loss, if any.  TheCompany believes that it has strong defenses to the suit and will vigorouslydefend against the claims.

13

----

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

During the fourth quarter of our fiscal year endedSeptember 30, 2006, there were no matters submitted to a vote of ourstockholders.

**PART II**

**ITEM 5.**                             MARKET FORCOMMON EQUITY AND RELATED STOCKHOLDER MATTERS

**Marketfor Common Stock**

Our common stock is traded on the electronic bulletinboard on the over the counter market and on the pink sheets under the tradingsymbol “BRSI.OB.”  Several internet stocktracking and trading services show the Company’s trading volumes with bid andask prices as far back as 1995.  Based oninformation provided by these internet stock tracking services, the Companybelieves that the asking price and bid price was $1.55 as of September 29,2006.

The following table lists the high and low price forour common stock as quoted, in U.S. dollars, on the internet tracking servicesduring each quarter within the last two fiscal years:
| ** **             | ** ** | **Price Range**           | ** ** |
|------------------------|------------|--------------------------------|------------|
| ** **             | ** ** | **Fiscal Year 2006** | ** ** | **Fiscal Year 2005** | ** ** |
| **Quarter Ended** | ** ** | **High**                       | ** ** | **Low** | ** ** | **High** | ** ** | **Low** | ** ** |
| **December  31**       | ** ** | **$**                          | **2.28**   | ** ** | **$** | **1.50** | ** ** | **$** | **3.70** | ** ** | **$** | **2.05** | ** ** |
| **March  31**          | ** ** | **1.90**                       | ** ** | **1.40** | ** ** | **4.90** | ** ** | **2.95** | ** ** |
| **June 30**            | ** ** | **2.40**                       | ** ** | **1.39** | ** ** | **4.34** | ** ** | **2.51** | ** ** |
| **September 30**       | ** ** | **2.45**                       | ** ** | **1.45** | ** ** | **3.00** | ** ** | **2.15** | ** ** |
|                        |            |                                |            |  |  |  |  |  |  |  |  |  |  |

 

The quotations from the internet tracking servicesreflect inter-dealer prices, without retail mark-up, mark-down or commission,and may not represent actual transactions.

**RecordHolders**

The number of holders of record of our common stock asof November 30, 2006 was approximately 372.

**Dividends**

During fiscal year 2005, the Company declared adividend in the amount of $0.08 per share, payable November 22, 2004 to allCommon Shareholders of Record on November 8, 2004 for an aggregate of $547,543.The Company also declared a dividend in the amount of $0.085 per share, payableApril 15, 2005 to all Common Shareholders of Record on April 1, 2005 for anaggregate of $648,914.  Under the termsof the settlement agreement with Parsons and Aerospace Marketing, the Company wasnot allowed to declare or pay dividends in excess of 10% of net profit for anyone fiscal year.  This restriction waseliminated with the November 15, 2006 payment to Parsons and AerospaceMarketing (See Note 9 to the Consolidated Financial Statements).  Future dividends will be determined at thediscretion of the Board of Directors. The Company does not anticipate any dividends will be paid during thefiscal year ending September 30, 2007.

14

----

**RecentSales of Unregistered Securities**

On June 22, 2006 and June 23, 2006, theCompany accepted subscriptions from five directors and executive officers ofthe Company relating to the issuance of 322,956 shares of common stock andwarrants to acquire 16,401 shares of common stock for an aggregate purchase priceof $439,220. The warrants have a three-year term and an exercise price of $2.00per share and have piggy-back registration rights. The Company paid nounderwriting discounts or commissions in connection with these sales.  The Company relied on the exemption fromfederal registration under Section 4(2) of the Securities Act of1933, and/or Rule 506 promulgated thereunder. The Company relied on thisexemption and/or the safe harbor rule thereunder based on the fact that(i) there were only five investors, all of whom, either alone or through apurchaser representative, had knowledge and experience in financial andbusiness matters such that each was capable of evaluating the risks of theinvestment, and (ii) the Company has obtained subscription agreements fromthe investors indicating that they are accredited investors and purchasing forinvestment only.

** **On October 25, 2006, as partof its private placement offering of $3 million in equity securities, theCompany accepted subscriptions relating to the issuance of 975,736 shares ofcommon stock and warrants to purchase an additional 243,934 shares of commonstock.  The warrants have a three-yearterm and an exercise price of $2.00 per share. The Company received gross proceeds from the sale of common stock andwarrants of $1,327,001, less commissions in the aggregate amount of $92,890 andless a retainer and expenses in the aggregate amount of $20,000 paid to aplacement agent assisting in the placement. Additionally, the Company will be required to issue a three-year warrantto purchase 17,075 shares of common stock at an exercise price of $2.00 pershare to the placement agent.  TheCompany has agreed to register the resale of the common stock and the commonstock issuable upon exercise of the warrants. The disclosure about the foregoing agreements and instruments, and therelated private placement does not constitute an offer to sell or asolicitation of an offer to buy any securities of the Company, and is made asrequired under applicable laws for filing annual reports with the United StatesSecurities and Exchange Commission, and as permitted under Rule 135c under theSecurities Act.

For these issuances, the Company relied on theexemption from federal registration under Section 4(2) of the Securities Act of1933, and/or Rule 506 promulgated thereunder. The Company relied on this exemption and/or the safe harbor rulethereunder based on the fact that (i) there were 23 investors, all of whom,either alone or through a purchaser representative, had knowledge andexperience in financial and business matters such that each was capable ofevaluating the risks of the investment, and (ii) the Company has obtainedsubscription agreements from the investors indicating that they are accreditedinvestors and purchasing for investment only.

On November 22, 2006, the Company acceptedsubscriptions in a private placement offering relating to the issuance of864,704 shares of common stock and warrants to purchase an additional 216,176shares of common stock.  The warrantshave a three-year term and an exercise price of $2.00 per share.  The Company received gross proceeds from thesale of common stock and warrants of $1,175,997, less commissions in theaggregate amount of $82,320 paid to a placement agent assisting in the placement.  Additionally, the Company will be required toissue a three-year warrantto purchase 15,132 shares of common stock at an exercise price of $2.00 pershare to the placement agent.  TheCompany has agreed to register the resale of the common stock and the commonstock issuable upon exercise of the warrants. The disclosure about the foregoing agreements and instruments, and therelated private placement does not constitute an offer to sell or asolicitation of an offer to buy any securities of the Company, and is made asrequired under applicable laws for filing annual reports with the United StatesSecurities and Exchange Commission, and as permitted under Rule 135c under theSecurities Act.

15

----

For these issuances, the Company relied on theexemption from federal registration under Section 4(2) of the Securities Act of1933, and/or Rule 506 promulgated thereunder. The Company relied on this exemption and/or the safe harbor rulethereunder based on the fact that (i) there were 26 investors, all of whom, eitheralone or through a purchaser representative, had knowledge and experience infinancial and business matters such that each was capable of evaluating therisks of the investment, and (ii) the Company has obtained subscriptionagreements from the investors indicating that they are accredited investors andpurchasing for investment only.

16

----

**EquityCompensation Plan Information**

The following table summarizes outstanding optionsunder our 2004 Stock Option Plan, as well as outstanding options that we haveissued to certain officers, directors and employees of our company outside ofany plan as of September 30, 2006: 
| **Plan category**                                     | ** ** | **Number of  securities to be  issued upon  exercise of  outstanding options,  warrants and rights  (a)** | ** ** | **Weighted  average  exercise price  of outstanding  options,  warrants and  rights  (b)** | ** ** | **Number of securities  remaining available  for future issuance  (excluding securities  reflected in column  (a))  (c)** | ** ** |
|------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  compensation plans approved by stockholders(1)     |       | 0                                                                                                                                                 |       | N/A                                                                                                       |       | 600,000                                                                                                                                                           |       |
| Equity compensation plans  not approved by stockholders(2) |       | 90,000                                                                                                                                            |       | $                                                                                                         | 1.22       |                                                                                                                                                              | 0          |   |
|                                                            |            |                                                                                                                                                   |            |                                                                                                           |            |                                                                                                                                                                   |            |  |

----

**(1)**          Represents shares ofcommon stock authorized for issuance under the 2004 Stock Option Plan.

**(2)**          Represents stock optionsgranted to employees and directors at then current market prices.

**ITEM 6.**                             MANAGEMENT’SDISCUSSION AND ANALYSIS OR PLAN OF OPERATION.

**Operations**

The following discussion and analysis should be readin conjunction with our selected consolidated financial data and ourconsolidated financial statements and notes appearing elsewhere in this AnnualReport.

**Introduction**

We derive our revenue primarily from contracted salesto aircraft original equipment manufacturers (“OEMs”).  Approximately 16% of our sales are throughagents or representatives throughout the world and approximately 4% of oursales are through direct sales to aircraft owners.  Per unit revenue depends on various factors,including the discounts given to large OEM customers, the commissions ordiscounts given to dealers and the type of product sold.  All individual orders are pre-paid before theorder ships.

Sales

Total sales increased $1,076,185, or 13.3%, from$8,115,544 for the year ended September 30, 2005 to $9,191,729 for the yearended September 30, 2006.  Sales from theCompany’s general aviation products, which consist primarily of sales toCirrus, increased $306,257, or 4.8% from $6,328,436 for the year endedSeptember 30, 2005 to $6,634,693 for the year ended September 30, 2006.   Sales from the Company’s general aviationproducts accounted for 72.2% of total revenue for fiscal year 2006 compared to78.0% of total sales for fiscal year 2005. Sales from the Company’s recreational and LSA products increased $764,666,or 47.0% from $1,627,114 for the year ended September 30, 2005 to $2,391,780for

17

----

the year ended September 30, 2006.   Other revenue decreased by $2,661, or -1.7%from $160,588 for the year ended September 30, 2005 to $157,927 for the yearended September 30, 2006 due to reductions in shipping and packingcharges.  The effect on total revenuecaused by the reduction in shipping and packing charges was more than offset bynew sales activity as well as increases in pricing on direct sales units.

The Company’s general aviation products are standardequipment on the Cirrus SRV, SR20 and SR22 model aircraft.  The Company delivered 706 and 633 units toCirrus in fiscal years 2006 and 2005, respectively.  The Company believes that Cirrus has abacklog of aircraft orders, all of which are required to include the Company’sparachute systems.  The Companyunderstands that Cirrus expects to be able to fill the backlog of firm aircraftorders during the next 12 months.  TheCompany also understands that Cirrus is expected to maintain fiscal year 2006manufacturing volumes for its aircraft throughout fiscal year 2007.  As a result, the Company is forecasting flatgrowth in 2007 in its general aviation revenues.  No assurance can be given that generalaviation revenues will remain as anticipated. Future production volumes for the Cirrus aircraft, and therefore, theCompany’s parachute systems, will be dictated by ultimate market demands forCirrus’ products.  Accordingly, theCompany is, and will likely be, dependent on Cirrus for a material portion ofits revenues for fiscal year 2007.  Anynegative impact on Cirrus’ sales would have a significant negative impact onthe Company’s revenues.

Near the end of fiscal year 2004, the Companyfinalized development of a parachute recovery system for the Cessna 182 modelof aircraft, which is called the BRS-182. The Company received the STC from the FAA in June 2004.   This STC allows the product to be installedon certified Cessna 182 series aircraft. The first customer delivery and installation was completed in July2004.  The Company’s sales and marketingefforts resulted in the sale and delivery of five BRS-182 units during fiscalyear 2006.  The Company continues directsales and marketing for the BRS-182.  Noassurances can be made as to the success of sales efforts or if the productwill sell in sufficient volumes to impact the Company’s financial performance.

The Company also has in production the BRS-172 productfor the Cessna 172 model aircraft certified in July 2002.  The Company’s sales and marketing effortsresulted in the sale and delivery of five BRS-172 units during fiscal year2006.  Although certified, there can beno assurances that the BRS-172 product will sell in volumes that will have amaterial impact on the Company.

The Company’s recreational and LSA aircraft productline sales increased by 47.0% during fiscal year 2006 compared to the priorfiscal year driven mostly by increased sales to Flight Design for the CTaircraft.  LSA and recreational salesaccounted for 26.0% of the Company’s revenues for fiscal year 2006 versus 20.1%of the Company’s revenues for the prior fiscal of 2005.  The LSA and recreational aircraft productsbusiness relies on customer acceptance of the Company’s parachute concept andthe existence of installation designs for light sport and recreationalaircraft.

The Company anticipates being able to expand itsgeneral aviation and recreational product lines to include other certified andnon-certified aircraft as the Company’s recovery systems gain further marketacceptance.  The Company is in ongoingdiscussions with domestic and foreign general aviation and recreationalaircraft companies that have expressed interest in utilizing certain of theCompany’s products.  These companiesproduce both certified and non-certified aircraft.  No assurance can be made as to the future benefits,if any, that the Company will derive from these discussions.

The Company has commenced the establishment of arepack center which will have the capacity to repack the parachutesystems.  Cirrus will be notifying itsowners on a systematic basis of the need to have the parachute systemrepacked.  The Company anticipates thatit will be the exclusive provider of repacking services on Cirrus aircraft.

18

----

Gross Margin

Gross margin as a percentage of revenues was 36.2% forfiscal year 2006 compared to 38.3% for fiscal year 2005.  The largest factor contributing to this 2.1%reduction in gross margin was a price reduction for Cirrus associated withincreased purchase quantities.  TheCompany expects to provide additional pricing reductions to its largercustomers in the future and as a result, the gross margins could beimpacted.  However, the Company has beensuccessful in identifying cost savings and receiving material cost reductionsand will continue to look for further savings and cost reductions on an ongoingbasis.  The Company’s objective is tomaintain or improve overall gross margins in the future.

Selling, General and Administrative

Selling, general and administrative costs as apercentage of sales were 27.9% for fiscal year 2006 as compared to 29.4% forfiscal year 2005.  Administrative costsdecreased in fiscal year 2006 driven by significant reductions in legalexpenses, outside consulting services, and outside labor.  We have focused our advertising and marketingefforts and reduced overall expenditures on advertising space and marketingservices.  Director’s fees decreased by$26,029 during fiscal year 2006.  Legalfees decreased $365,428 in fiscal year 2006 compared to fiscal year 2005primarily due to legal proceedings noted in Item 3.  Delays in the regulatory requirements underthe Sarbanes-Oxley Act have resulted in a decrease in expenditures by $18,833for fiscal year 2006.  Management expectsselling, general and administrative costs as a percentage of sales to remainrelatively stable going forward.

Research and Development

Research and development costs were 5.1%, or $465,415,and 4.4%, or $357,702, of sales for fiscal years 2006 and 2005,respectively.  Management believes thatresearch and development is an integral part of the growth strategy for theCompany, and will continue to play an important role in the Company’s success.  Therefore, increases in research anddevelopment expenditures are planned for the future in the areas of new productdevelopment and in the expansion of currently developed products for additionalapplications.  The Company has budgetedapproximately $900,000 for engineering and 2% of net projected sales, or$215,000, for research and development expenditures for fiscal 2007.

The Company has undertaken research and development onpotential new products and services including enhancements to currentproducts.  Such efforts may result infuture offerings and model upgrades to existing products.  The development efforts are funded throughcurrent operations and it is unclear what impact, if any, these will have onfuture sales or financial performance of the Company.

Payroll and Employee Benefit Expenses

Payroll and employee benefit expenses increased$190,835, or 11.4%, from $1,669,351 for the year ended September 30, 2005 to$1,860,186 for the year ended September 30, 2006.  This increase was primarily due to theaddition of personnel to respond to increased business and new markets.  However, as a percentage of overall sales,the payroll and employee benefit expenses decreased by 0.4%, from 20.6% for theyear ended September 20, 2005 to 20.2% for the year ended September 20,2006.  We expect these average laborcosts to remain stable in the future.

Depreciation

Depreciation increased $47,834, or 47.0%, from$101,790 for the year ended September 30, 2005 to $149,624 for the year endedSeptember 30, 2006, primarily due to addition of capital equipment for theMexico operations.

19

----

Amortization

Amortization of intangibles increased by $9,399, or8.4%, from $112,241 for the year ended September 30, 2005 to $121,640 for theyear ended September 30, 2006.  Thisincrease was the result of a full year of amortization in fiscal year 2006 inconnections with the non-compete agreement entered into with Mr. Thomas, ourformer chief executive officer, in the first quarter of 2005.

Interest Expense

Interest expense increased by $107,619, or 436.9%,from $24,630 for the year ended September 30, 2005 to $132,249 for the yearended September 30, 2006.  This increasewas caused by higher debt balances and higher interest rates than historicallyincurred, primarily because of the settlement agreement associated with theParsons lawsuit.

Net Income (Loss) and Earnings (Loss) per Share

Income (loss) before income taxes as a percentage ofrevenues was 0.5% and (21.7%) for fiscal years 2006 and 2005,respectively.  On a fully diluted basis,after-tax net income (loss) of ($1,119,764) for fiscal year 2005 was ($0.15)per share, as compared to net income of $27,377, which was $0.00, on a fullydiluted basis per share for the 2006 fiscal year.

Liquidity and Capital Resources

As of September 30, 2006, the Company had cash andcash equivalents of $53,722.  The Companyhas a secured line-of-credit for $400,000, with a balance outstanding under theline-of-credit of $302,265, including interest, at September 30, 2006.

On June 22, 2006 and June 23, 2006, theCompany accepted subscriptions from five directors and executive officers ofthe Company relating to the issuance of 322,956 shares of common stock andwarrants to acquire 16,401 shares of common stock for an aggregate purchaseprice of $439,220. The warrants have a three-year term and an exercise price of$2.00 per share and have piggy-back registration rights. The Company paid nounderwriting discounts or commissions in connection with these sales.

During the third quarter of 2006, 15,000 stock optionswere exercised resulting in net proceeds to the Company of $15,750.  During the second quarter of 2006, 30,000stock options were exercised resulting in net proceeds to the Company of$27,189.  In addition, the Companyretired 8,771 shares in the second quarter of 2006, and the proceeds were usedby the individual to exercise an additional 15,000 stock options.

On October 25, 2006, theCompany accepted subscriptions relating to the issuance of 975,736 shares ofcommon stock and warrants to purchase an additional 243,934 shares of commonstock.  The warrants have a three-yearterm and an exercise price of $2.00 per share. The Company received gross proceeds from the sale of common stock andwarrants of $1,327,001, less commissions in the aggregate amount of $92,890 andless a retainer and expenses in the aggregate amount of $20,000 paid to aplacement agent assisting in the placement. Additionally, the Company will be required to issue a three-year warrantto purchase 17,075 shares of common stock at an exercise price of $2.00 pershare to the placement agent.  TheCompany has agreed to register the resale of the common stock and the commonstock issuable upon exercise of the warrants. The disclosure about the foregoing agreements and instruments, and therelated private placement does not constitute an offer to sell or asolicitation of an offer to buy any securities of the Company, and is made asrequired under applicable laws for filing 

20

----

annual reports with the United States Securities andExchange Commission, and as permitted under Rule 135c under the Securities Act.

On November 22, 2006, the Company acceptedsubscriptions relating to the issuance of 864,704 shares of common stock andwarrants to purchase an additional 216,176 shares of common stock.  The warrants have a three-year term and anexercise price of $2.00 per share.  TheCompany received gross proceeds from the sale of common stock and warrants of$1,175,997, less commissions in the aggregate amount of $82,320 paid to aplacement agent assisting in the placement. Additionally, the Company will be required to issue a three-year warrant to purchase 15,132shares of common stock at an exercise price of $2.00 per share to the placementagent.  The Company has agreed toregister the resale of the common stock and the common stock issuable uponexercise of the warrants.  The disclosureabout the foregoing agreements and instruments, and the related privateplacement does not constitute an offer to sell or a solicitation of an offer tobuy any securities of the Company, and is made as required under applicablelaws for filing annual reports with the United States Securities and ExchangeCommission, and as permitted under Rule 135c under the Securities Act.

On November 15, 2006, the Company paid the unpaidprincipal and interest outstanding of $721,143 on the first note payable toParsons and Aerospace Marketing and paid $5,000 towards unpaid principal on thesecond note payable to Parsons and Aerospace Marketing, leaving a principalbalance payable of $315,000.

The Company anticipates a need to make continuingcapital improvements of approximately $138,000 during the fiscal year endingSeptember 30, 2007 to its current production facilities in both the US andMexico and continued equipment and tooling upgrades.

The Company expects to decrease inventory during the2007 fiscal year and beyond as a result of moving more production into Mexicoand improvements in inventory management. Inventory increased by approximately $997,000 in fiscal year 2006, due primarilyto the addition of the Mexican facility and increasing the supply on hand ofcertain key components.  It is theintention of the Company to fund expenditures through current operations aswell as revenues generated by sales.

The Company does not presently have product liabilityinsurance on any products other than the Cirrus products and must fund theexpenses of its pending lawsuits. Furthermore, a significant judgment against the Company in its existinglitigation could have a material impact on the Company.  The Company has incurred approximately$258,000 in legal fees for fiscal year 2006 attributable to all legal supportmatters and the defense of its pending lawsuits.

In addition, requirements under the Sarbanes-Oxley Actwill require increased expenditures as the Company implements expandedcompliance infrastructure and oversight.

The Company believes that existing line of credit andcash generated from operations and the proceeds received in October andNovember 2006 from the sale of common stock and warrants will supply sufficientcash flow to meet short-term and long-term debt obligations, working capital,capital expenditure and operating requirements during the next 12 monthsincluding the recent payment on November 15, 2006 related to the first notepayable to Parsons and Aerospace Marketing.

The Private Securities Litigation Reform Act of 1995provides a “safe harbor” for forward-looking statements.  Certain information included in this Form10-KSB and other materials filed or to be filed by the Company with theSecurities and Exchange Commission (as well as information included in oralstatements or other written statements made or to be made by the Company)contain statements that are forward-looking, such as statements relating toanticipated Cirrus Design delivery orders and

21

----

schedules, the repack business, plans for researchprojects, development, anticipated delivery orders and schedules for the Cessna182 system,  the Cessna 172 system,  success of contracts for NASA SBIR researchprojects, the timing and impact of regulations on Light Sport Aircraft sales,other business development activities as well as other capital spending,financial sources, and the effects of competition.  Such forward-looking information involvesimportant risks and uncertainties that could significantly affect anticipatedresults in the future and, accordingly, such results may differ fromthose expressed in any forward-looking statements made by or on behalf ofthe Company.  These risks anduncertainties include, but are not limited to, dependence on Cirrus, potentialproduct liability claims and payment if such claims are successful, federaltransportation rules and regulation which may negatively impact the Company’sability to ship its products in a cost efficient manner, the elimination of fundingfor new research and development projects, the decline in registered andunregistered aircraft sales, dependence on discretionary consumer spending,dependence on existing management, general economic conditions, and changes infederal or state laws or regulations.

**CriticalAccounting Policies and Estimates**

Our Management Discussion and Analysis or Plan ofOperation is based upon our consolidated financial statements, which have beenprepared in accordance with generally accepted accounting principles in theUnited States of America.  Thepreparation of these consolidated financial statements requires us to makeestimates and assumptions that affect the reported amounts of assets andliabilities at the date of the consolidated financial statements, the reportedamounts of revenues and expenses during the reporting period, and relateddisclosures of contingent assets and liabilities for the periods indicated.  The notes to the consolidated financialstatements contained herein describe our significant accounting policies usedin the preparation of the consolidated financial statements.  On an on-going basis, we evaluate ourestimates, including, but not limited to, those related to our allowance fordoubtful accounts, inventory valuation allowance, the lives and continuedusefulness of furniture, fixtures and leasehold improvements and contingencies.  Due to uncertainties, however, it is at leastreasonably possible that management’s estimates will change during the nextyear, which cannot be estimated.  We baseour estimates on historical experience and on various other assumptions that webelieve to be reasonable under the circumstances, the results of which form thebasis for making judgments about the carrying values of assets and liabilitiesthat are not readily apparent from other sources.  Actual results could differ from theseestimates under different assumptions or conditions.

**Disclosuresabout Contractual Obligations and Commercial Commitments**

The following summarizes our contractual obligationsat September 30, 2006, and the effects of these contractual obligations areexpected to have on our liquidity and cash flows in future periods:

|                            | ** ** | ** ** | ** ** | **1 Year**  | ** ** | **1-3**   | ** ** | **Over**         | ** ** |
|----------------------------|------------|------------|------------|------------------|------------|-----------|------------|------------------|------------|
| ** **                 | ** ** | **Total**  | ** ** | **or Less** | ** ** | **Years** | ** ** | **3 Years** | ** ** |
| Operating Leases           |       | $          | 207,307    |             | $          | 162,036   |       | $                | 45,271     |   | — |   |
| Long-Term Debt             |       | $          | 1,049,091  |             | $          | 160,446   |       | $                | 568,645    |   | $ | 320,000 |   |
| Line of Credit  Borrowings |       | $          | 302,265    |             | $          | 302,265   |       | —           |       | — |   |
| Total                      |       | $          | 1,558,663  |             | $          | 624,747   |       | $                | 613,916    |   | $ | 320,000 |   |

 

22

----

The following summarizes our contractual obligationsupdated for the effects of the November 15, 2006 payment on the notes payableto Parsons and Aerospace Marketing, and the effects of these contractualobligations are expected to have on our liquidity and cash flows in futureperiods:

|                            | ** ** | ** ** | ** ** | **1 Year**  | ** ** | **1-3**   | ** ** | **Over**         | ** ** |
|----------------------------|------------|------------|------------|------------------|------------|-----------|------------|------------------|------------|
| ** **                 | ** ** | **Total**  | ** ** | **or Less** | ** ** | **Years** | ** ** | **3 Years** | ** ** |
| Operating Leases           |       | $          | 207,307    |             | $          | 162,036   |       | $                | 45,271     |   | $ | — |   |
| Long-Term Debt             |       | $          | 315,000    |             | $          | —    |       | $                | —     |   | $ | 315,000 |   |
| Line of Credit  Borrowings |       | $          | 302,265    |             | $          | 302,265   |       | $                | —     |   | $ | — |   |
| Total                      |       | $          | 824,572    |             | $          | 464,301   |       | $                | 45,271     |   | $ | 315,000 |   |

 

**ITEM 7.**                             CONSOLIDATEDFINANCIAL STATEMENTS

For a list of the consolidated financial statementsand related footnotes filed as part of this report, see the Index toConsolidated Financial Statements beginning at Page F-1 of this Annual Reporton Form 10-KSB.

**ITEM 8.**                             CHANGES INAND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

There have been no disagreements with the Company’sindependent certified public accountants on accounting principles or practicesor financial statement disclosures.

**ITEM 8A.**                    CONTROLS ANDPROCEDURES

Under the supervision and with the participation ofour Principal Executive Officer, Larry E. Williams, and our PrincipalAccounting Officer, Don R. Hedquist, we have evaluated the effectiveness of ourdisclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)of the Securities and Exchange Act of 1934, as amended) as of September 30,2006.  Based upon that review, our ChiefExecutive Officer and Principal Accounting Officer concluded that, as of theevaluation date, our controls and procedures are effective.

During the fourth quarter of fiscal year 2006, therewere no changes in our internal control over financial reporting that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

**ITEM 8B.       OTHER INFORMATION**

The Company previously disclosed on its Form 8K’sfiled October 31, 2006 and November 29, 2006 that the warrants issued toinvestors in its recent private placements had five-year terms  The term of such warrants is in fact threeyears.

**PART III**

**ITEM 9.**                             DIRECTORS,EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THEEXCHANGE ACT

The information required by this item is incorporatedby reference from the Proxy Statement.

23

----

**ITEM 10.**                           EXECUTIVE COMPENSATION

The information required by this item is incorporatedby reference from the Proxy Statement.

**ITEM 11.**                           SECURITY OWNERSHIP OFCERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this item is incorporatedby reference from the Proxy Statement.

**ITEM 12.**                           CERTAIN RELATIONSHIPS ANDRELATED TRANSACTIONS

The information required by this item is incorporatedby reference from the Proxy Statement.

**ITEM 13.**                           EXHIBITS

Exhibits

The following documents are included or referenced inthis report.
| Exhibit Number | ** ** | **Description**                                                                                                                                                                                                                                                                                   | ** ** |
|---------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| 3.1                 |       | Company’s  Articles of Incorporation, as amended, appear as Exhibit 3.1 to the Company’s  Registration Statement on Form S-1 (No. 33-21843) filed May 12, 1988 (“Form  S-1”) and are incorporated herein by reference.                                                        |       |
| 3.2                 |       | Company’s  Restated Bylaws as amended, were filed as Exhibit 3.2, under Form 8,  Amendment No. 1 (“1990 Amendment”) to the Company’s Report on Form 10-K for  the fiscal year ended September 30, 1990 (the “1990 10-K”) and are  incorporated herein by reference. |       |
| 4.1                 |       | Form  of Director Stock Option Agreement (filed as exhibit 4.1 to the Company’s  Registration Statement Form S-8 filed o February 23, 2005 and incorporated  herein by reference).                                                                                                           |       |
| 4.2                 |       | Schedule  of Director Stock Options pertaining to Exhibit 4.1 (filed as exhibit 4.2 to  the Company’s Registration Statement Form S-8 filed on February 23, 2005 and  incorporated herein by reference).                                                                                     |       |
| 4.3                 |       | Form  of Subscription Agreement entered into with certain investors dated as of  October 25, 2006 and November 22, 2006                                                                                                                                                                           |       |
| 4.4                 |       | Form  of Warrant issued to certain investors                                                                                                                                                                                                                                                      |       |
| 4.5                 |       | Form  of Agent Warrant issued to placement agent                                                                                                                                                                                                                                                  |       |
| 10.1                |       | Purchase  and Supply Agreement dated September 17, 1999 between the Company and Cirrus  Design Corporation appears as exhibit 10.1 to the Company’s Report on Form  8-K filed September 20, 1999 and is incorporated herein by reference.                                                    |       |
| 10.2                |       | Amendment  to Purchase and Supply Agreement dated February 6, 2006 between the Company  and Cirrus Design Corporation appears as Exhibit 10.1 to the Company’s  Quarterly Report for the quarter ended March 31, 2006 filed on May 22, 2006,  and is incorporated herein by reference.       |       |

 

24

----

 
| 10.3  |   | Covenant  not to Compete Agreement dated October 26, 1995 between the Company and the  President and majority shareholder of Second Chantz Aerial Survival  Equipment, Inc. appears as Exhibit 10.2 to the Company’s Report on Form  10-KSB for the fiscal year ended September 30, 1995 and is incorporated  herein by reference. |   |
|-------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| 10.4  |   | Stipulation  and Confession of Judgment among the Company, Charles F. Parsons, and  Aerospace Marketing, Inc. dated September 19, 2005 (filed as  Exhibit 10.1 to the Company’s Current Report on Form 8-K filed September 23,  2005 and incorporated herein by reference).                                              |   |
| 10.5  |   | Security  Agreement dated September 19, 2005 granted by the Company in favor of  Charles F. Parsons and Aerospace Marketing, Inc. (filed as Exhibit 10.2  to the Company’s Current Report on Form 8-K filed September 23, 2005 and  incorporated herein by reference).                                                   |   |
| 10.6  |   | Resignation,  Consulting, Non-Competition and General Release Agreement dated October 14,  2004 with Mark B. Thomas (filed as exhibit 10.1 to the Company’s  Quarterly Report on Form 10-QSB for the quarter ended December 31, 2004 and  incorporated herein by reference).                                             |   |
| 10.7  |   | Interim  Services Agreement with Robert L. Nelson dated November 17, 2004 (filed as  exhibit 10.2 to the Company’s Quarterly Report on Form 10-QSB for the quarter  ended December 31, 2004 and incorporated herein by reference).                                                                                                 |   |
| 10.8  |   | Consulting  Agreement with Thomas H. Adams, Jr. dated November 17, 2004 (filed as Exhibit  10.3 to the Company’s Quarterly Report on Form 10-QSB for the quarter ended  December 31, 2004 and incorporated herein by reference).                                                                                                   |   |
| 10.9  |   | Consulting  Agreement with Boris Popov dated November 17, 2004 (filed as Exhibit 10.4 to  the Company’s Quarterly Report on Form 10-QSB for the quarter ended December  31, 2004 and incorporated herein by reference).                                                                                                            |   |
| 10.10 |   | Employment  Agreement between the Company and Larry E. Williams dated May 6, 2005 appears  as Exhibit 10.10 to the Company’s Report on Form 8-K filed May 16, 2005 and  is incorporated herein by reference.                                                                                                                       |   |
| 14.1  |   | Code  of Ethics for Senior Financial Executives (filed as Exhibit B with 2004 Proxy  Statement filed January 23, 2004)                                                                                                                                                                                                                  |   |
| 21.1  |   | List  of Subsidiaries                                                                                                                                                                                                                                                                                                                   |   |
| 23.1  |   | Consent  of Virchow, Krause & Company, LLP                                                                                                                                                                                                                                                                                          |   |
| 31.1  |   | Rule  13a-14(a)/15d-14(a) Certifications.                                                                                                                                                                                                                                                                                               |   |
| 31.2  |   | Rule  13a-14(a)/15d-14(a) Certifications.                                                                                                                                                                                                                                                                                               |   |
| 32.1  |   | Section  1350 Certifications.                                                                                                                                                                                                                                                                                                           |   |
| 32.2  |   | Section 1350  Certifications.                                                                                                                                                                                                                                                                                                           |   |

 

**ITEM 14.**                      PRINCIPALACCOUNTANT FEES AND SERVICES

Audit Fees

The aggregate fees billed or expected to be billed bythe Company’s auditors for professional services rendered in connection withthe audit of the Company’s annual consolidated financial statements 

25

----

for fiscal year 2006 and2005, reviews of the consolidated financial statements included in the Company’sForm 10-KSB and Form 10-QSB, responses to SEC comment letter and amended 10-KSBand 10-QSB filings for fiscal year 2006 and 2005 were $66,375 and $78,325,respectively.

Audit-Related Fees

For fiscal 2006 and 2005, the Company’s auditors didnot bill any fees for assurances and related services that are reasonablyrelated to the performance of the audit or review of the Company’s consolidatedfinancial statements and are not reported under “Audit Fees” above.

Tax Fees

The aggregate fees billed by the Company’s auditorsfor professional services for tax compliance, tax advice, and tax planning were$9,115 and $7,730 for fiscal year 2006 and 2005, respectively.

All Other Fees

For fiscal 2006 and 2005 the Company’s auditors didnot bill any fees for any other non-audit services rendered to the Company,such as attending meetings and other miscellaneous financial consulting.

Audit Committee

The policy of the Company’s audit committee is toreview and pre-approve both audit and non-audit services to be provided by theindependent auditors (other than de minimis exceptions permitted by theSarbanes Oxley Act of 2002).  This dutymay be delegated to one or more designated members of the audit committee withany such approval reported to the committee at its next regularly scheduledmeeting.  Approval of non-audit servicesshall be disclosed to investors in periodic reports required by section 13(a)of the Securities and Exchange Act of 1934. 100% of fees paid to the Company’s auditors were pre-approved by theaudit committee.

26

----

**SIGNATURES**

In accordance with Section 13 or 15(d) of theSecurities Exchange Act, Ballistic Recovery Systems, Inc. has duly caused thisreport to be signed on its behalf by the undersigned, thereunto dulyauthorized, on December 22, 2006.
|        | Ballistic Recovery Systems, Inc. |
|--------|----------------------------------|
|   |                             |   |
|   | By:                              | /s/ Larry E. Williams |
|   |                             | Larry E. Williams |
|   |                             | Principal Executive Officer, |
|   |                             | Chief Executive Officer, President and Chief   Operating Officer |
|   |                             |   |
|   | By:                              | /s/ Don R. Hedquist |
|   |                             | Don R. Hedquist |
|   |                             | Principal Accounting Officer |

 

27

----

**Indexto Consolidated Financial Statements**
| ** **                                                                                             | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|
| Report  of Independent Registered Public Accounting Firm Virchow, Krause &  Company, LLP           |       |
| Consolidated  Balance Sheets as of September 30, 2006 and 2005                                         |       |
| Consolidated  Statements of Operations for the Years Ended September 30, 2006 and 2005                 |       |
| Consolidated  Statements of Shareholders’ Equity for the Years Ended September 30, 2006 and  2005 |       |
| Consolidated Statements of Cash Flows for the Years  Ended September 30, 2006 and 2005                 |       |
| Notes to Consolidated Financial Statements                                                             |       |

 

F-28

----

**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

 

Shareholders, Audit Committee and Board of Directors

BallisticRecovery Systems, Inc. and Subsidiary

South St. Paul, Minnesota

We haveaudited the accompanying consolidated balance sheets of Ballistic RecoverySystems, Inc. and Subsidiary as of September 30, 2006 and 2005 and the relatedconsolidated statements of operations, shareholders’ equity and cash flows forthe years then ended. These consolidated statements are the responsibility ofthe Company’s management.  Ourresponsibility is to express an opinion on these consolidated financialstatements based on our audits.

We conducted our audits in accordance with standards of thePublic Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the consolidated financial statements are free of materialmisstatement.  An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe consolidated financial statements. An audit also includes assessing the accounting principles used andsignificant estimates made by management as well as evaluating the overallconsolidated financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the consolidatedfinancial position of Ballistic Recovery Systems, Inc. and Subsidiary as ofSeptember 30, 2006 and 2005 and the results of their operations and their cashflows for the years then ended in conformity with accounting principlesgenerally accepted in the United States of America.

/s/ Virchow, Krause &Company, LLP

 

 

Minneapolis, Minnesota

December 14, 2006

F-29

----

**Ballistic Recovery Systems, Inc. and Subsidiary**

**ConsolidatedBalance Sheets**

**September30, 2006 and 2005**

** **
| ** **                                                                                               | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-----------|------------|-----------|------------|
| Assets                                                                                                   |       |      |       |      |       |
| Current assets:                                                                                          |       |      |       |      |       |
| Cash and cash  equivalents                                                                               |       | $         | 53,722     |      | $          | 103,102 |   |
| Accounts  receivable — net of allowance for doubtful accounts of $22,924 and $10,000,  respectively |       | 541,642   |       | 457,808   |       |
| Note receivable  — shareholder                                                                      |       | —    |       | 4,036     |       |
| Inventories                                                                                              |       | 2,458,003 |       | 1,460,919 |       |
| Deferred tax  asset — current portion                                                               |       | 160,700   |       | 160,700   |       |
| Income taxes  receivable                                                                                 |       | —    |       | 230,544   |       |
| Prepaid expenses                                                                                         |       | 144,509   |       | 61,517    |       |
| Total current  assets                                                                                    |       | 3,358,576 |       | 2,478,626 |       |
|                                                                                                     |       |      |       |      |       |
| Furniture,  fixtures and leasehold improvements                                                          |       | 1,092,085 |       | 942,475   |       |
| Less accumulated  depreciation and amortization                                                          |       | (506,831  | )          | (357,207  | )          |
| Furniture,  fixtures and leasehold improvements — net                                               |       | 585,254   |       | 585,268   |       |
|                                                                                                     |       |      |       |      |       |
| Other assets:                                                                                            |       |      |       |      |       |
| Patents, net of  accumulated amortization of $11,425 and $10,739, respectively                           |       | 989       |       | 925       |       |
| Goodwill                                                                                                 |       | 103,774   |       | 103,774   |       |
| Deferred tax  asset — net of current portion                                                        |       | 1,221,516 |       | 1,296,700 |       |
| Long-term  prepaid expenses                                                                              |       | 109,925   |       | 28,269    |       |
| Covenants not to  compete, net of accumulated amortization of $569,789 and $448,149,  respectively       |       | 35,222    |       | 156,862   |       |
| Total other  assets                                                                                      |       | 1,471,426 |       | 1,586,530 |       |
|                                                                                                     |       |      |       |      |       |
| Total assets                                                                                             |       | $         | 5,415,256  |      | $          | 4,650,424 |   |

 

See notes toconsolidated financial statements.

F-30

----

**Ballistic Recovery Systems, Inc. and Subsidiary**

**ConsolidatedBalance Sheets**

**September30, 2006 and 2005**

 
| ** **                                                                                                                                                       | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| Liabilities And Shareholders’ Equity                                                                                                                        |       |       |       |       |       |
| Current liabilities:                                                                                                                                             |       |       |       |       |       |
| Line of credit —  bank                                                                                                                                      |       | $          | 302,265    |       | $          | 204,715 |   |
| Current portion  of long-term debt                                                                                                                               |       | —     |       | 153,951    |       |
| Current portion  of covenants not to compete, shareholder                                                                                                        |       | 7,069      |       | 87,672     |       |
| Accounts payable                                                                                                                                                 |       | 692,550    |       | 305,297    |       |
| Customer  deposits                                                                                                                                               |       | 42,916     |       | 125,255    |       |
| Accrued payroll                                                                                                                                                  |       | 73,613     |       | 88,561     |       |
| Other accrued  liabilities                                                                                                                                       |       | 244,930    |       | 183,870    |       |
|                                                                                                                                                             |       |       |       |       |       |
| Total current  liabilities                                                                                                                                       |       | 1,363,343  |       | 1,149,321  |       |
|                                                                                                                                                             |       |       |       |       |       |
| Long-term debt,  less current portion                                                                                                                            |       | 320,000    |       | 1,046,049  |       |
| Long-term debt  refinanced through equity offering in October and November 2006                                                                                  |       | 729,091    |       | —     |       |
| Covenants not to  compete, shareholder, less current portion                                                                                                     |       | —     |       | 7,068      |       |
|                                                                                                                                                             |       |       |       |       |       |
| Total  liabilities                                                                                                                                               |       | 2,412,434  |       | 2,202,438  |       |
|                                                                                                                                                             |       |       |       |       |       |
| Shareholders’  equity:                                                                                                                                      |       |       |       |       |       |
| Undesignated  shares $(.01 par value; 10,000,000 and 15,000,000 shares authorized,  respectively; none issued and outstanding)                                   |       | —     |       | —     |       |
| Common stock $(.01  par value; 15,000,000 and 10,000,000 shares authorized, respectively;  8,089,619 and 7,685,434 shares, respectively, issued and outstanding) |       | 80,896     |       | 76,854     |       |
| Additional  paid-in capital                                                                                                                                      |       | 6,306,007  |       | 5,782,590  |       |
| Accumulated  deficit                                                                                                                                             |       | (3,384,081 | )          | (3,411,458 | )          |
| Total  shareholders’ equity                                                                                                                                 |       | 3,002,822  |       | 2,447,986  |       |
|                                                                                                                                                             |       |       |       |       |       |
| Total liabilities and  shareholders’ equity                                                                                                                 |       | $          | 5,415,256  |       | $          | 4,650,424 |   |

 

See notes toconsolidated financial statements.

F-31

----

**Ballistic Recovery Systems, Inc.****and Subsidiary**

**ConsolidatedStatements of Operations**

**For theYears Ended September 30, 2006 and 2005**

** **
| ** **                                                    | ** ** | **2006**  | ** ** | **2005**   | ** ** |
|---------------------------------------------------------------|------------|-----------|------------|------------|------------|
| Sales                                                         |       | $         | 9,191,729  |       | $          | 8,115,544 |   |
| Cost of sales                                                 |       | 5,860,516 |       | 5,003,519  |       |
|                                                          |       |      |       |       |       |
| Gross profit                                                  |       | 3,331,213 |       | 3,112,025  |       |
|                                                          |       |      |       |       |       |
| Selling, general  and administrative                          |       | 2,566,624 |       | 2,383,261  |       |
| Research and  development                                     |       | 465,415   |       | 357,702    |       |
| Legal  settlements                                            |       | —    |       | 2,010,000  |       |
| Intangible  amortization                                      |       | 121,640   |       | 112,241    |       |
|                                                          |       |      |       |       |       |
| Income (loss)  from operations                                |       | 177,534   |       | (1,751,179 | )          |
|                                                          |       |      |       |       |       |
| Other income  (expense):                                      |       |      |       |       |       |
| Interest expense                                              |       | (132,249  | )          | (24,630    | )          |
| Other income                                                  |       | 292       |       | 13,045     |       |
|                                                          |       |      |       |       |       |
| Income (loss)  before income taxes                            |       | 45,577    |       | (1,762,764 | )          |
|                                                          |       |      |       |       |       |
| Income taxes  expense (benefit)                               |       | 18,200    |       | (643,000   | )          |
|                                                          |       |      |       |       |       |
| Net income  (loss)                                            |       | $         | 27,377     |       | $          | (1,119,764 | ) |
|                                                          |       |      |       |       |       |
|                                                          |       |      |       |       |       |
|                                                          |       |      |       |       |       |
| Basic earnings  (loss) per common share                       |       | $         | 0.00       |       | $          | (0.15 | ) |
|                                                          |       |      |       |       |       |
| Weighted average  number of shares outstanding — Basic   |       | 7,810,186 |       | 7,320,328  |       |
|                                                          |       |      |       |       |       |
|                                                          |       |      |       |       |       |
| Diluted earnings  (loss) per common share                     |       | $         | 0.00       |       | $          | (0.15 | ) |
|                                                          |       |      |       |       |       |
| Weighted average  number of shares outstanding — Diluted |       | 7,842,257 |       | 7,320,328  |       |
|                                                          |       |      |       |       |       |
|                                                          |       |      |       |       |       |
|                                                          |       |      |       |       |       |
|                                                          |       |      |       |       |       |
| Dividends per  share                                          |       | $         | 0.00       |       | $          | 0.1634 |   |

 

See notes toconsolidated financial statements.

F-32

----

**Ballistic Recovery Systems, Inc.****and Subsidiary**

**ConsolidatedStatements of Shareholders’ Equity**

**For theYears Ended September 30, 2006 and 2005**

 

 
| ** **                                                                        | ** ** | **Common Stock** | ** ** | **Additional** | ** ** | ** **  | ** ** | **Share-**      | ** ** |
|-----------------------------------------------------------------------------------|------------|-----------------------|------------|----------------|------------|-------------|------------|-----------------|------------|
| ** **                                                                        | ** ** | **Number of**    | ** ** | ** **     | ** ** | **Paid-in** | ** ** | **Accumulated** | ** ** | **holders’** | ** ** |
| ** **                                                                        | ** ** | **Shares**            | ** ** | **Amount**     | ** ** | **Capital** | ** ** | **Deficit**     | ** ** | **Equity** | ** ** |
| Balance  September 30, 2004                                                       |       | 6,844,284             |       | $              | 68,443     |        | $          | 3,838,132       |       | $ | (1,095,237 | ) | $ | 2,811,338 |   |
|                                                                              |       |                  |       |           |       |        |       |            |       |   |   |
| Issuance of  common stock in lieu of cash for general and administrative expense  |       | 31,150                |       | 311            |       | 69,776      |       | —          |       | 70,087 |   |
| Stock warrant  exercise                                                           |       | 650,000               |       | 6,500          |       | 806,000     |       | —          |       | 812,500 |   |
| Income tax  benefit associated with exercise of common stock warrants and options |       | —                |       | —         |       | 830,000     |       | —          |       | 830,000 |   |
| Stock option  exercises for cash                                                  |       | 160,000               |       | 1,600          |       | 169,476     |       | —          |       | 171,076 |   |
| Expenses from  stock based transaction                                            |       | —                |       | —         |       | 69,206      |       | —          |       | 69,206 |   |
| Dividend  declaration                                                             |       | —                |       | —         |       | —      |       | (1,196,457      | )          | (1,196,457 | ) |
| Net income                                                                        |       | —                |       | —         |       | —      |       | (1,119,764      | )          | (1,119,764 | ) |
|                                                                              |       |                  |       |           |       |        |       |            |       |   |   |
| Balance  September 30, 2005                                                       |       | 7,685,434             |       | 76,854         |       | 5,782,590   |       | (3,411,458      | )          | 2,447,986 |   |
|                                                                              |       |                  |       |           |       |        |       |            |       |   |   |
| Issuance of common  stock in lieu of cash for board of directors fees             |       | 30,000                |       | 300            |       | 45,000      |       | —          |       | 45,300 |   |
| Stock option  exercises for cash                                                  |       | 51,229                |       | 512            |       | 42,427      |       | —          |       | 42,939 |   |
| Issuance of  common stock in private placement                                    |       | 322,956               |       | 3,230          |       | 435,990     |       | —          |       | 439,220 |   |
| Net income                                                                        |       | —                |       | —         |       | —      |       | 27,377          |       | 27,377 |   |
|                                                                              |       |                  |       |           |       |        |       |            |       |   |   |
| Balance September 30,  2006                                                       |       | 8,089,619             |       | $              | 80,896     |        | $          | 6,306,007       |       | $ | (3,384,081 | ) | $ | 3,002,822 |   |

 

See notes toconsolidated financial statements.

F-33

----

**Ballistic Recovery Systems, Inc. and Subsidiary**

**Consolidated Statementsof Cash Flow**

**For the Years Ended September 30, 2006 and 2005**
| ** **                                                                       | ** ** | **2006** | ** ** | **2005**   | ** ** |
|----------------------------------------------------------------------------------|------------|----------|------------|------------|------------|
| Cash flows from  operating activity:                                             |       |     |       |       |       |
| Net income (loss)                                                                |       | $        | 27,377     |       | $          | (1,119,764 | ) |
| Adjustments to reconcile  net income (loss) to net cash from operating activity: |       |     |       |       |       |
| Deferred income tax                                                              |       | 75,184   |       | (374,700   | )          |
| Depreciation and  amortization                                                   |       | 150,310  |       | 102,476    |       |
| Amortization of  covenants not to compete                                        |       | 121,640  |       | 112,241    |       |
| Expense from stock  based transaction — employee                            |       | —   |       | 69,206     |       |
| Amortization of stock  issued in lieu of cash                                    |       | 18,120   |       | 70,087     |       |
| Loss on retirement of  furniture and equipment                                   |       | —   |       | 2,435      |       |
| Litigation settlement  financed by long term debt                                |       | —   |       | 1,200,000  |       |
| Change in allowance for  doubtful accounts                                       |       | 12,924   |       | —     |       |
| (Increase) decrease in:                                                          |       |     |       |       |       |
| Accounts  receivable                                                             |       | (96,758  | )          | (55,695    | )          |
| Inventories                                                                      |       | (997,084 | )          | (328,423   | )          |
| Income taxes  receivable                                                         |       | 230,544  |       | (230,544   | )          |
| Prepaid expenses                                                                 |       | (82,992  | )          | (17,492    | )          |
| Long-term  prepaid expenses                                                      |       | 18,188   |       | 24,851     |       |
| Increase (decrease) in:                                                          |       |     |       |       |       |
| Accounts payable                                                                 |       | 387,253  |       | 131,782    |       |
| Customer  deposits                                                               |       | (82,339  | )          | 46,194     |       |
| Accrued payroll  and other accrued liabilities                                   |       | 46,112   |       | (170,655   | )          |
|                                                                             |       |     |       |       |       |
| Net cash from operating  activities                                              |       | (171,521 | )          | (538,001   | )          |
|                                                                             |       |     |       |       |       |
| Cash flows from  investing activities:                                           |       |     |       |       |       |
| Capital  expenditures                                                            |       | (149,610 | )          | (251,328   | )          |
| Payment for  Patent                                                              |       | (750     | )          | —     |       |
| Purchase of  assets of Paranetics Technology, Inc.                               |       | —   |       | (242,336   | )          |
|                                                                             |       |     |       |       |       |
| Net cash from investing  activities                                              |       | (150,360 | )          | (493,664   | )          |
|                                                                             |       |     |       |       |       |
| Cash flows from  financing activities:                                           |       |     |       |       |       |
| Proceeds from  exercise of common stock warrants                                 |       | —   |       | 812,500    |       |
| Proceeds from  exercise of common stock options                                  |       | 42,939   |       | 171,076    |       |
| Proceeds from  issuance of common stock                                          |       | 439,220  |       | —     |       |
| Payments for  long-term prepaid expenses - stock offering costs                  |       | (72,664  | )          | —     |       |
| Net proceeds  from borrowings under line of credit - bank                        |       | 97,550   |       | 204,715    |       |
| Principal  payments on long-term debt                                            |       | (150,909 | )          | —     |       |
| Principal  payments on covenant not to compete                                   |       | (83,635  | )          | (171,624   | )          |
| Dividends paid                                                                   |       | —   |       | (1,196,457 | )          |
|                                                                             |       |     |       |       |       |
| Net cash from financing  activities                                              |       | 272,501  |       | (179,790   | )          |
|                                                                             |       |     |       |       |       |
| Decrease in cash and  cash equivalents                                           |       | (49,380  | )          | (1,211,455 | )          |
| Cash and cash  equivalents - beginning of year                                   |       | 103,102  |       | 1,314,557  |       |
|                                                                             |       |     |       |       |       |
| Cash and cash equivalents - end of year                                          |       | $        | 53,722     |       | $          | 103,102 |   |

 

See notes toconsolidated financial statements.

F-34

----

**Ballistic Recovery Systems, Inc. and Subsidiary**

**Notes to ConsolidatedFinancial Statements**

**September 30,2006 and 2005**

**1.     Nature of Business**

Ballistic RecoverySystems, Inc. (the “Company”) designs, manufactures and distributes rocketdeployed whole-aircraft emergency parachute systems for use on general aviationand recreational aviation aircraft. The emergency parachute systems areintended for use in the event of an in-air emergency and are designed to bringdown the entire aircraft and its occupants under the parachute canopy.  In the general aviation market, the Companyis currently producing and selling emergency recovery systems for fourfour-place general aviation aircraft, known as the Cirrus Design SR20 (SR20)and SR22, and the Cessna 172 and 182. The products for Cirrus Design Corporation (Cirrus Design) weredeveloped in a joint effort between the Company and Cirrus Design.

In therecreational aviation market, the Company sells products to several hundreddifferent aircraft designs that are categorized as ultralights and experimentalaircraft.

The Company’sproducts are sold both domestically and internationally.

**2.     Summary of Significant Accounting Policies**

***Principlesof Consolidation***

In September 2005,the Company formed its wholly-owned subsidiary, BRS de Mexico S.A. de C.V.  The consolidated financial statements includethe wholly-owned subsidiary.  Allsignificant intercompany transactions and balances have been eliminated inconsolidation.

***ForeignCurrency Translations and Transactions***

The Companyaccounts for its foreign asset and liability transactions in U.S. dollars.  Therefore, there is not any materialaccumulated other comprehensive income or loss. Results of operations are translated using the average exchange ratesthroughout the year.  Transaction gainsor losses are recorded as incurred.

***AccountingPrinciples***

The consolidatedfinancial statements and accompanying notes are prepared in accordance withaccounting principles generally accepted in the United States of America.

***Use of Estimates***

The preparation ofconsolidated financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect certain reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe consolidated financial statements and the reported amounts of expensesduring the reporting period. Actual results could differ from those estimates.

***CashConcentrations***

Bank balances exceededfederally insured levels during 2006 and 2005 and exceeded federally insuredlevels as of September 30, 2006. Generally, these balances may be redeemed upon demand and therefore bearminimal risk.

F-35

----

***Cashand Cash Equivalents***

Short-term investmentswith an original maturity of three months or less are considered to be cashequivalents and are stated at their fair value.

***AccountsReceivable, credit risk and allowance for doubtful accounts***

The Company sells itsproducts to domestic and foreign companies. The Company reviews customers’ credit history before extending unsecuredcredit and established an allowance for doubtful accounts based upon factorssurrounding the credit risk of specific customers and other information.  The Company does not accrue interest on pastdue accounts receivable.  Unless specificarrangements have been made, accounts receivable over 30 days are consideredpast due. The Company writes off accounts receivable when they are deemeduncollectible.  Accounts receivable areshown net of an allowance for doubtful accounts of $22,924 and $10,000 atSeptember 30, 2006 and 2005, respectively. The Company’s contract research and development projects are billed toits customers on an uncollateralized credit basis.  The estimated loss that management believesis probable is included in the allowance for doubtful accounts.  Due to uncertainties in the collectionprocess, however, it is at least reasonably possible that management’s estimatewill change during the next year, which cannot be estimated.

***CustomerConcentration***

The Company had sales toone major customer, Cirrus Design, which represented 70.7% of the Company’stotal sales for fiscal year 2006 and 74.0% of the Company’s total sales forfiscal year 2005.  This customer alsoaccounted for 63% (or $339,000) and 90% (or $413,000) of accounts receivable atSeptember 30, 2006 and 2005, respectively. The Company supplies parachute systems to Cirrus Design from the Company’sgeneral aviation product line.

In its recreationalaviation product line, the Company primarily distributes its products throughdealers and distributors who in turn sell the products to the endconsumer.  The Company believes that inthe event that any individual dealers or distributors cease to represent theCompany’s products, alternative dealers or distributors can be established.

***Valuationof Inventories***

The Company’s inventoriesare stated at the lower of cost or market. Cost is determined by the first-in, first-out (“FIFO”) method.

Provisions to reduceinventories to the lower of cost or market are made based on a review of excessand obsolete inventories through an examination of historical component consumption,current market demands and shifting production methods.  Significant assumptions, with respect tomarket trends and customer product acceptance are utilized to formulate theprovision methods.  Sudden or continuingdownward changes in the Company’s product markets may cause the Company torecord additional inventory revaluation charges in future periods.  No write-off provision was made toinventories for the years ended September 30, 2006 and 2005.

F-36

----

***CustomerDeposits***

The Company requiresorder deposits from most of its domestic and international customers.  These deposits represent either partial orcomplete down payments for orders.  Thesedown payments are recorded as customer deposits.  The deposits are recognized as revenue whenthe product is shipped.

***IncomeTaxes***

Differences betweenaccounting rules and tax laws cause differences between the bases of certainassets and liabilities for financial reporting purposes and tax purposes.  The tax effects of these differences, to theextent they are temporary, are recorded as deferred tax assets and liabilitiesunder Statement of Financial Accounting Standards No. (SFAS) 109.  Temporary differences relate primarily to:stock based compensation; allowances for doubtful accounts; inventory valuationallowances; depreciation; valuation of warrants issued to a customer; netoperating loss; and accrued expenses not currently deductible.

***Furniture,Fixtures and Leasehold Improvements***

Furniture, fixtures andleasehold improvements are stated at cost. Depreciation is computed using thestraight-line method over the estimated useful lives of the related assets,ranging from three to seven years for equipment and ten years for the airplane.When assets are retired or otherwise disposed of, the cost and related accumulateddepreciation are removed from the accounts and the resulting gain or loss isrecognized in income for the period.  Thecost of maintenance and repairs is expensed as incurred; significant renewalsand betterments are capitalized. Deduction is made for retirements resultingfrom renewals or betterments.  Leaseholdimprovements are amortized using the straight-line method over the shorter ofthe lease term, or the estimated useful life of the assets.

***Goodwill***

The Company applies SFASNo. 142*, Goodwill and Other Intangible Assets*relatedto the carrying amount of goodwill and other intangible assets.  Goodwill will be tested for impairmentannually in the fourth quarter or more frequently if changes in circumstancesor the occurrence of events suggest an impairment exists.  The Company has concluded that no impairmentof goodwill or other intangible assets exists as of September 30, 2006.

***Intangibles***

Patents are recorded atcost and are being amortized on a straight-line method over 17 years.  The covenants not to compete are recorded atcost and are being amortized using the straight-line method over the terms ofthe agreement which range from two to fifteen years.  The weighted average life of the covenantsnot to compete is 2.5 years at September 30, 2006.

Components of intangibleassets are as follows:

|                                                   | ** ** | **September 30, 2006** | ** ** | **September 30, 2005** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                        | ** ** | **Gross Carrying**          | ** ** | **Accumulated**                  | ** ** | **Gross Carrying** | ** ** | **Accumulated** | ** ** |
| ** **                                        | ** ** | **Amount**                       | ** ** | **Amortization**                 | ** ** | **Amount** | ** ** | **Amortization** | ** ** |
| Intangible  assets subject to amortization:  |       |                             |       |                             |       |   |   |   |   |
| Patents                                           |       | $                                | 12,414     |                             | $          | 11,425 |   | $ | 11,664 |   | $ | 10,739 |   |
| Covenants not to  compete                         |       | $                                | 605,011    |                             | $          | 569,789 |   | $ | 605,011 |   | $ | 448,149 |   |

 

F-37

----

Amortization expense of intangible assets was $122,326and $112,927 for the years ended September 30, 2006 and 2005,respectively.  Amortization expense isestimated to approximate $19,241, $8,854, $8,116 and $0 for the years endingSeptember 30, 2007, 2008, 2009, and 2010, respectively.

***Revenue Recognition***

The Company recognizes revenue in accordance withSecurities and Exchange Commission, Staff Accounting Bulletin No. 104, “RevenueRecognition”.  The Company recognizesrevenue on product sales upon shipment to customers.

***Comprehensive Income***

SFAS No. 130 establishes standards for the reportingand disclosure of comprehensive income and its components, which will bepresented in association with a company’s consolidated financialstatements.  Comprehensive income isdefined as the change in a business enterprise’s equity during a period arisingfrom transactions, events or circumstances relating to non-owner sources, suchas foreign currency translation adjustments and unrealized gains or losses onavailable-for-sale securities.  Itincludes all changes in equity during a period except those resulting frominvestments by or distributions to owners. For the years ended September 30, 2006 and 2005, net income (loss) andcomprehensive income (loss) were equivalent.

***Fair Value of FinancialInstruments***

SFAS No. 107, “Disclosures About Fair Value ofFinancial Instruments” requires disclosure of the estimated fair value offinancial instruments as follows:

Short-term Assets andLiabilities:

The fair values of cash and cash equivalents, accountsreceivable, accounts payable, accrued liabilities, and short-term debtapproximate their carrying values due to the short-term nature of thesefinancial instruments.

Long-term Debt andCovenants Not to Compete:

The fair value oflong-term debt and covenants not to compete approximate their carrying valuebecause the terms are equivalent to borrowing rates currently available to theCompany for debt with similar terms and maturities.

***Segment Reporting***

Abusiness segment is a distinguishable component of an enterprise that isengaged in providing an individual product or service or a group of relatedproducts or services and that is subject to risks and returns that aredifferent from those of other business segments. The Company’s segments havesimilar economic characteristics and are similar in the nature of the productssold, type of customers, methods used to distribute the Company’s products andregulatory environment.  Management 

F-38

----

believesthat the Company meets the criteria for aggregating its operating segments intoa single reporting segment.

***Stock-Based Compensation***

SFAS No. 123, *Accounting for Stock-Based Compensation* (“SFAS123”), provides for the use of a fair value based method of accounting foremployee stock compensation.  However,SFAS 123 also allows an entity to continue to measure compensation cost forstock options granted to employees using the intrinsic value method ofaccounting prescribed by Accounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees* (“APB25”) and related interpretations, which only requires charges to compensationexpense for the excess, if any, of the fair value of the underlying stock atthe date a stock option is granted (or at an appropriate subsequent measurementdate) over the amount the employee must pay to acquire the stock*,* if such amounts differ materially fromhistorical amounts.  The Company haselected to continue to account for employee stock options using the intrinsicvalue method under APB 25.  By makingthat election, it is required by SFAS 123 and SFAS 148, “Accounting forStock-Based Compensation — Transition and Disclosure” to provide pro formadisclosures of net income (loss) and earnings (loss) per share as if a fairvalue based method of accounting had been applied.

Had compensation costsbeen determined in accordance with the fair value method prescribed by SFASNo. 123 for all options issued to employees and amortized over the vestingperiod, the Company’s net income (loss) applicable to common shares andearnings (loss) per common share (basic and diluted) for plan options wouldhave been decreased to the pro forma amounts indicated below.  

|                                            | ** ** | **Fiscal Year ended  September 30,** | ** ** |
|--------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                 | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| **Net  Income (loss):**                    |       |                                                |       |   |   |
| As reported                                |       | $                                                   | 27,377     |   | $ | (1,119,764 | ) |
| Pro forma                                  |       | $                                                   | 27,377     |   | $ | (1,119,764 | ) |
|                                       |       |                                                |       |   |   |
| Basic earnings  (loss) per common share:   |       |                                                |       |   |   |
| As reported                                |       | $                                                   | 0.00       |   | $ | (0.15 | ) |
| Pro forma                                  |       | $                                                   | 0.00       |   | $ | (0.15 | ) |
|                                       |       |                                                |       |   |   |
| Diluted earnings  (loss) per common share: |       |                                                |       |   |   |
| As reported                                |       | $                                                   | 0.00       |   | $ | (0.15 | ) |
| Pro forma                                  |       | $                                                   | 0.00       |   | $ | (0.15 | ) |
|                                       |       |                                                |       |   |   |
| Stock based  compensation:                 |       |                                                |       |   |   |
| As reported                                |       | —                                              |       | $ | 69,206 |   |
| Pro forma                                  |       | —                                              |       | — |   |

 

No options were grantedor vested during fiscal years 2006 and 2005.

F-39

----

**Ballistic Recovery Systems, Inc. and SubsidiaryNotes to Consolidated Financial StatementsSeptember 30, 2006 and 2005**

***Earnings (loss) per Common Share***

Basic earnings (loss) per common share is computed bydividing net income (loss) by the weighted average number of common sharesoutstanding during the period.  Dilutedearnings (loss) per common share is computed by dividing net income (loss) bythe weighted average number of common shares outstanding plus all additionalcommon stock that would have been outstanding if potentially dilutive commonstock related to stock options and warrants had been issued.  Weighted average shares outstanding-dilutedincludes 32,071 and 0 shares of dilutive securities for the years endedSeptember 30, 2006 and 2005, respectively. The stock based compensation in fiscal 2005 related to a modification ofstock options and in fiscal 2004 related to non-employee warrants.

Following is a reconciliation of basic and dilutedearnings (loss) per common share for fiscal years ended September 30, 2006and 2005, respectively:

|                                                                   | ** ** | **Fiscal Year ended  September 30,** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                        | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| Earnings (loss) per common share — basic:                    |       |                                                |       |   |   |
|                                                              |       |                                                |       |   |   |
| Net income (loss)                                                 |       | $                                                   | 27,377     |   | $ | (1,119,764 | ) |
|                                                              |       |                                                |       |   |   |
| Weighted average shares  outstanding                              |       | 7,810,186                                           |       | 7,320,328 |   |
|                                                              |       |                                                |       |   |   |
| Earnings (loss) per  common share — basic                    |       | $                                                   | 0.00       |   | $ | (0.15 | ) |
|                                                              |       |                                                |       |   |   |
| Earnings (loss) per common share — diluted:                  |       |                                                |       |   |   |
|                                                              |       |                                                |       |   |   |
| Net income (loss)                                                 |       | $                                                   | 27,377     |   | $ | (1,119,764 | ) |
|                                                              |       |                                                |       |   |   |
| Weighted average shares  outstanding                              |       | 7,810,186                                           |       | 7,320,328 |   |
| Common stock  equivalents                                         |       | 32,071                                              |       | 0 |   |
|                                                              |       |                                                |       |   |   |
| Weighted average shares  and potential diluted shares outstanding |       | 7,842,257                                           |       | 7,320,328 |   |
|                                                              |       |                                                |       |   |   |
| Earnings (loss) per  common share — diluted                  |       | $                                                   | 0.00       |   | $ | (0.15 | ) |

 

The Company uses the treasury method for calculatingthe dilutive effect of the stock options and warrants (using the average marketprice).

Warrants for 16,401 were excluded from the computationof diluted earnings per share for the year ended September 30, 2006 since theireffect was anti-dilutive for the year.

In the year ended September 30, 2005, 150,000 optionswere excluded from the computation of diluted loss per share since their effectwas anti-dilutive with the current year loss.

The Company issued additional common shares afterSeptember 30, 2006 (see Note 14) that will impact the number of shares used tocalculate future earnings per common share.

F-40

----

***Recently Issued AccountingPronouncements***

In November 2004, the Financial Accounting StandardsBoard (FASB) issued SFAS No. 151 “Inventory Costs,” (SFAS No. 151) which amendsthe guidance in ARB No. 43 (ARB 43), Chapter 4 “Inventory Pricing,” to clarifythe accounting for abnormal amounts of idle facility expense, freight, handlingcosts, and wasted material (spoilage).  Paragraph5 of ARB 43, Chapter 4, previously stated that under some circumstances, itemssuch as idle facility expense, excessive spoilage, double freight, andrehandling costs may be so abnormal as to require treatment as current periodcharges.  SFAS No. 151 requires thatthose items be recognized as current-period charges regardless of whether theymeet the criterion of “so abnormal.”  Inaddition, SFAS No. 151 requires that allocation of fixed production overheadsto the costs of conversion be based on the normal capacity of the productionfacilities.  SFAS No. 151 shall beeffective for inventory costs incurred during fiscal years beginning after June15, 2005.  Earlier application ispermitted for inventory costs incurred during fiscal years beginning after thedate SFAS No. 151 was issued.  SFAS No.151 shall be applied prospectively.  Theadoption of SFAS No. 151 was not material to the consolidated financialstatements.

In December 2004, FASB issued SFAS No. 153 “Exchangesof Nonmonetary Assets” (SFAS No. 153) which amends APB Opinion No. 29, “Accountingfor Nonmonetary Transactions.” APB No. 29 is based on the principle thatexchanges of nonmonetary assets should be measured based on the fair value ofthe assets exchanged.  The guidance inthat Opinion, however, included certain exceptions to that principle.  SFAS No. 153 amends APB No. 29 to eliminatethe exception for nonmonetary exchanges of similar productive assets andreplaces it with a general exception for exchanges of nonmonetary assets thatdo not have commercial substance.  Anonmonetary exchange has commercial substance if the future cash flows of theentity are expected to change significantly as a result of the exchange.  SFAS No. 153 will be effective fornonmonetary asset exchanges occurring in fiscal periods beginning after June15, 2005.  Earlier application ispermitted for nonmonetary asset exchanges occurring in fiscal periods beginningafter the date SFAS No. 153 was issued.  SFASNo. 153 shall be applied prospectively.  Theadoption of SFAS No. 153 was not material to the consolidated financialstatements.

In December 2004, FASB issued SFAS No. 123 (revised2004), “Share-Based Payment,” (SFAS No. 123R) that focuses primarily onaccounting for transactions in which an entity obtains employee services inshared-based payment transactions.  Thisstatement replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” andsupersedes APB Opinion No. 25, “Accounting for Stock issued to Employees.”  Beginning October 1, 2006, we will berequired to expense the fair value of employee stock options and similarawards.  As a public company we areallowed to select from two alternative transition methods, each havingdifferent reporting implications.  Theimpact of SFAS No. 123R for unvested stock options outstanding at September 30,2006 on the results of operations for the fiscal year ending September 30, 2007is zero as all options are vested as of September 30, 2006.

In June 2005, FASB issued SFAS No. 154, “AccountingChanges and Error Corrections”, a replacement of APB Opinion No. 20 and FASBStatement No. 3.  The statement appliesto all voluntary changes in accounting principle, and changes the requirementsfor accounting for and reporting of a change in accounting principle.  SFAS No. 154 requires retrospectiveapplication to prior periods’ consolidated financial statements of a voluntarychange in accounting principle unless it is impracticable.  SFAS No. 154 is effective for accountingchanges and corrections of errors made in fiscal years beginning after December15, 2005.  Earlier application ispermitted for accounting changes and corrections of errors made occurring infiscal years beginning after June 1, 2005. The statement does not change the transition provisions of any existingaccounting pronouncements, including those that are in a transition phase as ofthe effective date of this statement.  TheCompany 

F-41

----

does not expect the adoption of SFAS No. 154 to have amaterial effect on its consolidated financial statements.

In June 2006, the FASB has published FASBInterpretation (FIN) No. 48 (FIN No. 48), Accounting for Uncertainty in IncomeTaxes, to address the noncomparability in reporting tax assets and liabilitiesresulting from a lack of specific guidance in FASB SFAS No. 109, Accounting forIncome Taxes, on the uncertainty in income taxes recognized in an enterprise’sfinancial statements. Specifically, FIN No. 48 prescribes (a) a consistentrecognition threshold and (b) a measurement attribute for the financialstatement recognition and measurement of a tax position taken or expected to betaken in a tax return, and provides related guidance on derecognition,classification, interest and penalties, accounting in interim periods,disclosure and transition.  Theprovisions of FIN No. 48 are effective for fiscal years beginning afterDecember 15, 2006.  The Company iscurrently evaluating the impact the adoptions of FIN No. 48 will have on itsconsolidated financial statements.

In September 2006, the FASB has published FASB SFASNo. 157, Fair Value Measurements, to eliminate the diversity in practice thatexists due to the different definitions of fair value and the limited guidancefor applying those definitions in GAAP that are dispersed among the manyaccounting pronouncements that require fair value measurements. SFAS No. 157retains the exchange price notion in earlier definitions of fair value, butclarifies that the exchange price is the price in an orderly transactionbetween market participants to sell an asset or liability in the principal ormost advantageous market for the asset or liability. Moreover, the SFAS statesthat the transaction is hypothetical at the measurement date, considered fromthe perspective of the market participant who holds the asset or liability.Consequently, fair value is defined as the price that would be received to sellan asset or paid to transfer a liability in an orderly transaction betweenmarket participants at the measurement date (an exit price), as opposed to theprice that would be paid to acquire the asset or received to assume theliability at the measurement date (an entry price).  SFAS No. 157 also stipulates that, as amarket-based measurement, fair value measurement should be determined based onthe assumptions that market participants would use in pricing the asset orliability, and establishes a fair value hierarchy that distinguishes between(a) market participant assumptions developed based on market data obtained fromsources independent of the reporting entity (observable inputs) and (b) thereporting entity’s own assumptions about market participant assumptionsdeveloped based on the best information available in the circumstances(unobservable inputs). Finally, SFAS No. 157 expands disclosures about the useof fair value to measure assets and liabilities in interim and annual periodssubsequent to initial recognition. Entities are encouraged to combine the fairvalue information disclosed under SFAS No. 157 with the fair value informationdisclosed under other accounting pronouncements, including SFAS No. 107,Disclosures about Fair Value of Financial Instruments, where practicable. Theguidance in this Statement applies for derivatives and other financialinstruments measured at fair value under SFAS No. 133 , Accounting forDerivative Instruments and Hedging Activities, at initial recognition and inall subsequent periods.  The provisionsof SFAS No. 157 are effective for fiscals years beginning after November 15,2007.  The Company believes the impact ofSFAS No. 157 will not have a material effect of its consolidated financialstatements.

In September 2006, the FASB has published FASB SFASNo. 158, Employers’ Accounting for Defined Benefit Pension and OtherPostretirement Plans, to require an employer to fully recognize the obligationsassociated with single-employer defined benefit pension, retiree healthcare,and other postretirement plans in their financial statements. Previousstandards required an employer to disclose the complete funded status of itsplan only in the notes to the financial statements. Moreover, because thosestandards allowed an employer to delay recognition of certain changes in planassets and obligations that affected the costs of providing benefits, employersreported an asset or liability that 

F-42

----

almost always differed from the plan’s funded status.Under SFAS No. 158, a defined benefit postretirement plan sponsor that is apublic or private company or a nongovernmental not-for-profit organization must(a) recognize in its statement of financial position an asset for a plan’soverfunded status or a liability for the plan’s underfunded status, (b) measurethe plan’s assets and its obligations that determine its funded status as ofthe end of the employer’s fiscal year (with limited exceptions), and (c)recognize, as a component of other comprehensive income, the changes in thefunded status of the plan that arise during the year but are not recognized ascomponents of net periodic benefit cost pursuant to SFAS No. 87, Employers’Accounting for Pensions, or SFAS No. 106, Employers’ Accounting forPostretirement Benefits Other Than Pensions. SFAS No. 158 also requires anemployer to disclose in the notes to financial statements additionalinformation on how delayed recognition of certain changes in the funded statusof a defined benefit postretirement plan affects net periodic benefit cost forthe next fiscal year.  The Companybelieves the impact of SFAS No. 158 will not have a material effect on itsconsolidated financial statements.

In September 2006, the Securities and ExchangeCommission (SEC) issued Staff Accounting Bulletin 108, “Considering theEffects on Prior Year Misstatements when Quantifying Misstatements in CurrentYear Financial Statements,” (“SAB 108”). SAB 108 requires registrantsto quantify errors using both the income statement method (i.e. iron curtainmethod) and the rollover method and requires adjustment if either methodindicates a material error. If a correction in the current year relating toprior year errors is material to the current year, then the prior yearfinancial information needs to be corrected. A correction to the prior yearresults that are not material to those years, would not require a “restatementprocess” where prior financials would be amended. SAB 108 is effective forfiscal years ending after November 15, 2006. The Company does notanticipate that SAB 108 will have a material effect on its consolidatedfinancial statements.

***Research and Development Costs***

Research and development costs are charged to expenseas incurred.

***Advertising Expenses***

Non-direct response advertising expenses arerecognized in the period incurred.  Non-directresponse advertising expenses totaled $18,649 in 2006 and $40,805 in 2005.

***Legal Costs***

The Company expenses its legal costs as incurredexcept settlements which are expensed when a claim is probable and estimatable.

***Shipping and Handling Costs***

The Company records amounts being charged to customersfor shipping and handling as sales and costs incurred in cost of sales.

**3.****                                      CirrusDesign Purchase and Supply Agreement**

The Company currently operates under a Purchase andSupply Agreement with Cirrus, dated as of September 1999 and amended February2006 (the “Cirrus Supply Agreement”).  Underthe Cirrus Supply Agreement, BRS is the non-exclusive supplier of the parachuterecovery system to Cirrus.

F-43

----

The current term of the Cirrus Supply Agreementexpires in July 2007, but the Agreement is subject to rolling automatic renewalterms of 18 months, unless terminated by either party upon 18 months advancenotice.  The recent amendment to theAgreement also provides that Cirrus will maintain product liability insuranceon the parachute system whose components are directly or indirectly supplied byBRS.  Additionally, Cirrus has agreed toindemnify BRS for all related product liability claims involving the BRSparachute system (except for claims for economic losses or damage relatedsolely to the aircraft).  The CirrusSupply Agreement also gives Cirrus limited exclusivity for an increased grossweight (3,600 pound) system for a period of one year after introduction.

**4.****                                      WarrantsIssued to Cirrus Under Purchase and Supply Agreement**

On September 17, 1999, the Company entered into aPurchase and Supply Agreement with Cirrus, the manufacturer of the SR20 andSR22 aircraft that utilize the Company’s parachute system as standardequipment.  Under the Agreement, Cirruswas issued four warrants to acquire an aggregate of up to 1.4 million shares ofunregistered Company common stock.  Inorder to execute the warrants, Cirrus was required to meet certain purchaselevels of the Company’s emergency parachute systems for the SR20, SR22 andderivative aircraft over the subsequent five years.  Cirrus met their minimum purchase commitmentfor the first warrant period, but did not exercise the warrant to purchase250,000 shares of common stock which expired on February 28, 2003. Cirrusmet their minimum purchase commitment for warrant periods two and three, andexercised warrants to purchase an aggregate of 500,000 shares of common stockon February 29, 2004, for an aggregate exercise price of $562,500.  Cirrus met their minimum purchase commitmentfor warrant period four in 2004 and exercised a warrant for 650,000 shares ofcommon stock on February 23, 2005 for an aggregate exercise price of $812,500.  Cirrus currently owns 14.22%, of theoutstanding shares of BRS common stock.

**5.****                                      CovenantsNot to Compete**

On October 26, 1995 the Company entered into anagreement with the president and majority shareholder of Second Chantz AerialSurvival Equipment, Inc. (SCI), whereby SCI ceased all business activities, andSCI’s president and majority shareholder entered into a ten-year covenant notto compete with the Company.  Thepayments required under this agreement contained a non-interest-bearing portionand a portion that bears interest at a rate below the Company’s incrementalborrowing rate.  Under generally acceptedaccounting principles the future payments were discounted at the Company’sincremental borrowing rate.  The 4% tenyear note called for monthly payments of $4,036 through October 2005.  Payments under this agreement were unsecured.

On August 16, 2004, the Company extended thenon-compete period by five additional years in exchange for the exercise ofstock options held by SCI’s president under a stock subscription agreementbacked by a promissory note.  The notehad a principal sum of $12,500 together with aggregate interest on the unpaidprincipal balance of $2,500.  Paymentsunder the note began July 1, 2005 and continued monthly with a final maturitydate of October 1, 2005.  The presentvalue of the Company’s obligation under this agreement was recorded as anintangible asset and is being amortized over a range of two to 15 years asshown in the accompanying consolidated financial statements.

On October 14, 2004, the Company and Mr. Mark Thomasentered into a Resignation, Consulting, Non-Competition and General ReleaseAgreement (the “Resignation Agreement”) in connection with Mr. Thomas’ resignationas Chief Executive Officer, Chief Financial Officer, President, and as adirector of the Company.  Pursuant to theterms of the Resignation Agreement, Mr. Thomas resigned 

F-44

----

such offices effective October 14, 2004.

Mr. Thomas agreed, for a two year period, not to 1)call on or solicit Company customers, 2) directly or indirectly, becomeemployed by, consult with, manage, own or operate any business engaged in thedesign, manufacturing, marketing or distribution of (i) emergency parachuterecovery systems for recreational, general and commercial aviation aircraft andunmanned aircraft or (ii) general aviation aircraft.  Mr. Thomas also agreed not to divulge anytrade secrets or confidential information regarding the Company.  In exchange for such Resignation Agreement,the Company agreed to pay Mr. Thomas an aggregate of $230,000; $60,000 of whichwas paid 15 days after execution of the Agreement and $170,000 of which wouldbe paid over a 24 month period $(7,083 per month) during the compliance of Mr. Thomas’non-competition /non-disclosure requirements. The present value of the Company’s obligation under this agreement wasrecorded as an intangible asset and is being amortized over two years as shownin the accompanying consolidated financial statements.

Future payments under these agreements are as follows:

| Fiscal Year | ** ** | ** ** | ** ** | **Future Dollars** | ** ** | **Present Dollars** | ** ** |
|------------------|------------|------------|------------|-------------------------|------------|--------------------------|------------|
| 2007             |       | $          | 7,083      |                    | $          | 7,069                    |       |
|             |       | $          | 7,083      |                    | $          | 7,069                    |       |

 

**6.****                                      OtherFinancial Information**

Inventories

The components of inventory consist of the followingat September 30:

|                   | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------|------------|----------|------------|----------|------------|
| Raw materials     |       | $        | 2,100,501  |     | $          | 1,162,175 |   |
| Work in process   |       | 340,434  |       | 252,225  |       |
| Finished goods    |       | 17,068   |       | 46,519   |       |
| Total inventories |       | $        | 2,458,003  |     | $          | 1,460,919 |   |

 

Furniture, Fixtures and Leasehold Improvements

Furniture, fixtures and leasehold improvementsconsisted of the following categories at September 30:

|                                 | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|
| Office furniture and  equipment |       | $        | 345,535    |     | $          | 293,930 |   |
| Manufacturing equipment         |       | 463,367  |       | 383,078  |       |
| Airplane                        |       | 283,183  |       | 265,467  |       |
| Total fixed assets              |       | $        | 1,092,085  |     | $          | 942,475 |   |

 

Depreciation Expense

Depreciation expense totaled $149,624 in 2006 and$101,790 in 2005.

Long-Term Prepaid Expenses 

Long-term prepaid expenses consist of the following atSeptember 30: 

| ** **                       | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|
| Stock offering costs             |       | $        | 72,664     |     | $          | 0 |   |
| Other                            |       | 37,261   |       | 28,269   |       |
| Total long-term prepaid expenses |       | $        | 109,925    |     | $          | 28,269 |   |

 

The stock offering costs will be netted against theproceeds received from the common stock proceeds the Company received afterSeptember 30, 2006.  See Note 14. 

F-45

----

Long-Lived Assets

In accordance with SFAS No. 144, Accounting For TheImpairment Of Long-Lived Assets And For Long-Lived Assets To Be Disposed Of,the Company reviews its long-lived assets and intangibles related to thoseassets periodically to determine potential impairment by comparing the carryingvalue of the long-lived assets outstanding with estimated future cash flowsexpected to result from the use of the assets, including cash flows fromdisposition.  Should the sum of theexpected future cash flows be less than the carrying value, the Company wouldrecognize an impairment loss.  Animpairment loss would be measured by comparing the amount by which the carryingvalue exceeds the fair value of the long-lived assets and intangibles.  To date, management has determined that noimpairment of long-lived assets exists.

Other Accrued Liabilities

Other accrued liabilities consisted of the followingcategories at September 30:

|                                        | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|
| Bonus and Profit  Sharing Plan Accrual |       | $        | 215,971    |     | $          | 44,530 |   |
| Contingency Accrual                    |       | —   |       | 80,000   |       |
| Other Miscellaneous  Accruals          |       | 28,959   |       | 59,340   |       |
|                                   |       | $        | 244,930    |     | $          | 183,870 |   |

 

Export Sales

The Company’s international sales are made throughindependent representatives in various foreign countries.  International sales as a percentage of totalsales were 12.4% in 2006 and 9.6% in 2005.

Major Suppliers

During the years ended September 30, 2006 and 2005,the Company purchased its parachutes from a certain key vendor. The Companymanufactures its own ballistic devices, but the propellant for the ballisticdevices is purchased from a single source. The Company routinely searches for new suppliers and feels alternatesources can be found should any of these suppliers be unable to meet theCompany’s needs.

Related Parties

*Active Agreement*

Effective as of November 19, 2004, the Company enteredinto a Consulting Agreement with Mr. Boris Popov, a director of the Company,pursuant to which Mr. Popov would provide certain consulting services relatingto the Company’s new product development. Pursuant to this agreement, the term of which is six months, Mr. Popovis required to provide a minimum of 64 hours of service per month for $3,200per month and shall be paid an additional $50 per hour for each hour over the64 hour minimum.  On March 16, 2005 theCompany extended this agreement for 12 additional months.  Consulting expenses for Mr. Popov were$25,573 and $21,162 for the years ended September 30, 2006 and 2005,respectively.

*Expired Agreements*

Effective as of November 19, 2004, the Company enteredinto a Consulting Agreement with Mr. Thomas 

F-46

----

H. Adams, Jr., a director of the Company, pursuant towhich Mr. Adams would provide certain consulting and advisory services to theCompany relating to after market business development of the Company’sproducts.  Pursuant to this agreement,the term of which was six months, Mr. Adams was required to provide a minimumof 50 hours of services per month for $2,500 and shall be paid an additional$50 per hour for each hour over the 50 hour minimum.  On March 16, 2005 the Company extended thisagreement for three months.  Consultingexpenses for Mr. Adams were $0 and $10,323 for the years ended September 30,2006 and 2005, respectively.  Thisagreement has expired.

Also effective as of November 19, 2004, the Companyentered into an Interim Services Agreement with Robert L. Nelson, the Company’sChairman of the Board, Chief Executive Officer, President and Chief FinancialOfficer, in connection with his consulting services as interim Chief ExecutiveOfficer, Chief Financial Officer and President while the Company pursued acandidate to fill those positions on a permanent basis.  The term of this agreement was three months,with an automatic renewal of three months unless otherwise agreed to inwriting.  Mr. Nelson received $11,000 permonth as a fee for his services during this Agreement.  Effective March 16, 2005, Mr. Nelson’spayment under this agreement was continued at $4,000 per month and thisagreement was extended an additional two months.  Consulting expenses for Mr. Nelson were $0and $49,000 for the years ended September 30, 2006 and 2005, respectively.  This agreement has expired.

For all such agreements, the fees paid were and willbe in addition to and independent of any fees or compensation owed to suchdirectors in their capacity as non-employee directors.

Profit Sharing Plan

The Company adopted a pre-tax salary reduction plan,under the provisions of Section 401(k) of the Internal Revenue Code, in fiscalyear 2000, which covers its full-time employees over age 21.  Company match contributions made for the yearsended September 30, 2006 and 2005, respectively, were $12,431 and $11,336.  The Company can also make discretionaryprofit sharing contributions.  Companycontributions made at the discretion of management and the board of directorsfor the years ended September 30, 2006 and 2005, respectively, were $0 and $0.

Product Warranties

The Company offers its customers up to a one-yearwarranty on its products.  The warrantycovers only manufacturing defects, which will be replaced or repaired by theCompany at no charge to the customer.  Todate, the Company has not had any material claims against its products.  The Company has not recorded an accrual forpossible warranty claims and believes that the product warranties as offeredwill not have a material effect on the Company’s financial position, results ofoperations or cash flows.

**7.****                                      GeographicalInformation**

The Company has operations in South St. Paul,Minnesota and Tijuana, Mexico.  Informationabout the Company’s operations by geographical location are as follows for theyear ended September 30, 2006.  TheCompany did not have operations in Mexico until late September 2005, thereforethere is no geographical information to disclose for 2005.

|                                                  | ** ** | **United States** | ** ** | **Mexico** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|------------|------------|------------------|------------|
| As of September 30,  2006 or for the year ended: |       |                   |       |       |       |             |       |
| Total assets                                     |       | $                      | 4,687,830  |       | $          | 727,426          |       | $ | 5,415,256 |   |
| Long-lived  assets                               |       | $                      | 890,705    |       | $          | 201,380          |       | $ | 1,092,085 |   |
| Inventories                                      |       | $                      | 1,931,957  |       | $          | 526,046          |       | $ | 2,458,003 |   |

 

F-47

----

**8.****                                      Line-ofCredit Borrowings**

The Company has a $400,000 line-of-credit with a bankon an annual renewal basis and is collateralized by all of the Company’sassets.  The current line-of-creditexpires February 6, 2007.  The line callsfor a variable interest rate of 9.75% at September 30, 2006 (average rate forthe year ended September 30, 2006 was 8.36%). At September 30, 2006 and 2005, there were outstanding balances of$302,265 and $204,715, respectively, under the line of credit.

**9.****                                      Long-TermDebt**

In 2005, a jury awarded damages to Parsons andAerospace Marketing in the combined amount of approximately $3.4 million forbreach of contract. BRS settled this matter directly with Parsons and Aerospaceon September 19, 2005 by agreeing to pay $1.9 million.  An initial payment of $700,000 plus interestwas made on September 19, 2005.  Theremainder of $1.2 million was to be paid by the Company over a term of 8 years,although the Company had the right to pre-pay remaining amounts due at anytime.  On November 15, 2006, the Companypaid the entire unpaid principal and interest outstanding on the first notedetailed below and paid $5,000 towards unpaid principal on the second note detailedbelow with money raised through equity financing on October 25, 2006 (see Note14).  As such, the first note payable detailedbelow was classified at September 30, 2006 as long-term pursuant to SFAS No. 6“Classification of Short-Term Obligations Expected to be Refinanced”.

The components of long-term debt consisted of thefollowing at September 30:

|                                                                                                                                                                                                                                                                                                       | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------|------------|-----------|------------|
| Note payable — Parsons,  principal and interest payments due in monthly installments of $17,885  including interest at 8.25%, through September 2010, collateralized by  substantially all assets of the Company                                                                                 |       | $         | 729,091    |      | $          | 880,000 |   |
| Note payable — Parsons,  interest only payments at 8.25% through September 2010, then principal and  interest payments due in monthly installments of $10,065 including interest  at 8.25%, from October 2010 through September 2013, collateralized by  substantially all assets of the Company |       | 320,000   |       | 320,000   |       |
| Total long-term debt                                                                                                                                                                                                                                                                                  |       | 1,049,091 |       | 1,200,000 |       |
| Less: debt refinanced  with equity offering                                                                                                                                                                                                                                                           |       | 729,091   |       | —    |       |
| Less: current portion                                                                                                                                                                                                                                                                                 |       | —    |       | 153,951   |       |
| Long-term debt, net of current portion                                                                                                                                                                                                                                                                |       | $         | 320,000    |      | $          | 1,046,049 |   |

 

Future minimum payments required at September 30, 2006are as follows:

| Fiscal Year    | ** ** | ** ** | ** ** | **Amount** | ** ** |
|---------------------|------------|------------|------------|------------|------------|
| 2007                |       | $          | —     |       |
| 2008                |       | —     |       |
| 2009                |       | —     |       |
| 2010                |       | —     |       |
| 2011                |       | 98,027     |       |
| 2012 and thereafter |       | 221,973    |       |
|                |       | $          | 320,000    |       |

 

Future minimum payments that would have been requiredat September 30, 2006 if the Company had not refinanced the first note payablethrough the sale of common shares in October 2006 and November 2006 assumingall covenant violations would have been waived are as follows:

 

| Fiscal Year    | ** ** | ** ** | ** ** | **Amount** | ** ** |
|---------------------|------------|------------|------------|------------|------------|
| 2007                |       | $          | 160,446    |       |
| 2008                |       | 174,195    |       |
| 2009                |       | 189,122    |       |
| 2010                |       | 205,328    |       |
| 2011                |       | 98,027     |       |
| 2012 and thereafter |       | 221,973    |       |
|                |       | $          | 1,049,091  |       |

 

F-48

----

**10.****                               IncomeTaxes**

At September 30, 2006 and 2005, the Company had$2,000,000 and $2,050,000 in net operating loss carryforwards which will expirein 2025.  The provision for income taxesconsisted of the following components for the years ended September 30:

|                                                                                            | ** ** | **2006** | ** ** | **2005**   | ** ** |
|--------------------------------------------------------------------------------------------|------------|----------|------------|------------|------------|
| Current:                                                                                   |       |     |       |       |       |
| Federal                                                                                    |       | $        | (56,984    | )          | $          | (242,300 | ) |
| State                                                                                      |       | 0        |       | (26,000    | )          |
| Deferred                                                                                   |       | 75,184   |       | (1,204,700 | )          |
| Tax benefit of stock  option and warrant exercises, credited to additional paid-in capital |       | 0        |       | 830,000    |       |
|                                                                                       |       | $        | 18,200     |       | $          | (643,000 | ) |

 

The tax benefit of $830,000 in 2005 noted above,relates to compensation expense for tax purposes in excess of amountsrecognized for financial reporting purposes.

Components of net deferred income taxes are as followsat September 30:

|                                                      | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|------------------------------------------------------|------------|-----------|------------|-----------|------------|
| Deferred income tax  assets:                         |       |      |       |      |       |
| Amortization                                         |       | $         | 12,000     |      | $          | 24,700 |   |
| Allowance for doubtful  accounts                     |       | 9,000     |       | 4,000     |       |
| Vacation accruals                                    |       | 12,000    |       | 24,200    |       |
| Asset valuation  reserves                            |       | 39,600    |       | 39,600    |       |
| Net Operating Losses                                 |       | 707,516   |       | 729,700   |       |
| Legal Settlement  Accruals                           |       | 420,000   |       | 510,000   |       |
| Income Tax Credits                                   |       | 115,000   |       | 115,000   |       |
| Other accruals                                       |       | 51,900    |       | —    |       |
| Inventory Section 263  adjustment                    |       | 36,200    |       | 36,200    |       |
|                                                 |       | 1,403,216 |       | 1,483,400 |       |
| Deferred income tax  liabilities — depreciation |       | (21,000   | )          | (26,000   | )          |
| Net deferred income tax assets                       |       | $         | 1,382,216  |      | $          | 1,457,400 |   |

 

The net deferred income taxes are reflected in theconsolidated balance sheet at September 30, 2006 and 2005 as follows:

|                                                | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|------------------------------------------------|------------|-----------|------------|-----------|------------|
| Deferred tax asset —  current portion     |       | $         | 160,700    |      | $          | 160,700 |   |
| Deferred tax asset —  non-current portion |       | 1,221,516 |       | 1,296,700 |       |
| Total                                          |       | $         | 1,382,216  |      | $          | 1,457,400 |   |

 

Reconciliation between the statutory rate and theeffective tax rate for the years ended September 30, is as follows:

 

F-49

----

 

|                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|
| Federal statutory tax  rate          |       | 34.0     | %          | (34.0    | )%         |
| State taxes, net of  federal benefit |       | 6.3      |       | (6.3     | )          |
| Other                                |       | (0.4     | )          | 3.8      |       |
| Effective tax rate                   |       | 39.9     | %          | (36.5    | )%         |

 

**11.  Shareholders’ Equity**

Common Stock

On June 22, 2006and June 23, 2006, the Company accepted subscriptions from certain directorsand executive officers of the Company relating to the issuance of 322,956shares of common stock and warrants to acquire 16,401 shares of common stockfor an aggregate purchase price of $439,220. The warrants have a three-year term and an exercise price of $2.00 pershare and have piggy-back registration rights. The Company paid no underwriting discounts or commissions in connectionwith these sales.  The price per sharewas determined by the placement agent that assisted with the equity offeringthat closed on October and November 2006 (see Note 14).  The common shares issued were restricted andunregistered shares.  The price percommon share was $1.36 per share and the market price was approximately $1.50per share.  The discount to market wasdue to the significant amount of shares issued and the fact the shares wererestricted and unregistered.  Thediscount was not in exchange for board services or any other services renderedor to be rendered.

On June 15, 2006 ,the Company issued 6,000 shares of common stock to each of its five BoardMembers for a total of 30,000 shares, as partial compensation for the next fiveboard meetings through the Company’s 2007 Annual Meeting of Stockholders.  The shares were valued at $1.51 (fair valueat the date of issuance) and are expensed as services are provided.

During the thirdquarter of 2006, 15,000 stock options were exercised resulting in net proceedsto the Company of $15,750.  During thesecond quarter of 2006, 30,000 stock options were exercised resulting in netproceeds to the Company of $27,189.  Inaddition, the Company retired 8,771 shares in the second quarter of 2006, andthe proceeds were used by the individual to exercise an additional 15,000 stockoptions.

During the yearended September 30, 2005, the Company issued 31,150 registered shares of commonstock at $2.25 per share (the stock trading price on the date of issuance) forservices rendered valued at $70,087.

Stock Options

In March 2004, theshareholders at their annual meeting approved the 2004 Stock Option Plan (the2004 Plan), which provides for the granting of up to 600,000 options toofficers, directors, employees and consultants for the purchase of stock.  No grants were made under this plan in fiscalyears 2006 and 2005.

F-50

----

Stock optionactivity for the years ended September 30, 2006 and 2005 is as follows:

|                                                                         | ** ** | **Number of  Shares** | ** ** | **Option Price Range per  Share** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------|------------|--------------------------------------------------|------------|
| Balance at September  30, 2004                                          |       | 310,000                    |       | $0.44 to $1.38                                   |       |
|                                                                    |       |                       |       |                                             |       |
| Granted during fiscal  year 2005                                        |       | —                     |       | —                                           |       |
| Options exercised                                                       |       | (160,000                   | )          | $0.44 to $1.38                                   |       |
| Expirations                                                             |       | —                     |       | —                                           |       |
|                                                                    |       |                       |       |                                             |       |
| Balance at September  30, 2005                                          |       | 150,000                    |       | $0.91 to $1.38                                   |       |
|                                                                    |       |                       |       |                                             |       |
| Granted during fiscal  year 2006                                        |       | —                     |       | —                                           |       |
| Options exercised                                                       |       | (60,000                    | )          | $0.91 to $1.05                                   |       |
| Expirations                                                             |       | —                     |       | —                                           |       |
|                                                                    |       |                       |       |                                             |       |
| Balance at September  30, 2006                                          |       | 90,000                     |       | $1.05 to $1.38                                   |       |
|                                                                    |       |                       |       |                                             |       |
|                                                                    |       |                       |       |                                             |       |
| Weighted average fair  value of options granted during fiscal year 2006 |       | —                     |       |                                             |       |
|                                                                    |       |                       |       |                                             |       |
| Weighted average fair  value of options granted during fiscal year 2005 |       | —                     |       |                                             |       |
|                                                                    |       |                       |       |                                             |       |
|                                                                    |       |                       |       |                                             |       |
| At September 30, 2006:                                                  |       |                       |       |                                             |       |
| Options vested and  exercisable                                         |       | 90,000                     |       |                                             |       |
| Shares available for  options                                           |       | 600,000                    |       |                                             |       |
|                                                                    |       |                       |       |                                             |       |
| At September 30, 2005:                                                  |       |                       |       |                                             |       |
| Options vested and  exercisable                                         |       | 150,000                    |       |                                             |       |
| Shares available for options                                            |       | 600,000                    |       |                                             |       |

 

The followingtables summarize information about stock options outstanding and exercisable asof September 30, 2006:

 

| Options Outstanding and  Exercisable | ** ** |
|--------------------------------------|------------|
| **Exercise Price**              | ** ** | **Number  Outstanding** | ** ** | **Weighted-Average  Remaining  Contractual Life** | ** ** | **Weighted-Average  Exercise  Price** | ** ** |
|                                 |       |   |   |   |   |   |   |
| $1.05                                |       | 45,000 |   | 1.46 |   | $ | 1.05 |   |
| $1.38                                |       | 45,000 |   | 0.46 |   | $ | 1.38 |   |
|                                 |       |   |   |   |   |   |   |
| $1.05 to $1.38                       |       | 90,000 |   | 0.96 |   | $ | 1.22 |   |

 

F-51

----

Stock Warrants

On June 22, 2006and June 23, 2006, the Company accepted subscriptions from certain directorsand executive officers of the Company relating to the issuance of 322,956shares of common stock and warrants to acquire 16,401 shares of common stockfor an aggregate purchase price of $439,220. The warrants have a three-year term and an exercise price of $2.00 pershare and have piggy-back registration rights. The Company paid no underwriting discounts or commissions in connectionwith these sales.

On February 23,2005 Cirrus Design exercised its warrant to purchase 650,000 shares of commonstock pursuant to the Purchase and Supply Agreement dated September 17,1999.  The exercise price related to thiswarrant was $1.25 per share for total consideration of $812,500.

**12.  Acquisitions**

In September 2005,the Company completed the purchase through its subsidiary, BRS de Mexico S.A.de C.V., of certain assets of Paranetics Technology, Inc. (Paranetics) for thepurpose of manufacturing parachutes and related components.

The acquisition ofassets from Paranetics was pursuant to an Asset Purchase Agreements with apurchase price for the net assets of $204,695. The Company financed the purchase with proceeds from borrowings underthe line of credit with their bank.

SFAS No. 141 “BusinessCombinations” requires that all business combinations after June 30, 2001 beaccounted for under the purchase method of accounting.  The acquisition of assets was accounted forunder the purchase method of accounting and, accordingly, the purchase pricewas allocated to property acquired based on the estimated fair value as of theacquisition date.  The excess of thepurchase price and expenses relating to the acquisition over the fair value ofthe assets received resulted in goodwill of $103,774.

**13.  Commitments and Contingencies**

Leases

The Company leasesits production facility on an airport in South St. Paul, Minnesota. Totalrental expense for this operating lease during 2006 and 2005 was $42,831 and$43,138, respectively.  The Companybought out the remaining portion of its five-year sublease with its landlord inSeptember 2002.  This buyout resulted inshort-term prepaid lease expense of $24,851 at September 30, 2006 and 2005, andlong-term prepaid lease expense of $3,418 and $28,269, respectively, asreflected in the accompanying consolidated financial statements.  This buyout allowed the Company to become adirect lessee with the City of South St. Paul. This lease expires December 31, 2007.

The Company leasesa second facility on the same airport for office space.  Total rental expense for this operating leaseduring 2006 and 2005 was $14,808 and $0, respectively.  This lease expires April 30, 2008.

The Company leasesoffice and production space in Tijuana, Mexico. Total rental expense for thisoperating lease during 2006 and 2005 was $88,332 and $0, respectively. Thislease expires November 14, 2007.

The Company hadleased a facility on the same airport for use in research and development.  Total rental expense for this operating leaseduring 2006 and 2005 was $27,603 and $31,758, respectively.  This lease was terminated on July 31, 2006.

F-52

----

Future minimumlease payments required on non-cancelable operating leases at September 30,2006 are as follows:
| Fiscal Year | ** ** | **Amount** | ** ** |
|------------------|------------|------------|------------|
| 2007             |       | $          | 162,036    |   |
| 2008             |       | 45,271     |       |
|             |       |       |       |
| Total            |       | $          | 207,307    |   |

 

Legal Proceedings

(a) InAugust 2003, the Company was served in two related actions, Kathleen F.Fischer and Susan Sedgwick in U.S. District Court for the Northern District ofNew York.  These actions arise from thecrash of a Cirrus Design Corp. SR22 airplane in April 2002 near Parish,New York.  The Plaintiffs have brought claims for strict productsliability, negligence and breach of warranty against Cirrus Design, theairplane’s manufacturer, the Company, which manufactures the CAPS (CirrusAirframe Parachute System), a parachute system which is a required component ofthe plane, and Wings Aloft, Inc., which provided training on the SR22 to thedecedents.

In June and August2006, the Company settled with such plaintiffs without any liability to theCompany.

(b) On April 17,2004, an action was commenced against the Company by Aerospace Marketing, Inc.and Charles Parsons v. Ballistic Recovery Systems, Inc., U.S. District Court,Middle District of Florida, File No. 04-CV-242. The action resulted from the Company’s notification to Charles F. Parsonin April 2004 of its intent to terminate the sales and marketing contractbetween the Company and Mr. Parsons relating to the BRS-172 and BRS-150products for lack of performance.

In 2005, a juryawarded damages to Parsons and Aerospace Marketing in the combined amount ofapproximately $3.4 million for breach of contract. BRS settled this matterdirectly with Parsons and Aerospace on September 19, 2005 by agreeing to pay $1.9million pursuant to terms described in the settlement agreement.  Aninitial payment of $700,000 plus interest was made on September 19, 2005. The remainder of the settlement amount was to be paid by BRS over a term of 8years, although BRS had the right to pre-pay remaining amounts due atany time.  On November 16, 2006, theCompany prepaid $721,219 of such sum. The current balance is $315,000, which requires interest only paymentsthrough September 2010, and principal and interest payments from October 2010through September 2013.

(c) In April 2005,an action was commenced against the Company by Sue Jean McGrath, individuallyand as successor in interest to Charles W. McGrath, deceased, Charles W.McGrath III, Tanya Sue McGrath, Janny Sue McGrath, individually v. CirrusDesign Corporation, Ballistic Recovery Systems, Inc., and Aerospace Systems andTechnologies, Inc., U.S. District Court, Northern District of California, FileNo. C05-1542.  The plaintiffs have allegedvicarious liability, strict product liability, negligence and breach ofwarranty against the defendants arising from the crash of a Cirrus Design Corp.SR22 airplane near Sugar Bowl, California. The case is currently in the early stages of discovery.  At this time the Company cannot state withany degree of certainty what the outcome of the matter or the amount or rangeof potential damages will be.

(d) On September16, 2005, an action was commenced against the Company by Robert Treat Rayner,in the Circuit Court of the 5th Judicial Circuit in and from Lake CountyFlorida, File No. 04 CA 1749.  The 

F-53

----

Complaint allegesthat plaintiff was injured when his ultralight aircraft crashed while beingtowed by another ultralight.  Plaintiffalleges that he deployed his BRS system, but that it failed to deployproperly.  BRS is undertaking aninvestigation of the claim and has responded to the suit.  At this time, the Company cannot state withany degree of certainty what the outcome of these matters will be or the amountor range of potential loss, if any.  BRSbelieves that it has strong defenses to the suit and will vigorously defendagainst the claims.

**14.  Subsequent Events**

On October 25,2006, the Company, as part of its private placement offering of $3 million ofequity securities, accepted subscription agreements from 23 accreditedinvestors for the sale of 975,736 shares of the Company’s common stock, parvalue $.01 per share (the “Common Stock”), and warrants (the “Warrants”) topurchase 243,934 shares of Common Stock. The Warrants have a three-year term and an exercise price of $2.00 pershare.  The Company received grossproceeds from the sale of Common Stock and Warrants of $1,327,001, lesscommissions in the aggregate amount of $92,890 and less a retainer and expensesof in the aggregate amount of $20,000 paid to a placement agent assisting inthe placement.  Additionally, the Companywill be required to issue a three-year warrant to purchase 17,075 shares ofCommon Stock at an exercise price of $2.00 per share to the placement agent(the “Agent’s Warrant”).  The Company hasagreed to register the resale of the Common Stock and the Common Stock issuableupon exercise of the Warrants and Agent’s Warrant.  The disclosure about the foregoing agreementsand instruments, and the related private placement does not constitute an offerto sell or a solicitation of an offer to buy any securities of the Company, andis made as required under applicable laws for filing annual reports with theUnited States Securities and Exchange Commission, and as permitted under Rule135c under the Securities Act.

On November 15,2006, the Company paid the unpaid principal and interest outstanding of$721,143 on the first note payable to Parsons and Aerospace Marketing and paid$5,000 towards unpaid principal on the second note payable to Parsons andAerospace Marketing, leaving a principal balance payable of $315,000 (See Note9).

On November 22,2006, the Company accepted subscription agreements from 26 accredited investorsfor the sale of 864,704 shares of the Company’s common stock, par value $.01per share (the “Common Stock”), and warrants (the “Warrants”) to purchase216,176 shares of Common Stock.  TheWarrants have a three-year term and an exercise price of $2.00 per share.  The Company received gross proceeds from thesale of Common Stock and Warrants of $1,175,997, less commissions in theaggregate amount of $82,320 to a placement agent assisting in theplacement.  Additionally, the Companywill be required to issue a three-year warrant to purchase 15,132 shares ofCommon Stock at an exercise price of $2.00 per share to the placement agent(the “Agent’s Warrant”).  The Company hasagreed to register the resale of the Common Stock and the Common Stock issuableupon exercise of the Warrants and Agent’s Warrant.  The disclosure about the foregoing agreementsand instruments, and the related private placement does not constitute an offerto sell or a solicitation of an offer to buy any securities of the Company, andis made as required under applicable laws for filing annual reports with theUnited States Securities and Exchange Commission, and as permitted under Rule135c under the Securities Act.

As noted above,the Company has agreed to register for resale the Common Stock and Common Stockissuable upon exercise of the Warrants and Agent’s Warrants.  The private placement offering requires theCompany to file a registration statement after the closing of the privateplacement offering within 45 days.  Theestimated closing of the private placement offering is January 5, 2007.  In addition, if the registration statement isnot declared effective by he Securities and Exchange Commission within 120 daysafter filing the registration statement, the Company is require to pay a penaltyof Units equal to an 

F-54

----

additional 1% ofthe warrants issued for each month that the registration statement is notdeclared effective.  The Company hasadopted EITF 05-4, The Effect of Liquidated Damages Clause on a FreestandingFinancial Instrument Subject to Issue No. 00-19, View C to account for itsregistration rights agreements. The Company has entered into registrationrights agreements in association with the issuance of common stock andwarrants. View C of EITF 05-4 takes the position that the registration rightsshould be accounted for separately from the financial instrument as the payoffof the financial instruments is not dependent on the payoff of the registrationrights agreement, and according to DIG K-1, registration rights agreements andthe financial instruments do not meet the combining criteria as they relate todifferent risks. The Company believes the probability of the registrationstatement not being declared effective by the SEC within the prescribedtimeframe is remote as defined under SFAS No. 5.  Therefore, the Company has a contingentliability for the potential penalty units. The Financial Accounting Standards Board (Board) has postponed furtherdiscussion on EITF 05-4. Since the Board has not reached a consensus, theCompany’s accounting for the registration rights may change when the Boardreaches a consensus.

**15.  Supplemental Cash Flow Information**
| Cash paid for:      | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|
| Interest                      |       | $        | 127,816    |     | $          | 21,380 |   |
| Income taxes paid  (refunded) |       | (287,428 | )          | 144,846  |       |
|                               |            |          |            |          |            |  |  |

Summary ofnon-cash activity:

·                  The Companyissued 6,000 shares of common stock to each of its five Board Members for atotal of 30,000 shares ($45,300), as partial compensation for the next fiveboard meetings on June 15, 2006.

·                  The Companyrecognized a deferred tax benefit of $830,000 for stock option and warrantexercises, credited to additional paid-in capital during fiscal year 2005.

·                  The Companyentered into a covenant not to compete agreement for $225,573 in exchange for acovenant not to compete payable during fiscal year 2005.

·                  The Companyapplied a covenant not to compete payable in the amount of $4,036 and $8,464 toa note receivable from shareholder during fiscal year 2006 and 2005.

** **

F-55

----