EVANS & SUTHERLAND COMPUTER CORP - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549
--------------------------

FORM 10-K

(MARK ONE)

/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001

/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM ________________ TO ________________

COMMISSION FILE NUMBER 0-8771
--------------------------

EVANS & SUTHERLAND

COMPUTER CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

UTAH 87-0278175
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)

600 KOMAS DRIVE, SALT LAKE CITY, UTAH 84108
(Address of Principal Executive (Zip Code)
Offices)

Registrant's telephone number, including area code: (801) 588-1000

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

"NONE"

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

TITLE OF CLASS

COMMON STOCK, $.20 PAR VALUE
6% CONVERTIBLE DEBENTURES DUE 2012
PREFERRED STOCK PURCHASE RIGHTS

------------------------------

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /

The aggregate market value of the voting and non-voting Common Stock held by
non-affiliates of the registrant as of March 1, 2002 was approximately
$33,242,000, based on the closing market price of the Common Stock on such date,
as reported by The Nasdaq Stock Market.

The number of shares of the registrant's Common Stock outstanding at
March 1, 2002 was 10,398,314.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the 2002 Annual Meeting of Shareholders
to be held on May 16, 2002 are incorporated by reference into Part III hereof.

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EVANS & SUTHERLAND COMPUTER CORPORATION
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2001

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FORM 10-K

PART I

ITEM 1. BUSINESS

GENERAL

Evans & Sutherland Computer Corporation ("Evans & Sutherland," "E&S," "we,"
"us," or "our") was incorporated in the State of Utah on May 10, 1968. An
established high-technology company, E&S is a worldwide leader in providing
visual system solutions for simulation. E&S visual systems are used in military
and commercial training simulators, planetariums and interactive domed theaters,
as well as engineering and other applications. E&S is unique among visual
simulation companies in that it offers a complete range of solutions from low
cost, PC-based products to the most advanced systems in the world. All E&S
products are backed by unrivaled customer service and support, ensuring
customers low life-cycle cost and the best value in visual simulation.

E&S's principal offices are located at 600 Komas Drive, Salt Lake City, Utah
84108, and its telephone number is (801) 588-1000. E&S's home page on the
Internet is www.es.com. You can learn more about E&S by reviewing SEC filings on
the E&S web site. The SEC also maintains a web site at www.sec.gov that contains
reports, proxy statements and other information regarding SEC registrants,
including E&S. E&S makes its web site content available for information purposes
only. It should not be relied upon for investment purposes, nor is it
incorporated by reference into this Form 10-K.

During 2001, our core computer graphics technology was shared among three
business groups:

(1) Simulation Group, which produces a full range of image generators,
software, databases, and display systems for military and commercial
simulation;

(2) REALimage Solutions Group, which provides graphics acceleration
technology for PC-based simulation, the professional digital content
creation (DCC) market, and video processing technology for animation,
broadcasting, and netcasting applications; and

(3) Applications Group, which leverages our core technologies and applies
them to other growth markets, such as digital theaters and visualization
software for real estate development applications.

RESTRUCTURING

Early in 2001, we announced our intention to spin out or sell our REALimage
Solutions Group. In the third quarter of 2001, E&S sold the REALimage Group to
Real Vision, Inc., a Japanese company that has been a partner with E&S in the
development of technology for professional video applications. The sale was for
a maximum value of $12 million, consisting of cash of $6.3 million plus future
royalties, on a when and if earned basis, of up to $6 million for REALimage
technology, other assets, and the performance of certain development support
during a seven-month transition period leading to closing the transaction in
April 2002. Real Vision has indicated it will continue the development of the
technology, and E&S is maintaining a technical staff to support Real Vision in
Salt Lake City during the transition period. Shortly after the sale of the
REALimage Group, E&S closed its offices in Seattle, Washington, and San Jose,
California.

Throughout 2001, we had been actively seeking sale or spin-off opportunities
for our RAPIDsite-TM- visualization solutions business which is part of the
Applications Group. The general economic downturn made it difficult to sell this
business. In December, we decided to discontinue the RAPIDsite business and
incorporate its technology into the core simulation business.

In the third quarter of 2001, we initiated a restructuring plan focused on
reducing the operating cost structure of E&S. As part of the plan, we recorded a
charge of $2.1 million relating to a reduction

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in force of approximately 80 employees. In the fourth quarter of 2001, we
extended the restructuring plan initiated in the third quarter. As part of the
plan, we recorded a charge of $0.7 million relating to a reduction in force of
approximately 12 employees. We estimate that this restructuring plan will reduce
expenses by $8.2 million per year going forward. As of December 31, 2001, we had
paid $1.9 million in severance benefits. The majority of the remaining benefits
will be paid out over the next two quarters. The charge was recorded in
accordance with Emerging Issues Task Force Issue 94-03 "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit (Including
Certain Cost Incurred in a Restructuring)" and Staff Accounting Bulletin
No. 100, "Restructuring and Impairment Charges".

In the third quarter of 1999, E&S initiated a restructuring plan focused on
reducing the operating cost structure of its REALimage Solutions Group. As part
of the plan, E&S recorded a charge of $1.5 million relating to 28 employee
terminations, including 17 employees in San Jose and 11 employees in Salt Lake
City. The charge was recorded in accordance with Emerging Issues Task Force
Issue 94-03, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit (Including Certain Costs Incurred in a Restructuring)."

During 2000, after all employee severance costs were incurred, E&S reversed
$0.8 million of the restructuring charge as a result of certain employees being
transferred within E&S rather than being terminated and estimated severance and
related charges being lower than expected for the terminated employees.

FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS

This annual report, including all documents incorporated herein by
reference, includes certain "forward-looking statements" within the meaning of
that term in Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Exchange Act of 1934, as amended, including, among others,
those statements preceded by, followed by or including the words "estimates,"
"believes," "expects," "anticipates," "plans," "projects," and similar
expressions.

These forward-looking statements include, but are not limited to, the
following statements:

- the successful execution of the Big 6 programs by the end of 2002;

- we will generate $5 million of cash per quarter and will be profitable in
the second half of 2002;

- projections of sales and net income and issues that may affect sales or
net income;

- projections of capital expenditures;

- plans for future operations;

- financing needs or plans;

- plans relating to our products and services;

- Simulation Group will experience growth in its markets as simulation
training increases in value as an alternative to other training methods,
and as simulation training technology and cost-effectiveness improve;

- additional enhancements to iNTegrator will expand its functionality and
help secure E&S's dominant position in its main target markets, both
commercial and military simulation;

- E&S is able to compete effectively in the simulation market and will
continue to be able to do so in the foreseeable future;

- approximately two-third's of Simulation Group's 2001 backlog will be
converted to sales in 2002 and replaced with new orders;

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- the Applications Group's new product will be launched in the first half of
2002;

- our properties are suitable for our immediate needs;

- total research and development spending will be lower in 2002 than in
2001;

- E&S will ultimately prevail in the litigation with Lockheed Martin
Corporation;

- E&S will not be liable for any further material liquidated damages and
late delivery penalties during 2002;

- existing cash, cash equivalents, borrowings available under E&S's various
borrowing facilities, other asset-related cash sources and expected cash
from future operations will be sufficient to meet E&S's anticipated
working capital needs, routine capital expenditures and current debt
service obligations for the next twelve months;

- the guarantees of E&S issued in connection with the services of our joint
venture entity, Quest Flight Training Ltd., to the UK Ministry of Defence
or other parties will not be called upon for payment or performance;

- revenue is expected to contract by 10% from 2001 to 2002; and

- assumptions relating to the foregoing.

Forward-looking statements are inherently subject to risks and
uncertainties, some of which cannot be predicted or quantified. Future events
and actual results could differ materially from those set forth in, contemplated
by, or underlying the forward-looking information. Our actual results could
differ materially from these forward-looking statements. In addition to the
other risks described in the "Factors That May Affect Future Results" discussion
under Item 7--Management's Discussion and Analysis of Financial Condition and
Results of Operations on page 35 of this annual report, important factors to
consider in evaluating such forward-looking statements include risk of product
demand, market acceptance, economic conditions, competitive products and
pricing, difficulties in product development, product delays, commercialization
and technology, and E&S's ability to maintain credit facilities to support its
operations on favorable and acceptable terms. In light of these risks and
uncertainties, there can be no assurance that the events contemplated by the
forward-looking statements contained in this annual report will, in fact, occur.

REPORTABLE SEGMENTS

During 2001, our business units were aggregated into the following three
reportable segments: the Simulation Group, the REALimage Solutions Group, and
the Applications Group. The three groups benefit from shared core graphics
technology, and each group's new products are based on open Intel and Microsoft
hardware and software standards. Each reportable segment markets its products to
a worldwide customer base. As described above under the heading "Restructuring",
we sold the REALimage Solutions Group and discontinued the RAPIDsite business in
the Applications Group. Financial information by reportable segment for each of
the three years ended December 31, 2001 is included in Note 18 of the Notes to
Consolidated Financial Statements included in Part II of this annual report.

SIMULATION GROUP

E&S is an industry leader in providing visual systems to both government and
commercial simulation customers. The Simulation Group provides more than 30% of
the worldwide market for government and military applications and commercial
airline training simulators. The group anticipates growth in these markets as
simulation training increases in value as an alternative to other training
methods, and as simulation training technology and cost-effectiveness improve.

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Throughout 2001, we continued development of our
iNTegrator-Registered Trademark- software product, which provides the real-time
control and modeling tools for the Symphony-TM- family of hardware platforms.
Performance optimizations and new functionality have continuously been added
with each new software release to meet existing contract requirements and to
increase the product performance. While the majority of iNTegrator development
is complete, some additional enhancements are planned in 2002, which management
believes will expand its functionality and help secure our dominant position in
our main target markets, both commercial and military.

In addition to continued development of iNTegrator software, we completed
the major development efforts on our most advanced image generator product,
Harmony-Registered Trademark-. All major Harmony programs are now in training or
in final stages of completion and acceptance.

PRODUCTS & MARKETS

The Simulation Group provides a complete line of visual systems for flight
and ground training and related services to the United States and international
armed forces, NASA, commercial airlines, and aerospace companies. E&S remains an
industry leader in visual systems sales to many U.S. government agencies and
more than 20 foreign governments for training military vehicle operators. The
Simulation Group is also a leading independent supplier of visual systems for
commercial airline flight simulators. This group provides over 30% of the visual
systems installed in full-flight training simulators for commercial airlines,
training centers, simulator manufacturers, and aircraft manufacturers.

The group's visual systems create high-quality, interactive, out-the-window
scenes that realistically simulate what vehicle operators see under actual
operating conditions. The visual systems are an integral part of full mission
simulators, which incorporate a number of other components, including cockpits
or vehicle cabs and large hydraulic motion systems.

Generally, the Simulation Group's visual systems products consist of the six
major components listed below. These components are available as subsystems, but
are typically sold together as a complete visual system solution delivered to an
end user or prime contractor.

(1) Image generators (IGs) create computer-generated real-time images and
send these images to display devices, such as projectors or computer
monitors. The group's primary IG offerings include the Symphony family of
products from Harmony on the high end to OpenGL, PC-based simFUSION-TM-
at the low end, and its legacy ESIG-Registered Trademark- products, which
continue to show strong sales. E&S offers a complete, high-to-low family
of IGs that can use the same software and databases. Harmony is our
flagship for highest performance, Ensemble-TM- is the first PC-based true
image generator offering deterministic performance and
simulation-specific functionality, and simFUSION is the first OpenGL
PC-based hardware platform targeted at low-cost applications. E&S is the
only visual system provider offering a complete line of compatible and
scalable products for real-time simulation and visualization.

(2) Display systems consist of projectors, display screens, computer
monitors, and specialized optics. These display systems are offered in a
broad range of configurations, from onboard instrument displays to domes
offering a 360-degree field of view, depending on the applications.

(3) Databases depicting synthetic environments are offered as options or as
custom solutions. The group provides database development as well as
database development tools such as iNTegrator and
EaSIEST-Registered Trademark-. Databases developed using iNTegrator are a
key element of the Symphony product family. These can be run on a full
range of image generators.

(4) Simulation of sensor imagery such as radar, infrared, and night vision
goggles (NVG) is often provided with the visual systems for
high-performance fixed and rotary wing aircraft. E&S develops and
manufactures a variety of hardware and software products to achieve
realistic

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sensor simulation, including the Vanguard-Registered Trademark- radar
image generator, infrared postprocessors, and customized systems for
either simulated or stimulated NVG solutions.

(5) System integration and installation services are offered in support of
the total simulator system. We have the capability to act as the main
prime contractor for large commercial and military contracts requiring
total systems integration.

(6) A full range of customer support services is offered to prime
contractors, system integrators, and military or commercial end users.
Service and Support product offerings include customized support
packages, called Encore(SM), that provide complete maintenance, spares,
and round-the-clock technical support; SimTech Training, which provides
training to the customers' simulation technicians and engineers; and
Computer-Based Training.

E&S also develops complete simulation solutions for specific training
applications. In 2001, we announced two new products, the Mission Command
Trainer, or MCT-TM-, and the Air Traffic Control Trainer, or ATCT-TM-. The MCT
is a low-cost tactics simulator that provides realistic command training,
mission planning, and mission rehearsal in a virtual environment against an
intelligent virtual enemy, all in the safety and security of a classroom.
Developed in a partnership with MicroNav, Ltd., one of the world's leading
producers of air traffic control training software, the ATCT is a complete,
advanced 3D tower simulator for licensing, refresher training, and conversion
training.

The Simulation Group's products are marketed worldwide by E&S and qualified
distributors. Products and services are sold directly to end users by E&S as a
prime contractor, through simulator prime contractors with E&S acting as a
subcontractor, and through system OEMs. E&S continues to form both domestic and
international alliances with aerospace and simulation companies that dominate
their respective market segments. Such strategic alliances have proved to be an
effective method for accessing specific markets. In addition, we have OEM and
Value Added Reseller agreements with several major distributors in Europe and
Asia.

COMPETITIVE CONDITIONS

Primary competitive factors for the Simulation Group's products are
performance, price, service, and product availability. Because competitors are
constantly striving to improve their products, the group must ensure that it
continues to offer products with the best performance at a competitive price.
Prime contractors, including Lockheed Martin, Flight Safety International (FSI),
Thales Training & Simulation Ltd., and CAE Electronics, Ltd. (CAE), offer
competing visual systems in the simulation market. We believe we are able to
compete effectively in this environment and will continue to be able to do so in
the foreseeable future. In 2001, the group was awarded several highly
competitive orders against FSI and CAE, the principal competitors in the
commercial simulation market. In the military simulation market, the group
competes primarily with Silicon Graphics, Inc. and CAE. In the low-cost,
PC-based market, our simFUSION product competes against companies that focus on
PC simulation using graphics accelerator cards, such as Quantum 3D.

In February 2001, a team of industry leaders led by Evans & Sutherland was
selected by the U.S. Army Simulation, Training, and Instrumentation Command
(STRICOM) to receive an Indefinite Delivery/Indefinite Quantity (ID/IQ)
contract. Under the terms of the contract, the E&S team is prequalified to bid
as a prime contractor on STRICOM contracts valued at up to $4 billion over the
next eight years.

A team comprised of E&S and others is one of 17 prime contractor teams
selected by STRICOM for the Virtual Domain, one of four business domains that
include Constructive, Live, and Test-Instrumentation. Core members of the E&S
team include Cubic Applications, Inc., CACI, J.F. Taylor, Inc., Raydon, and MTI.
The team also includes 13 subcontractors with extensive backgrounds in military
simulation.

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E&S is also a member of two contractor teams selected by STRICOM last fall
for the Constructive Domain. These key contract awards position Evans &
Sutherland to provide its state-of-the-art visual systems support, including
image generation, display systems, and database development, for future STRICOM
programs.

BACKLOG

The Simulation Group's backlog was $104.2 million on December 31, 2001,
compared with $134.6 million on December 31, 2000. It is anticipated that
approximately two-thirds of the 2001 backlog will be converted to sales in 2002.

BUSINESS SUBJECT TO GOVERNMENT CONTRACT RENEGOTIATION

A significant portion of the Simulation Group's business is dependent on
contracts and subcontracts associated with government business. The U.S.
Government, and other governments, may terminate any of our government contracts
and, in general, subcontracts, at their convenience as well as for default based
on performance. If any of our government contracts were to be terminated for
convenience, we generally would be entitled to receive payment for work
completed and allowable termination or cancellation costs.

Upon termination for convenience of a fixed-price type contract, we normally
are entitled, to the extent of available funding, to receive the purchase price
for delivered items, reimbursement for allowable costs for work-in-progress and
an allowance for profit on the contract or adjustment for loss if completion of
performance would have resulted in a loss. Upon termination for convenience of a
cost reimbursement contract, we normally are entitled, to the extent of
available funding, to reimbursement of allowable costs plus a portion of the
fee. The amount of the fee recovered, if any, is related to the portion of the
work accomplished prior to termination and is determined by negotiation.

U.S. government contracts also are conditioned upon the continuing
availability of Congressional appropriations. Long-term government contracts and
related orders are subject to cancellation if appropriations for subsequent
performance periods become unavailable. Congress usually appropriates funds on a
fiscal-year basis even though contract performance may extend over many years.
Consequently, at the outset of a program, the contract is usually partially
funded, and Congress annually determines if additional funds are to be
appropriated to the contract.

REALIMAGE SOLUTIONS GROUP

The REALimage Solutions Group was sold to Japan-based Real Vision, Inc., in
September 2001. As part of Real Vision, the group is continuing to develop the
"Studio-on-a-Chip" technology, which brings together real-time graphics and
video in a unique and effective way to support all aspects of visual content
creation for broadcasting and netcasting applications. The sale was for a
maximum value of $12 million, consisting of cash of $6.3 million plus future
royalties, on a when and if earned basis, up to $6 million for REALimage
technology, other assets, and the performance of certain development support
during a seven-month transition period leading to closing the transaction in
April 2002. Real Vision has indicated it will continue the development of the
technology, and E&S is maintaining a technical staff to support Real Vision in
Salt Lake City during the transition period. Shortly after the sale of the
REALimage Group, E&S closed its offices in Seattle, Washington, and San Jose,
California.

PRODUCTS & MARKETS

Prior to 2002, the REALimage Solutions Group developed and sold graphics
chips and graphics subsystems for professional PC workstations. Early in 2000,
the group's strategic focus changed from development and manufacture of graphics
accelerator cards for professional digital content creation customers to
development of the next generation REALimage chip, the RI 5000. This chip,
referred to

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as "Studio-on-a-Chip", brings together both graphics and video processing
technology on a single chip for digital video content creation and
post-production.

The group also began to establish a new application and market for REALimage
technology in 2000 when REALimage chips were selected by Honeywell for use in
cockpit navigation systems for military aircraft and business jets.

COMPETITIVE CONDITIONS

Due to the sale of the REALimage Solutions Group to Real Vision, Inc. of
Japan, we do not compete in this industry or market any longer.

BACKLOG

Because of the shift in strategic focus, the in-process development of the
new RI 5000 chipset, and the sale of REALimage, the group has no backlog as of
December 31, 2001, compared to $0.7 million as of December 31, 2000.

APPLICATIONS GROUP

The Applications Group is composed of synergistic businesses that use E&S
core technology in growth markets. The group's products are applications that
leverage E&S's technology and apply them to other growth markets. After these
applications have been developed and produced, our strategy is to spin them off
or sell them to companies involved in complementary businesses.

PRODUCTS & MARKETS

The Applications Group's digital theater products include hardware,
software, and content for both the entertainment and educational marketplaces.
Digital theater focuses on immersive all-dome theater applications combining
colorful, digitally produced imagery, full-spectrum audio, and audience-
participation capability. The group provides turnkey solutions incorporating
visual systems and subsystems from the Simulation Group. E&S integrates these
systems with projection equipment, audio components, and audience-participation
systems from other suppliers. Products include Digistar-Registered Trademark-
II, a calligraphic star projection system designed to compete with analog star
projectors in planetariums, and StarRider-Registered Trademark-, a full-color,
domed theater experience available in interactive or video playback formats. The
Applications Group is a leading supplier of digital display systems in the
planetarium marketplace. In addition to projection and theater systems, the
Applications Group develops and markets show content for planetariums and domed
theaters.

In 2001, the Applications Group achieved several important milestones. The
Applications Group launched its second interactive show called Crack the Cosmic
Code. The show debuted at the StarRider theater at Exploration Place in Wichita,
Kansas. The Applications Group continued its development of its new product,
which will be launched in the first half of 2002, as well as several new domed
theater shows, which are available to theaters around the world for licensing.

In 2001, the Applications Group continued to expand the market for E&S
RAPIDsite-TM-. E&S RAPIDsite is a photorealistic visualization tool designed for
use by real-estate developers, consulting engineers, architects, and municipal
planners involved with all types of land development projects. RAPIDsite
features fast 3D-model construction, accelerated graphics rendering performance
and easy-to-use interactive exploration of a proposed development on a Windows
NT computer with an OpenGL graphics accelerator.

Throughout 2001, we had been actively seeking sale or spin-off opportunities
for our RAPIDsite-TM- visualization solutions business which is part of the
Applications Group. The general economic

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downturn made it difficult to sell this business. In December, we decided to
discontinue the RAPIDsite business.

COMPETITIVE CONDITIONS

Primary competitive factors for the Applications Group's products are
functionality, performance, price, and access to customers and distribution
channels. Our digital theater products compete with traditional
optical-mechanical products and digital display systems offered by Minolta
Planetarium Co. Ltd., GoTo Optical Mfg. Co., Carl Zeiss Inc., Spitz, Inc.,
Trimension, Inc. and Sky-Skan, Inc.

BACKLOG

The Applications Group's backlog was $2.7 million December 31, 2001,
compared with $7.4 million on December 31, 2000. It is anticipated that most of
the 2001 backlog will be converted to sales in 2002.

SIGNIFICANT CUSTOMERS

Worldwide customers using E&S products include U.S. and international armed
forces, NASA, aerospace companies, most major airlines, laboratories, museums,
planetariums, and science centers.

Sales to the U.S. government, either directly or indirectly through sales to
prime contractors or subcontractors, accounted for $69.5 million or 48% of total
sales, $66.7 million or 40% of total sales, and $84.5 million or 42% of total
sales in 2001, 2000, and 1999, respectively. Sales to the United Kingdom
Ministry of Defense, either directly or indirectly through sales to prime
contractors or subcontractors, accounted for $13.6 million or 9% of total sales,
$22.3 million or 13% and $33.8 million or 17% of total sales in 2001, 2000 and
1999, respectively.

In 2001, sales to Thales Training & Simulation Ltd. totaled $23.9 million or
16.4% of total sales of which 57% related to U.S. government and United Kingdom
Ministry of Defence contracts and sales to The Boeing Company totaled
$15.1 million or 10% of total sales of which 100% related to U.S. government and
United Kingdom Ministry of Defence contracts.

In 2000, sales to Lockheed Martin Corporation were $22.5 million or 14% of
total sales, of which 100% related to U.S. government and United Kingdom
Ministry of Defence contracts and sales to Thales Training & Simulation Ltd.
were $19.6 million or 12% of total sales, of which 58% related to United Kingdom
Ministry of Defence contracts.

In 1999, sales to Lockheed Martin Corporation were $35.8 million or 18% of
total sales, of which 100% related to U.S. government and United Kingdom
Ministry of Defence contracts and sales to The Boeing Company were
$25.4 million or 13% of total sales, of which 100% related to U.S. government
and United Kingdom Ministry of Defence contracts.

All of our sales to significant customers are within the Simulation Group.

DEPENDENCE ON SUPPLIERS

Most of our current parts and assemblies are readily available through
multiple sources in the open market; however, a limited number are available
only from a single source. In these cases, we stock a substantial inventory, or
obtain the agreement of the vendor to maintain adequate stock for future
demands, and/or attempt to develop alternative components or sources where
appropriate.

On June 3, 1999, we entered into an electronic manufacturing services
agreement with Sanmina Corporation (now Sanmina-SCI). The agreement commits us
to purchase a minimum of $22 million of electronic products and assemblies from
Sanmina-SCI each year until June 3, 2002. If we fail to meet these minimum
purchase levels, subject to adjustment, we may be required to pay 25 percent of
the

12

difference between the $22 million and the amount purchased. We have fully
satisfied the requirements of this contract, which ends in June 2002. Various
alternatives, which include a renewed contract with Sanmina-SCI, are being
evaluated.

SEASONALITY

E&S believes there is no inherent seasonal pattern to its business. Sales
volume fluctuates quarter-to-quarter due to relatively large and nonrecurring
individual sales and customer-established shipping dates.

INTELLECTUAL PROPERTY

E&S owns a number of patents and trademarks and is a licensee under several
others. In the U.S. and internationally, we hold active patents that cover many
aspects of our graphics technology. Several patent applications are presently
pending in the U.S., Japan, and several European countries, and other patent
applications are in preparation. E&S actively pursues patents on its new
technology. E&S routinely copyrights software, documentation, and chip masks
designed by us and institutes copyright registration for such software,
documentation, and masks when appropriate.

RESEARCH & DEVELOPMENT

E&S considers the timely development and introduction of new products to be
essential to maintaining its competitive position and capitalizing on market
opportunities. Our research and development expenses were $28.8 million,
$44.3 million, and $44.4 million in 2001, 2000, and 1999, respectively. As a
percentage of sales, research and development expenses were 20%, 27%, and 22% in
2001, 2000, and 1999, respectively. We continue to fund substantially all
research and development efforts internally. It is anticipated that high levels
of research and development will be needed to continue to ensure that we
maintain technical excellence, leadership, and market competitiveness. However,
due to the sale of the REALimage Solutions Group, the discontinuation of the
RAPIDsite business and the reduction of effort required to develop our Harmony
and iNTegrator products, management expects that the total research and
development spending necessary to continue the timely development of products
will be lower in 2002 than in 2001.

INTERNATIONAL SALES

Sales of products known to be ultimately installed outside the United States
are considered international sales by E&S and were $49.5 million,
$60.9 million, and $86.7 million in 2001, 2000, and 1999, respectively.
International sales represented 34%, 36%, and 43% of total sales in 2001, 2000,
and 1999, respectively. For additional information, see Note 19 of Notes to
Consolidated Financial Statements included in Part II of this annual report.

EMPLOYEES

As of March 1, 2002, Evans & Sutherland and its subsidiaries employed a
total of 724 persons compared to 847 employees as of March 2, 2001. We believe
our relations with our employees are good. None of our employees is subject to
collective bargaining agreements.

ENVIRONMENTAL STANDARDS

We believe our facilities and operations are within standards fully
acceptable to the Environmental Protection Agency and that all facilities and
procedures are in accordance with environmental rules and regulations, and
international, federal, state, and local laws.

13

STRATEGIC RELATIONSHIPS

In October 2001, we announced an agreement with NVIDIA-Registered Trademark-
Corporation. As part of this agreement, NVIDIA Corporation acquired certain key
3D-graphics patents from E&S and the companies agreed to a broad cross-license
of technologies.

This agreement with NVIDIA allows E&S to leverage its general graphics
technology into high volume markets, while adding new capabilities including
NVIDIA's programmable Shader technology to E&S's base of unique technology and
patents for the simulation industry.

During the fourth quarter of 2001, E&S entered into a multiyear agreement
with graphics technology leader ATI Technologies Inc., under which ATI will
provide graphics accelerator chips for our next-generation PC-based visual
systems. ATI chips will replace REALimage chips in E&S's next-generation
Ensemble and simFUSION image generators.

On July 22, 1998, Intel purchased 901,408 shares of E&S's preferred stock
plus a warrant to purchase an additional 378,462 shares of the preferred stock
at an exercise price of $33.28125 per share for approximately $24.0 million. In
March 2001, Intel converted the 901,408 shares of E&S's preferred stock into
901,408 shares of E&S's common stock. In March 2001, Intel and E&S amended the
preferred stock and warrant purchase agreement to terminate certain contractual
rights of Intel, including registration rights, board and committee observation
rights, right of first refusal, right of participation, right of maintenance,
standstill agreement, and right to require E&S to repurchase the preferred stock
in the event of any transaction qualifying as a specific corporate event. E&S
also entered into an agreement to accelerate development of high-end graphics
and video subsystems for Intel-based workstations in July 1998.

ACQUISITIONS AND DISPOSITIONS

Early in 2001, we announced our intention to spin out or sell our REALimage
Solutions Group. In the third quarter of 2001, E&S sold the REALimage Solutions
Group to Real Vision, Inc., a Japanese company that has been a partner with E&S
in the development of technology for professional video applications. The sale
was for a maximum value of $12 million, consisting of cash of $6.3 million plus
future royalties, on a when and if earned basis, up to $6 million for REALimage
technology, other assets, and the performance of certain development support
during a seven-month transition period leading to closing the transaction in
April 2002. Real Vision has indicated it will continue the development of the
technology, and E&S is maintaining a technical staff to support Real Vision in
Salt Lake City during the transition period. As part of the sale of the
REALimage Group, E&S closed its offices in Seattle, Washington, and San Jose,
California.

In December 2000, we completed the divestiture of our German subsidiary via
a management-led buyout and recorded a loss of $0.3 million. The former
subsidiary, which was called Evans & Sutherland Computer GmbH, now operates
under a new name. The divested company has no remaining connection with E&S. We
will continue to operate in Germany and throughout Europe under our own name,
providing marketing, sales, and support for our growing visual systems business
and traditional customer base.

On March 28, 2000, we sold certain assets of our Application Group relating
to digital video products to RT-SET Real Time Synthesized Entertainment
Technology Ltd. and its subsidiary, RT-SET America Inc., for $1.4 million in
cash, common stock of RT-SET Real Time Synthesized Entertainment
Technology Ltd. valued at approximately $1.0 million, and the assumption of
certain liabilities. On June 15, 2000, we received additional common stock of
RT-SET Real Time Synthesized Entertainment Technology Ltd. valued at
$1.5 million related to the successful development of a product included in the
purchased assets.

14

On June 3, 1999, we sold certain of our manufacturing capital assets and
inventory of $6.0 million to Sanmina Corporation (now Sanmina-SCI) as part of
our efforts to outsource the production of certain electronic products and
assemblies. In addition, we entered into an electronic manufacturing services
agreement with Sanmina-SCI. The electronic manufacturing services agreement
commits us to purchase a minimum of $22.0 million of electronic products and
assemblies from Sanmina-SCI each year until June 3, 2002. If we fail to meet
these minimum purchase levels, subject to adjustment, we may be required to pay
25% of the difference between the $22.0 million and the amount purchased. We
have fully satisfied the requirements of this contract, which ends in
June 2002. Various alternatives, which include a renewed contract with
Sanmina-SCI, are being evaluated.

On June 26, 1998, E&S, through its wholly-owned subsidiary, Evans &
Sutherland Graphics Corporation ("ESGC"), acquired all of the outstanding stock
of AccelGraphics, Inc. ("AGI") to expand E&S's workstation graphics development,
integration and distribution within the workstation graphics marketplace. To
acquire AGI, E&S paid approximately $23.7 million in cash and 1,109,303 shares
of E&S's common stock, which was valued at $25.7 million. In addition, E&S
converted all outstanding AGI options into options to purchase approximately
351,000 shares of common stock of E&S with a fair value of $3.4 million and
incurred transaction costs of approximately $1.1 million.

To further expand E&S's presence within the workstation graphics
marketplace, on June 26, 1998, E&S acquired the assets and assumed certain
liabilities of Silicon Reality, Inc. ("SRI"), a designer and developer of 3D
graphics hardware and software products for the PC workstation marketplace. E&S
paid approximately $1.2 million and incurred transaction costs of approximately
$250,000.

ITEM 2. PROPERTIES

Evans & Sutherland's principal executive, engineering, manufacturing and
operations facilities for each of its business segments are located in the
University of Utah Research Park, in Salt Lake City, Utah, where it owns seven
buildings totaling approximately 450,000 square feet. E&S occupies four
buildings and leases one of the remaining three buildings to other businesses.
The remaining two buildings are vacant. We plan to sell the three buildings we
do not occupy. The buildings are located on land leased from the University of
Utah (the "U of U Property") with an initial term of 40-years or longer. Five of
the buildings have land leases that expire in 2030, with a ten-year renewal
option. The remaining two buildings have land leases that expire in 2012 and
2014 respectively, with 40-year renewal options. All of our interests in the U
of U Property are subject to a lien by Foothill Capital Corporation to secure
repayment of the borrowing facility as set forth in the Liquidity and Capital
Resources section of the Management's Discussion and Analysis of Financial
Condition and Results of Operations. E&S and its subsidiaries hold leases on
several sales, operations, service and production facilities located throughout
the United States, Europe and Asia, none of which is material to our
manufacturing, engineering or operating facilities. E&S believes that these
properties are suitable for its immediate needs and it does not currently plan
to expand its facilities or relocate.

ITEM 3. LEGAL PROCEEDINGS

LOCKHEED MARTIN CORPORATION V. EVANS & SUTHERLAND COMPUTER CORPORATION
(UNITED STATES (MIDDLE) DISTRICT COURT (FLORIDA), CASE NO. 6:00-CV-755-ORL-19C,
FILED ON MAY 23, 2000). On May 23, 2000, Lockheed Martin Corporation served E&S
with a civil complaint filed in the Circuit Court of the Ninth Judicial Circuit
in and for Orange County, Florida. Lockheed alleged in the complaint that we
breached a contract to provide certain visual systems for the Combined Arms
Tactical Trainer program for the United Kingdom Ministry of Defence. The
contract has an original value of $33.9 million. In the complaint, Lockheed
seeks compensatory damages of $8.5 million plus interest as well as
consequential damages and attorneys' fees. The $8.5 million being sought from
E&S by Lockheed was paid to us from May 1999 to March 2000 and was recognized as
revenue by us during 1999. On June 12, 2000, we filed our answer and
counterclaim. In the counterclaim, we allege as grounds for

15

recovery against Lockheed (1) breach of contract, (2) breach of implied covenant
of good faith and fair dealing, (3) unjust enrichment, (4) unfair competition,
(5) misappropriation of trade secrets, (6) intentional interference with
advantageous business relationship, (7) replevin, and (8) promissory estoppel.
In our counterclaim, we seek compensatory damages of not less than
$10.0 million and not more than $25.4 million.

On June 14, 2000, the case was removed to the Orlando Division of the United
States District Court for the District of Florida where it currently remains. On
July 7, 2000, Lockheed answered our counterclaim but also filed a motion for
dismissal of our counterclaims for unjust enrichment, unfair competition,
promissory estoppel, and incidental damages. On July 24, 2000, we filed our
opposition to Lockheed's motion to dismiss our counterclaims. On October 20,
2000 the court denied Lockheed's motion to dismiss in its entirety, without
prejudice. On January 16, 2001, we filed a motion for partial summary judgment,
asking the court to dismiss all of Lockheed's breach of contract claims. The
court denied that motion on August 30, 2001, citing the existence of material
disputed facts. On September 6, 2001 the court granted Lockheed's leave to amend
its complaint, which was filed on September 17, 2001. We filed a motion to
dismiss these new claims on October 4, 2001, and Lockheed has opposed it. The
court currently has that motion under advisement.

Discovery in the matter is scheduled to conclude on September 30, 2002. A
trial date is currently set for March, 2003. We dispute Lockheed's allegations
in the complaint, are vigorously defending the action, and are vigorously
prosecuting our counterclaims. Although management believes E&S will ultimately
prevail in the litigation, an unfavorable outcome of these matters would have a
material adverse impact on our financial condition and operations.

In the normal course of business, E&S has various other legal claims and
other contingent matters, including items raised by government contracting
officers and auditors. Although the final outcome of such matters cannot be
predicted, we believe the ultimate disposition of these matters would have a
material adverse effect on our consolidated financial condition, liquidity or
results of operations.

16

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth
quarter of fiscal year 2001.

EXECUTIVE OFFICERS OF THE REGISTRANT

The following sets forth certain information regarding the executive
officers of E&S as of March 1, 2002:

Mr. Oyler was appointed President and Chief Executive Officer of E&S and a
member of the Board of Directors in December 1994. He is also a director of Ikos
Systems, Inc. Before joining Evans & Sutherland, Mr. Oyler served as President
of AMG, Inc. from mid-1990 until December 1994, and a Senior Vice President for
Harris Corporation from 1976 through mid-1990. He has seven years of service
with E&S.

Mr. Figgins was appointed Vice President, Product Marketing, in
January 2002. He joined E&S as Vice President and General Manager, PC
Simulation, in April of 1998, and was appointed Vice President of the Simulation
Group in January 1999. In June 2001, he was appointed Vice President and
Operating Officer, Simulation Group. Before joining E&S, Mr. Figgins served as
Vice President of Business Development and Marketing for Raytheon Training,
where he was employed from May 1986 to April 1998. Mr. Figgins has over
25 years experience in the simulation and training industry and has held
increasingly responsible technical, marketing and management positions in small,
medium and large organizations with senior executive positions in the last
decade. Mr. Figgins is a graduate of Royal Air Force Halton and holds a M.S in
Management from Purdue University. He has four years of service with E&S.

Mr. Frazier was appointed Vice President, Strategic Visualization, in
January 2002. He joined E&S in September 1997 as Vice President, Programs. In
June of 1998, Mr. Frazier was appointed Vice President, Programs and Shared
Technology. In April of 1999, he was appointed Vice President and General
Manager, Systems. Mr. Frazier served as Vice President and General Manager of
Simulation Systems until June of 2001, when he was appointed Vice President and
Operating Officer for Simulation. Prior to his assignment at E&S, he was
Director, Technology Development and Advanced Programs at Lockheed Martin
Tactical Defense Systems. Before working with Lockheed Martin, he held
increasingly responsible assignments in Simulation for LORAL Corporation. He has
four years of service with E&S.

Mr. Thomas was appointed Vice President and Chief Financial Officer in
December 2000 and Corporate Secretary in February 2001. He became Treasurer in
January 2002. He joined E&S in

17

August 2000 as Vice President, Finance, for the Simulation Group. From May 1998
to August 2000, Mr. Thomas was Executive Vice President and Chief Financial
Officer for Edge Technologies, Inc. During the three year period from 1995 to
1998, Mr. Thomas was Chief Financial Officer for Stanley Aviation Corporation.
Previously, he was a Director of Finance for a Hughes Aircraft Company
subsidiary, Financial Executive and Strategic Planner for a Large Scale
Information Technology Business Unit, and Senior Business Manager and Assistant
Controller for multiple divisions of Hughes. Mr. Thomas was employed by Hughes
from 1982 to 1995. He has one year of service with E&S.

Mr. Atchison was appointed Vice President, Manufacturing, Service, and
Support, in October 2001. He joined E&S in 1998, when E&S acquired Silicon
Reality, Inc. in June 1998, and served as Director, Materials, until July of
1999, when he was appointed Vice President, Manufacturing. At Silicon Reality,
Mr. Atchison was Vice President, Operations, Chief Operating Officer, and Chief
Financial Officer from October 1997 to June 1998. Prior to Silicon Reality, he
was Vice President, Investor Relations and Business Development for Alphatec,
and managed production control for National Semiconductor/ Fairchild. He has
three years of service with E&S.

Mr. Gibbs is the Vice President and General Manager of the Simulation
Systems Business Unit. Prior to this role, he served as General Manager of the
Service and Support Division. He has also held management positions in Supply
Chain Management and Quality Assurance. Mr. Gibbs received a B.S. in Mathematics
from the University of Utah. Mr. Gibbs has been with E&S for over 15 years.

Mr. Flitton was appointed Vice President and General Manager for the
Commercial Simulation division of Evans & Sutherland in January 2002.
Mr. Flitton has been in the simulation industry since 1979, and has been with
E&S since 1994. His first assignment with E&S, was as UK Product Manager for the
Commercial Simulation group, followed by an 18-month assignment as Program
Manager for the E&S subsidiary Xionix Simulation, in Dallas TX. Mr. Flitton then
moved to the E&S Salt Lake City Headquarters and held the positions of US
Regional Program Manager and then Products Director for the Commercial Airline
group. His prior assignment was as the Product Manager for high-end IG systems
within the Simulation Systems Group in Salt Lake City. Prior to joining E&S,
Mr. Flitton served a full engineering apprenticeship with Rediffusion Simulation
in the UK. Mr. Flitton was Principal Engineer and then Group Leader of the
Visual Engineering Group of Rediffusion. Mr. Flitton has a BEng Hons in
Electo/Mechanical Engineering from the University of Brighton (UK) and an M.B.A.
from the University of Warwick (UK). He is also Member of The Royal Aeronautical
Society (MRAeS).

18

FORM 10-K

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

PRICE RANGE OF COMMON STOCK

Our common stock trades on The Nasdaq Stock Market under the symbol "ESCC."
The following table sets forth the range of the high and low sales prices per
share of our common stock for the fiscal quarters indicated, as reported by The
Nasdaq Stock Market. Quotations represent actual transactions in Nasdaq's
quotation system but do not include retail markup, markdown or commission.

APPROXIMATE NUMBER OF EQUITY SECURITY HOLDERS

On March 1, 2002, there were 657 shareholders of record of our common stock.
Because brokers and other institutions hold many of our shares on behalf of
shareholders, we are unable to estimate the total number of shareholders
represented by these record holders.

DIVIDENDS

We have never paid a cash dividend on our common stock, retaining our
earnings for the operation and expansion of our business. We intend for the
foreseeable future to continue the policy of retaining our earnings to finance
the development and growth of our business. The payment of dividends is
restricted under the terms of our credit facilities. See "Item 7--Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."

19

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The following selected financial data for the five fiscal years ended
December 31, 2001 are derived from our Consolidated Financial Statements. The
selected financial data should be read in conjunction with our Consolidated
Financial Statements and related notes included elsewhere in this annual report.
See also "Management's Discussion and Analysis of Financial Condition and
Results of Operations."

- ------------------------

(1) During 2001, we incurred an impairment loss of $0.2 million and
restructuring charges of $2.8 million. See Notes 1 and 21 of the Notes to
Consolidated Financial Statements included in Part II of this annual report.

(2) During 2000, we recorded deferred tax expense of $20.6 million as a result
of our decision to fully reserve net deferred tax assets due to cumulative
net operating losses and the cancellation of a significant contract and the
related complaint filed by Lockheed Martin Corporation.

(3) During 1999, we incurred a write-off of inventories of $13.2 million, an
impairment loss of $9.7 million and a restructuring charge of $1.5 million.
See Notes 1 and 21 of the Notes to Consolidated Financial Statements
included in Part II of this annual report.

(4) During 1998, we incurred a $20.8 million charge to expense acquired
in-process technology in connection with the acquisitions of
AccelGraphics, Inc. and Silicon Reality, Inc.

20

QUARTERLY FINANCIAL DATA (UNAUDITED)

(In thousands, except per share amounts)

- ------------------------

(1) Earnings per share are computed independently for each of the quarters
presented and therefore may not sum to the total for the year.

(2) During the third quarter of 2001, we recorded a restructuring charge of
$2.1 million and an income tax benefit of $2.0 million as a result of the
resolution of certain tax contingencies.

(3) During the fourth quarter of 2001, we recorded a $9 million gain on the sale
of certain patents. Also during this quarter, we recorded an impairment loss
of $0.2 million, a restructuring charge of $0.7 million and an income tax
benefit of $1.6 million as a result of the resolution of certain tax
contingencies.

(4) During the second quarter of 2000, we recorded a negative adjustment to
revenue of $10.9 million as a result of the cancellation of a significant
contract by Lockheed. Additionally, we recorded deferred tax expenses of
$20.6 million as a result of our decision to fully-reserve net deferred tax
assets due to cumulative net operating losses and the cancellation of a
significant contract and the related civil complaint filed by Lockheed.

(5) During the third quarter of 2000, we recorded a $6.7 million gain on the
sale of certain investment securities and a $1.9 million loss on available
for sale investment securities whose market value decline was determined to
be other than temporary.

(6) During the fourth quarter of 2000, we recorded a $5.9 million loss on
available for sale investment securities whose market value decline was
determined to be other than temporary.

21

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of sales and expenses during the reporting
period. Actual results could differ from those estimates. A summary of
significant accounting policies can be found in Note 1 to the consolidated
financial statements. We have identified the accounting policies which are
critical to our business and the understanding of our results of operation and
financial position.

REVENUE RECOGNITION

Revenue from long-term contracts which require significant production,
modification or customization is recorded using the percentage-of-completion
method, using the ratio of costs incurred to management's estimate of total
anticipated costs. Our estimates of total anticipated costs include assumptions,
such as estimated man-hours to complete, estimated materials costs, and
estimates of other direct and indirect costs. Actual results may vary
significantly from our estimates. If the actual costs are higher than
management's anticipated total costs, then an adjustment is required to reduce
the previously recognized revenue as the ratio of costs incurred to management's
estimate was overstated. If actual costs are lower than management's anticipated
total costs, then an adjustment is required to increase the previously
recognized revenue as the ratio of costs incurred to management's estimate was
understated.

COSTS AND ESTIMATED EARNINGS IN EXCESS OF BILLINGS ON UNCOMPLETED CONTRACTS AND
BILLINGS IN EXCESS OF COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS

Billings on uncompleted long-term contracts may be greater than or less than
incurred costs and estimated earnings and are recorded as an asset or liability
on the balance sheets. As revenue recognized on these long-term contracts
includes estimates of management's anticipated total costs, the amounts in costs
and estimated earnings in excess of billings on uncompleted contracts and
billings in excess of costs and estimated earnings on uncompleted contracts also
include these estimates.

INVENTORIES

Inventory amounts include materials at standard costs. Inventory also
includes inventoried costs on programs and long-term contracts which includes
direct engineering and production costs and applicable overhead, not in excess
of estimated realizable value, which have not yet been recognized as cost of
sales. We periodically review inventories for excess and obsolete amounts as
well as for amounts which are in excess of estimated realizable value, and
provide a reserve that we consider sufficient to cover these items. Assumptions
on which we estimate this reserve include future sales, pricing of future
products and estimates of total anticipated costs to complete projects. Changes
in any of these assumptions would result in adjustments to our operating
results.

ACCRUED EXPENSES

Accrued expenses include amounts for liquidated damages and late delivery
penalties on contracts on which we are late in delivering our products. (See
Note 8 to the consolidated financial statements). We have included all amounts
which management believes we are liable as of December 31, 2001. These
liquidated damages are based, in part, on our estimate of when we will complete
certain projects. To the extent delivery dates are not consistent with our
estimates, these liquidated damage

22

accruals may require additional adjustments. We are currently a party to
contracts which include further possible liquidated damages and late delivery
penalties.

LEGAL PROCEEDINGS

Lockheed Martin Corporation served us with a complaint on March 23, 2000
alleging breach of contract and is seeking $8.5 million in compensatory damages
plus interest as well as consequential damages and attorneys' fees. We believe
that a loss with respect to the $8.5 million collected from Lockheed as asserted
in their legal proceedings is remote and that no amount can be currently
estimated. As additional information becomes available, we will assess the
appropriateness of the accounting and reflect adjustments as considered
necessary. Although management believes we will ultimately prevail in the
litigation, an unfavorable outcome of these matters would have a material
adverse effect on our financial condition and liquidity.

INCOME TAXES

As part of the process of preparing our consolidated financial statements we
are required to estimate our actual income taxes in each of the jurisdictions in
which we operate. This involves estimating our actual current tax exposure
together with assessing temporary differences resulting from differing
treatments of items, such as accrued liabilities, for tax and accounting
purposes. These differences result in deferred tax assets and liabilities, which
are included in our consolidated balance sheet. We must then assess the
likelihood that our deferred tax assets will be recovered from future taxable
income and, to the extent we believe that recovery is not likely, we must
establish a valuation allowance. To the extent we establish a valuation
allowance or increase or decrease this allowance in a period, we must include a
corresponding adjustment within the tax provision in the statement of
operations. Significant management judgment is required to determine our
provision for income taxes, our deferred tax assets and liabilities and any
valuation allowance recorded against our net deferred tax assets.

ALLOWANCE FOR DOUBTFUL ACCOUNTS

The preparation of our financial statements requires us to make estimates
and assumptions that affect the reported amount of assets at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. We specifically analyze accounts receivable and consider
historic experience, customer creditworthiness, facts and circumstances specific
to outstanding balances, current economic trends and changes in our payment
terms when evaluating the adequacy of the allowance for doubtful accounts.
Changes in any of these factors may result in material differences in the
expense recognized for bad debts.

CERTAIN DEFENSE CONTRACTS

A significant factor in our financial performance is six large, fixed price
defense contracts which use our Harmony image generator. These six contracts
represented a significant portion of our $27.5 million net loss for the year
2001. We entered into these contracts between two and four years ago. However,
these six contracts are now 90% complete and we expect to have these contracts
essentially completed by 2002 year end.

23

RESULTS OF OPERATIONS

The following discussions should be read in conjunction with our
Consolidated Financial Statements contained herein under Item 8 of this annual
report.

2001 VS. 2000

SALES

In 2001, our total sales decreased $21.7 million, or 13% ($145.3 million in
2001 compared to $167.0 million in 2000). Sales in the Simulation Group declined
$14.6 million, or 10% ($135.3 million in 2001 compared to $149.9 million in
2000). Sales in the REALimage Solutions Group declined $4.0 million, or 70%
($1.7 million in 2001 compared to $5.7 million in 2000). Sales in the
Applications Group declined $3.1 million, or 27% ($8.2 million in 2001 compared
to $11.3 million in 2000). The primary reason for the decline in sales in the
Simulation Group is due to delays in government programs relating to our Harmony
image generator. In addition, the Simulation Group also experienced a decline in
sales volumes to its commercial airline customers. These declines more than
offset increases in the sales volumes of our simFUSION PC-based image generator
and support services. The decrease in the REALimage Solutions Group declined as
this group was sold during the third quarter of 2001. Sales in the Applications
Group declined due to lower sales volumes of our planetarium and large-format
entertainment products.

GROSS PROFIT

Gross profit was essentially unchanged in 2001 from 2000 (both
$29.4 million). As a percent of sales, gross profit increased to 20.3% in 2001
from 17.6% in 2000. Gross profit in the Simulation Group improved due to higher
sales volumes and lower costs of sales for support services and lower

24

costs of sales on sales to commercial airline customers. These improvements in
the Simulation Group were offset by lower sales to government customers and
higher costs of sales on sales of simFUSION PC-based image generators. The lower
sales to government customers was due to delays and cost over-runs on programs
involving our Harmony image generator. Gross profit in the Applications Group
increased as cost of sales decreased on sales of planetarium systems and higher
sales of our RAPIDsite real-estate planning tool.

SELLING, GENERAL AND ADMINISTRATIVE

Selling, general and administrative expenses decreased $4.3 million, or 13%
($30.1 million in 2001 compared to $34.4 million in 2000). As a percent of
sales, selling, general and administrative expenses increased to 20.7% in 2001
from 20.6% in 2000. These expenses decreased in the Simulation Group as the
result of lower headcount and lower incentive bonus expense. Selling, general
and administrative expenses decreased in the Application Group due to lower
headcount, lower commissions due to lower orders, lower advertising and lower
incentive bonus expense. The decrease in selling, general and administrative
expenses in 2001 is also partially due to all operating costs from April 1
through August 31, 2001 of $1.3 million associated with the REALimage Solutions
Group being recorded in the "REALimage transition costs" expense category.
Selling, general and administrative expenses were $31.4 million including the
$1.3 million of costs associated with the REALimage Solutions Group.

RESEARCH AND DEVELOPMENT

Research and development expenses decreased $15.5 million, or 35%
($28.8 million in 2001 compared to $44.3 million in 2000). As a percent of
sales, research and development expenses declined to 19.8% in 2001 from 26.5% in
2000. Research and development expenses in the Simulation Group declined during
2001 as a result of lower labor and related expenses as the effort required on
our Harmony, iNTegrator, Ensemble and PC-based simulation products has declined.
Research and development expenses in the Applications Group were essentially
unchanged. The decrease in research and development expenses in 2001 is also
partially due to all operating costs from April 1 through August 31, 2001
associated with the REALimage Solutions Group being recorded in the "REALimage
transition costs" expense category. Research and development expenses were
$32.7 million including these costs associated with the REALimage Solutions
Group. Due to the sale of the REALimage Solutions Group, the discontinuation of
the RAPIDsite business and the reduction of effort required to develop our
Harmony and iNTegrator products, management expects that the total research and
development spending necessary to continue the timely development of products
will be lower in 2002 than in 2001.

REALIMAGE TRANSITION COSTS

During the second quarter of 2001, we decided to sell the REALimage
Solutions Group. Accordingly, REALimage transition costs include all the
expenses associated with the REALimage Solutions Group that were incurred in the
second and third quarters of 2001. These costs totaled $5.3 million and were
3.6% of revenues for 2001. On August 31, 2001, we finalized an asset purchase
and intellectual property license agreement to sell the REALimage Solutions
Group to Real Vision, Inc. of Japan for a maximum value of $12.3 million which
is expected to close in April 2002. The consideration to E&S consisted of
$4.0 million cash, a receivable for $2.3 million which was paid in
December 2001, and future royalties payable on a when and if earned basis of up
to a maximum of $6.0 million. The consideration to Real Vision, Inc. consists of
REALimage technology, other assets, and an obligation from E&S to provide
certain development support of the REALimage technology during a seven-month
transition period concluding in April 2002. During 2000, no comparable
transition costs were incurred.

25

RESTRUCTURING CHARGE

During 2001, we initiated a restructuring plan focused on reducing the
operating cost structure of E&S. As part of the plan, we recorded a charge of
$2.8 million relating to a reduction in force of approximately 92 employees. We
estimate that this restructuring plan will reduce expenses by $8.2 million per
year going forward. As of December 31, 2001, we had paid $1.9 million in
severance benefits. The majority of the remaining benefits will be paid out over
the next two quarters. We also recognized a restructuring charge of
$1.5 million in 1999 and reversed $0.8 million of that charge in 2000. The
charge in 1999 was based on the expected costs related to the termination of 28
employees. The reversal of a portion of these charges in 2000 was the result of
certain of these employees being transferred within E&S rather than being
terminated and, therefore, these termination costs were not incurred. In
addition, estimated severance and related charges were lower than expected for
the terminated employees.

IMPAIRMENT LOSS

We recognized an impairment loss of $0.2 million in 2001 and there was no
such charge in 2000. The 2001 charge was 0.2% of sales. The impairment loss
related to the write-off of goodwill, acquired in our acquisition of
AccelGraphics, Inc. and Silicon Reality, Inc. in the second quarter of 1998.

GAIN ON SALE OF ASSETS HELD FOR SALE

In the fourth quarter of 2001, we recognized a gain of $9.0 million on the
sale of certain of our key 3D-graphics patents. This gain on sale of assets held
for sale was 6.2% of sales in 2001 and there was no such transaction in 2000.

GAIN ON SALE OF BUSINESS UNIT

We recognized a gain on sale of business unit of $0.8 million in 2001 and
$1.9 million in 2000. As a percent of sales the gain was 0.5% in 2001 and 1.1%
in 2000. The 2001 gain was the result of our sale of our REALimage Solutions
Group to Real Vision, Inc. of Japan. The sale was for a maximum value of
$12 million, consisting of cash of $6.3 million plus future royalties, on a when
and if earned basis, up to $6 million, for REALimage technology, other assets,
and the performance of certain development support during a seven-month
transition period leading to closing the transaction in April 2002. The 2000
gain was the result of our sale of certain assets of our Application Group
relating to its digital studio business to RT-SET Real Time Synthesized
Entertainment Technology Ltd. ("RT-SET") and its subsidiary, RT-SET
America Inc., for $1.4 million in cash, common stock of RT-SET and the
assumption of certain liabilities.

OTHER INCOME (EXPENSE), NET

Other income (expense), net improved by $1.4 million (an expense of
$2.6 million in 2001 compared to an expense of $4.0 million in 2000). The loss
on write-down of investment securities improved $7.5 million ($0.3 million in
2001 compared to $7.8 million in 2000). The losses in both years are the result
of other-than-temporary declines in the values of certain marketable investment
securities of E&S. The gain on sale of investment securities declined
$6.0 million ($0.5 million in 2001 compared to $6.5 million in 2000). The larger
gain in 2000 was primarily due to the sale of our investment in Silicon Light
Machines, Inc. to Cypress Semiconductor, Inc. ("Cypress") in which we received
Cypress stock. Interest income was essentially zero in 2001 compared to
$0.7 million in 2000. Interest expense increased $0.3 million to $2.5 million in
2001 from $2.2 million in 2000. The increase in net income expense was due to
lower average cash balances and higher average borrowing balances in 2001
compared to 2000.

26

INCOME TAXES

E&S recorded an income tax benefit of $3.2 million in 2001 compared to an
expense of $19.0 million in 2000. Income tax benefit of $3.2 million for 2001 is
primarily attributable to adjustments to prior year tax provisions as the result
of the resolution of certain worldwide tax contingencies. Included in this
amount is $0.6 million for withholding taxes paid in Japan for taxes associated
with the REALimage transaction. During the second quarter of 2000, we increased
our deferred tax asset valuation allowance by $20.6 million. As a result of
cumulative net operating losses, and the cancellation of a significant contract
and the related civil complaint filed by Lockheed as discussed in Note 14 to the
consolidated financial statements, we fully reserved our net deferred tax assets
which previously existed at the end of the first quarter of 2000 and those
deferred tax assets recognized during the second quarter of 2000. These net
deferred tax assets relate to temporary differences, tax credit carry forwards
and net operating loss carry forwards. The valuation allowance was recorded in
accordance with SFAS 109, which requires that a valuation allowance be
established when there is significant uncertainty as to the realizability of the
deferred tax assets. We evaluate the realizability of our deferred tax assets on
a quarterly basis. If the deferred tax assets are realized in the future, or if
a portion or all of the valuation allowance is no longer deemed to be necessary,
the related tax benefits will reduce future income tax provisions.

2000 VS. 1999

SALES

In 2000, our total sales decreased $33.9 million, or 17% ($167.0 million in
2000 compared to $200.9 million in 1999). Sales in the Simulation Group
decreased $20.7 million, or 12% ($149.9 million in 2000 compared to
$170.6 million in 1999). Sales in REALimage Solutions Group decreased
$16.3 million, or 74% ($5.7 million in 2000 compared to $22.0 million in 1999).
Sales in the Applications Group increased $3.0 million, or 36% ($11.3 million in
2000 compared to $8.3 million in 1999). The decrease in sales in the Simulation
Group is due to the cancellation of the contract with Lockheed Martin
Corporation for the delivery of visual systems to the United Kingdom Ministry of
Defence ("UK MOD") for the Combined Arms Tactical Trainer program ("UK CATT")
and an adjustment to revenue on percent complete contracts where a review of the
estimated costs to complete the contracts resulted in a negative adjustment to
revenue of $10.9 million in the second quarter of 2000. The decrease was
partially offset by increased sales volume of visual systems to commercial
airline customers, increased sales volumes of our simFUSION workstation-based
product and increased sales related to customer service and support contracts.
The decrease in sales in the REALimage Solutions Group is due to a decrease in
the number of units sold and decreased selling prices of existing products due
to increased competition and delays in the introduction of new products. The
increase in sales in the Applications Group is due to an increase in sales
volume of large-format entertainment products and planetarium systems which is
partially offset by decreased sales of our digital video products due to the
sale of this business to RT-SET Real Time Synthesized Entertainment
Technology Ltd. and its subsidiary RT-SET America Inc. (together "RT-SET") in
the first quarter of 2000.

GROSS PROFIT

Gross profit decreased $30.7 million, or 51% ($29.4 million in 2000 compared
to $60.1 million in 1999). As a percent of sales, gross profit decreased to
17.6% in 2000 from 29.9% in 1999. Gross profit in the Simulation Group in 2000
was negatively impacted by (i) the cancellation of the UK CATT contract due to
the loss of revenue and the write-off of obsolete and excess inventory specific
to the UK CATT contract, (ii) adjustment for estimated actual costs at
completion of contract on percent-complete contracts of $16.7 million
($10.9 million as a reduction in sales as discussed previously, and
$5.8 million as an increase in cost of sales relating to contracts with total
estimated actual costs that

27

exceed the contract value) and (iii) higher costs on several contracts to
government customers which include the Harmony image generator. Gross profit in
the REALimage Solutions Group decreased due to lower revenue attributed to a
decrease in the number of units sold and decreased selling prices of existing
products due to increased competition and delays in the introduction of new
products. Gross profit in the Applications Group increased due to increased
revenue from sales of large-format entertainment products and planetarium
systems which was partially offset by decreased sales of our digital video
products.

SELLING, GENERAL AND ADMINISTRATIVE

Selling, general and administrative expenses decreased $10.2 million, or 23%
($34.4 million in 2000 compared to $44.6 million in 1999). As a percent of
sales, selling, general and administrative expenses were 20.6% in 2000 compared
to 22.2% in 1999. The decrease in these expenses in the Simulation Group is due
primarily to lower marketing headcount, lower marketing consulting expenses and
lower marketing travel expenses. The decrease in these expenses in the REALimage
Solution Group is due to decreased sales volume resulting in decreased
commissions and other selling-related costs and decreased labor and associated
costs due to lower headcount as a result of the restructuring which took place
at the end of the third quarter of 1999. The decrease in these expenses in the
Applications Group is due to the reduction of employees and related expenses as
a result of the sale of certain assets of our digital video products business to
RT-SET.

RESEARCH AND DEVELOPMENT

Research and development expenses decreased $10.2 million, or 23%
($34.4 million in 2000 compared to $44.6 million in 1999). As a percent of
sales, research and development expenses were 20.6% in 2000 compared to 22.2% in
1999. Research and development expenses in the Simulation Group increased due to
increased efforts of the continued development of our simFUSION
workstation-based product and other value-priced simulation products. Research
and development expenses relating to the REALimage Solutions Group decreased due
to decreased headcount as a result of the group's restructuring at the end of
the third quarter of 1999.

AMORTIZATION OF GOODWILL AND OTHER INTANGIBLE ASSETS

Amortization of goodwill and other intangible assets decreased
$1.3 million, or 87% ($0.2 million in 2000 compared to $1.5 million in 1999).
The decrease in this expense was due to the write-off of $9.3 million of
goodwill and other intangible assets during the third quarter of 1999 in the
REALimage Solutions Group.

IMPAIRMENT LOSS

We recognized an impairment loss of $9.7 million in 1999 and related to the
write-down to fair value of goodwill, intangibles and other long-lived assets
acquired in our acquisitions of AccelGraphic, Inc. and Silicon Reality, Inc. in
the second quarter of 1998. The impairment consisted of the write-off of
$4.9 million of goodwill, $4.4 million of intangible assets and $0.4 million of
property, plant and equipment. There was no such charge in 2000.

RESTRUCTURING CHARGE

We recognized a restructuring charge of $1.5 million in 1999 and reversed
$0.8 million of that charge in 2000. The charge in 1999 was based on the
expected costs related to the termination of 28 employees. The reversal of a
portion of these charges in 2000 was the result of certain of these employees
being transferred within E&S rather than being terminated and, therefore, these
termination costs were not incurred. In addition, estimated severance and
related charges were lower than expected for the terminated employees.

28

GAIN ON SALE OF BUSINESS UNIT

During 2000, we sold certain assets of our Applications Group relating to
its digital video business and recognized $1.9 million of gain on the
transaction. See "Item 1--Business--Acquisitions and Dispositions." There was no
such event in 1999.

OTHER INCOME (EXPENSE), NET

Other income (expense), net was a net expense of $4.0 million in 2000
compared to a net income of $1.1 million in 1999. Interest income declined
$1.1 million, or 61% ($0.7 million in 2000 compared to $1.8 million in 1999).
The decline in interest income is due to lower average balances of cash, cash
equivalents and short-term investments in 2000 compared to 1999 and due to
interest income received in 1999 on delayed income tax refunds. Interest expense
increased $0.9 million or 69% ($2.2 million in 2000 compared to $1.3 million in
1999). The increase was due to higher average borrowing balances and a higher
average rate of interest paid on those borrowings in 2000 compared to 1999. Loss
on write-down of investment securities increased $7.4 million, or 1,850%
($7.8 million in 2000 compared to $0.4 million in 1999). The losses in both
years are the result of other-than-temporary declines in the values of certain
marketable investment securities of E&S. In 2000 we recognized $6.5 million gain
on the sale of investment securities. This gain was primarily due to the sale of
our investment in Silicon Light Machines, Inc. to Cypress in which we received
Cypress stock. There was no such event in 1999.

INCOME TAXES

Income tax expense (benefit) increased $34.4 million (expense of
$19.0 million in 2000 compared to a benefit of $15.4 million in 1999). During
the second quarter of 2000, we increased our deferred tax asset valuation
allowance by $20.6 million. As a result of the net operating loss in the second
quarter of 2000, the cumulative net operating losses for 2000, 1999 and 1998,
and the cancellation of a significant contract and the related civil complaint
filed by Lockheed as discussed in Note 14 to the consolidated financial
statements, we fully reserved our net deferred tax assets which previously
existed at the end of the first quarter of 2000 and those deferred tax assets
recognized during the second quarter of 2000. These net deferred tax assets
relate to temporary differences, tax credit carry forwards and net operating
loss carry forwards. The valuation allowance was recorded in accordance with
SFAS 109, which requires that a valuation allowance be established when there is
significant uncertainty as to the realizability of the deferred tax assets. We
evaluate the realizability of our deferred tax assets on a quarterly basis. If
the deferred tax assets are realized in the future, or if a portion or all of
the valuation allowance is no longer deemed to be necessary, the related tax
benefits will reduce future income tax provisions.

LIQUIDITY AND CAPITAL RESOURCES

At December 31, 2001, we had working capital of $54.5 million, including
cash, cash equivalents and restricted cash of $11.5 million, compared to working
capital of $75.1 million at December 31, 2000 including cash, cash equivalents,
short-term investments and restricted cash of $13.9 million. During 2001, we
used $28.2 million of cash in our operating activities, generated $12.4 million
of cash in our investing activities and generated $14.6 million of cash in our
financing activities.

Cash from our operating activities was provided by a $12.5 million decrease
in net costs and estimated earnings in excess of billings on uncompleted
contracts. The decrease in net costs and estimated earnings in excess of
billings on uncompleted contracts was due to the achievement of billing
milestones during the year and the adjustment to revenue on percent complete
contracts due to the change in estimated actual costs to complete the contracts.
Cash used in our operating activities included a $15.6 million decrease in
accounts payable and a $8.5 million decrease in accrued expenses.

29

Our investing activities included purchases of property, plant and equipment
of $6.6 million, proceeds from the sale of certain patents of $9.0 million,
proceeds from the sale of our REALimage Solutions Group of $6.3 million and
proceeds from sale of investment securities of $3.8 million.

Our financing activities during the year included net borrowings of
$13.0 million, proceeds from issuances of common stock of $0.4 million, and a
decrease in restricted cash of $1.2 million.

In December 2000, we entered into a secured credit facility (the "Foothill
Facility") with Foothill Capital Corporation ("Foothill"). The Foothill Facility
provides for borrowings and the issuance of letters of credit up to
$30.0 million. On February 22, 2002, E&S and Foothill amended the Foothill
Facility whereby Foothill waived all events of financial covenant default
through December 31, 2001 and revised E&S's 2002 financial covenants. The
Foothill Facility expires in December 2002. Borrowings under the Foothill
Facility bear interest at the Wells Fargo Bank National Association prevailing
prime rate plus 1.5% to 3.0%, depending on the amount outstanding. The Foothill
Facility provides Foothill with a first priority perfected security interest in
substantially all of our assets, including, but not limited to, all of our
intellectual property. Pursuant to the terms of the Foothill Facility, all cash
receipts of E&S must be deposited into a Foothill controlled account. The
Foothill Facility, among other things, (i) requires E&S to maintain certain
financial ratios and covenants, including a minimum tangible net worth that
adjusts each quarter, a minimum unbilled receivables to billed receivables
ratio, and a limitation of $12.0 million of aggregate capital expenditures in
any fiscal year; (ii) restricts our ability to incur debt or liens; sell,
assign, pledge or lease assets; merge with another company; and (iii) restricts
the payment of dividends and repurchase of any of our outstanding shares without
the prior consent of the lender. Due to Foothill's waiver on February 22, 2002
of E&S's noncompliance with financial covenants through December 31, 2001 and
the modification of the financial covenants, we are currently in compliance with
our financial covenants and ratios, although a continuation of recent negative
trends could impact future compliance with such covenants. Should the need
arise, we will negotiate with Foothill to modify and expand various financial
ratios and covenants, however no assurance can be given that such negotiations
will result in modifications that will allow us to continue to be in compliance
or otherwise be acceptable to us. E&S will need to replace the Foothill Facility
on or before December 14, 2002. In the event E&S is not able to obtain an
acceptable credit facility to replace the Foothill Facility on or before
December 14, 2002, E&S may be unable to meet its anticipated working capital
needs, routine capital expenditures, and current debt service obligations on a
short-term and long-term basis. As of December 31, 2001, we have $15.7 million
in outstanding borrowings and $6.0 million in outstanding letters of credit
under the Foothill Facility. Since the end of 2001, we have progressed against
the facility, and as of March 12, 2002 have $6.1 million in outstanding debt and
$4.8 million in outstanding letters of credit.

Evans & Sutherland Computer Limited, a wholly-owned subsidiary of Evans &
Sutherland Computer Corporation, has a $3.0 million overdraft facility (the
"Overdraft Facility") with Lloyds TSB Bank plc ("Lloyds"). Borrowings under the
Overdraft Facility bear interest at Lloyds' short-term offered rate plus 1.75%
per annum. As of December 31, 2001, there were $4.9 million in outstanding
borrowings. As of March 12, 2002, we had fully paid-off the outstanding balance.
The Overdraft Facility is subject to reduction or demand repayment for any
reason at any time at Lloyds' discretion and expires on November 30, 2002.
Evans & Sutherland Computer Limited executed a letter of negative pledge in
favor of Lloyds whereby it agreed not to sell or encumber its assets, except in
the ordinary course of business. Covenants contained in the Overdraft Facility
restrict dividend payments from Evans & Sutherland Computer Limited and require
maintenance of certain financial covenants. In addition, at December 31, 2001,
we have $0.9 million of cash on deposit with Lloyds in a restricted cash
collateral account to support certain obligations that the bank guarantees.

In July 2000, we formed a joint venture with Quadrant Group plc known as
Quest Flight Training Limited ("Quest"). Quest provides certain equipment,
software, training and other goods and services to the Secretary of State for
Defence of the U.K. Ministry of Defence and other related governmental

30

entities with regard to an upgrade of the Ministry of Defence E3D Facility and
E3D Sentry Aircrew Training Services. In connection with the services of Quest
to the U.K. Ministry of Defence, we guaranteed various obligations of Quest.
Some of our guaranteed obligations are without any maximum amount. We believe
that the guarantees we isssued in connection with this project will not be
called upon for payment or performance; however, no assurance can be made that
we will not be obligated to satisfy the obligations of the guarantees.

As of December 31, 2001, we had approximately $18.0 million of 6%
Convertible Subordinated Debentures due in 2012 (the "6% Debentures"). The 6%
Debentures are unsecured and are convertible at each bondholder's option into
shares of our common stock at a conversion price of $42.10 or 428,000 shares of
our common stock, subject to adjustment. The 6% Debentures are redeemable at our
option, in whole or in part, at par.

On February 18, 1998, our Board of Directors authorized the repurchase of up
to 600,000 shares of our common stock, including the 327,000 shares still
available from the repurchase authorization approved by the Board of Directors
on November 11, 1996. On September 8, 1998, our Board of Directors authorized
the repurchase of an additional 1,000,000 shares of our common stock. Between
February 18, 1998 and December 31, 1999, we repurchased 1,136,500 shares of our
common stock, leaving 463,500 shares available for repurchase as of March 12,
2002. We did not repurchase any shares of our stock during 2001. Stock may be
acquired on the open market or through negotiated transactions. Under the
program, repurchases may be made from time to time, depending on market
conditions, share price and other factors. The Foothill Facility requires that
we obtain prior consent from Foothill before we repurchase any shares.

We also maintain trade credit arrangements with certain of our suppliers.
The unavailability of a significant portion of, or the loss of, the various
borrowing facilities of E&S or trade credit from suppliers would have a material
adverse effect on our financial condition and operations.

In the event our various borrowing facilities were to become unavailable, we
were unable to make timely deliveries of products pursuant to the terms of
various agreements with third parties, or certain of our contracts were
adversely impacted for failure to meet delivery requirements, we may be unable
to meet our anticipated working capital needs, routine capital expenditures, and
current debt service obligations on a short-term and long-term basis.

We believe that the principal sources of liquidity for 2002 will be a result
of cash flows from operations and proceeds on the sale of certain of our
buildings which, subsequent to December 31, 2001, have been designated by
management as assets to be disposed of. Positive cash flows from operations
during 2002 are largely expected as a result of the restructuring which has
taken place, the progress to date on our Harmony image generator fixed-price
contracts and other cost-cutting measures which will be implemented during 2002.
Circumstances that could materially affect liquidity in 2002 include, but are
not limited to, the following: (i) our ability to meet contractual milestones
related to the delivery and integration of our Harmony image generators,
(ii) our ability to successfully develop and produce new technologies and
products, (iii) our ability to meet our forecasted sales levels during 2002,
(iv) our ability to reduce costs and expenses, (v) our ability to maintain our
commercial simulation business in light of current economic conditions and
(vi) our ability to favorably negotiate sale agreements related to certain of
our buildings.

Management believes that existing cash, cash equivalents, borrowings
available under our various borrowing facilities, other asset-related cash
sources and expected cash from future operations will be sufficient to meet our
anticipated working capital needs, routine capital expenditures and current debt
service obligations for the next twelve months. The Foothill Facility expires in
December 2002 and the Overdraft Facility expires on November 30, 2002. We
anticipate the need to replace these credit facilities; however, there can be no
assurances that we will be successful in renegotiating our existing borrowing
facilities or obtaining additional debt or equity financing. Our cash and cash
equivalents,

31

subject to various restrictions previously set forth, are available for working
capital needs, capital expenditures, strategic investments, mergers and
acquisitions, stock repurchases and other potential cash needs as they may
arise.

EFFECTS OF INFLATION

The effects of inflation were not considered material during fiscal years
2001, 2000 and 1999, and are not expected to be material for fiscal year 2002.

ACQUIRED IN-PROCESS TECHNOLOGY

In connection with the acquisitions of AGI and SRI, we made allocations of
the purchase price to various acquired in-process technology projects. These
amounts were expensed as non-recurring charges in the quarter ended June 26,
1998 because the acquired in-process technology had not yet reached
technological feasibility and had no future alternative uses.

Failure to complete the development of these projects in their entirety, or
in a timely manner, has had a material adverse impact on E&S's results of
operations. We recorded an impairment loss of $0.2 million relating to the
remaining balance of goodwill at the time of the sale of the REALimage Solutions
Group, in the third quarter of 2001. During the third quarter of 1999, we
recorded an impairment loss of $9.7 million consisting of a write-off of
$4.9 million of goodwill, $4.4 million of intangible assets and $0.4 million of
property, plant and equipment. Actual sales, operating profits and cash flows
attributable to acquired in-process technology have been significantly lower
than the original projections used to value such technology in connection with
each of the respective acquisitions. On-going operations and financial results
for the acquired technology and E&S as a whole are subject to a variety of
factors which may not have been known or estimable at the date of such
acquisitions, and the estimates discussed below should not be considered our
current projections for operating results for the acquired businesses or E&S as
a whole. Following is a description of the acquired in-process technology and
the estimates made by E&S for each of the technologies.

MID-RANGE PROFESSIONAL GRAPHICS SUBSYSTEM (2100). This technology is a
graphics subsystem with built in VGA core and integral DMA engines. This
technology provides superior graphics performance over previous
technologies, and includes features such as stereo and dual monitor support
and various texture memory configurations. The technology is used in the
AccelGALAXY product, which was completed and began shipping to customers in
late third quarter of 1998. The cost to complete this project subsequent to
the acquisition of AGI was $0.3 million, $0.1 million over the budgeted
amount and was funded by working capital. The project was also completed a
month later than scheduled. The assigned value for this acquired in-process
technology was $6.1 million.

CAD-FOCUSED PROFESSIONAL GRAPHICS SUBSYSTEM (1200). This technology is a
graphics subsystem with lower costs compared to the mid-range technology,
resulting in a more cost-effective graphics solution for the end-user. It
provides the cost sensitive user with adequate graphics performance, with
few features and a single texture configuration option. The technology is
used in the E&S Lightning 1200 product, which was completed in March 1999
and began shipping to customers in April 1999. The cost to complete this
project subsequent to the acquisition of AGI was $0.5 million, $0.2 million
over the budgeted amount and was funded by working capital. This project was
completed five months later than originally projected. The assigned value
for this acquired in-process technology was $6.2 million.

MULTIPLE-CONTROLLER GRAPHICS SUBSYSTEMS (2200). This technology is a
high-end graphics subsystem involving the parallel use of two or four
controllers. This technology is aimed at super users in the graphics area
who need significant increases in performance and features to accomplish
their tasks and are willing to pay the increased price necessary to support
those

32

requirements. During the third quarter of 1999, we determined the technology
and graphics subsystem, as originally designed, would not be a viable
product in the workstation marketplace. The cost to complete this project
subsequent to the acquisition of AGI was $1.7 million. The project was
completed in the fourth quarter of 1999, approximately 9 months later than
planned. This project was funded by working capital. The assigned value for
this acquired in-process technology was $2.7 million.

ON-BOARD GEOMETRY ENGINE GRAPHICS SUBSYSTEM (ACCELGMX). This technology is
a mid-range graphics subsystem with a geometry engine on board. This
technology is aimed at the performance intensive graphics end-user. It has
fewer features than the mid-range professional technology, but faster
geometry performance compared to the mid-range professional technology on
Pentium II processors. This technology was completed in the third quarter of
1998 and the AccelGMX product that uses this technology began shipping to
customers at that time. The cost to complete this project subsequent to the
acquisition of AGI was $0.1 million and was funded by working capital. The
assigned value for this acquired in-process technology was $5.3 million.

The AccelGALAXY performed below sales estimates due to the delay in our
product introduction by E&S and a delayed design win at one major OEM. These
delays, in addition to increased competition, caused an erosion of approximately
50% of the projected average selling price for the AccelGALAXY and a loss of
projected unit sales. Subsequent to our acquisition of AGI, the developer of the
chip used on the AccelGMX also acquired a board company and entered the graphics
accelerator market in direct competition with the AccelGMX. Due to the advantage
of producing the chip, the competitor can produce a comparable product at a
lower cost; thus, the AccelGMX has performed below sales estimates and we no
longer expects to generate significant sales from this product. The E&S
Lightning 1200 performed below sales estimates due to the delay in our product
introduction. As a result of the delay in product introduction, most
OEMs selected a competing product. The expected sales volume and average selling
price of the E&S Lightning 1200 have been significantly reduced. At the time of
the sale of the REALimage Solutions Group in the third quarter of 2001, sales of
all the group's products had decreased to nominal levels.

We periodically review the value assigned to the separate components of
goodwill, intangibles and other long-lived assets through comparison to
anticipated, undiscounted cash flows from the underlying assets to assess
recoverability. The assets are considered to be impaired when the expected
future undiscounted cash flows from these assets do not exceed the carrying
balances of the related assets. Based on the events described above and in
accordance with SFAS 121 during the third quarter of 1999 we recorded an
impairment loss of $9.7 million related to the acquisition of AGI and SRI. The
impairment loss consisted of the write-off of $4.9 million of goodwill,
$4.4 million of intangible assets and $0.4 million of property, plant and
equipment. We recorded an impairment loss of $0.2 million relating to the
remaining value of goodwill at the time of the sale of the REALimage Solutions
Group in the third quarter of 2001.

OUTLOOK

2002 is expected to be a year that returns E&S to a focus on its core
business. This encompasses visualization systems, components, spares, repairs,
and training for the simulation marketplace. Our focus is a function of the sale
of the REALimage Solutions Group in 2001 and closing down the RAPIDsite business
in 2001. Implicit in these changes is a consolidation of the business base.
Revenues are expected to contract by 10% from the $145 million mark set in 2001.
However, a more focused management team coupled with core product offerings is
expected to revive our financial performance through higher margin business. New
2001 core business bookings, averaging greater than 40% gross margin, have
positioned our year-end backlog, of $104 million, to support this improvement.

Our main near-term challenge continues to be the completion of our initial
Harmony programs (referred to as the "Big 6 Programs"). We did make significant
progress on these programs during

33

2001. Our return to profitability, on a quarter-by-quarter basis, is dependent
in large part on the successful execution of these programs in the first half of
2002. Year-to-date 2002, milestones are being met, a majority of first unit
systems have passed testing, and several are already in training. Combined, the
Big 6 Programs are in excess of 90% complete. In looking towards the second half
of the year when these programs are expected to be essentially complete, we
believe that the financial posture will be much improved. Cash generation for
the second half of 2002 is expected to increase to a level of $5 million per
quarter from operations and profits are expected to be produced.

The foregoing contains "forward-looking statements" within the meaning of
that term in Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Exchange Act of 1934, as amended, including, among others,
those statements preceded by, followed by or including the words "estimates,"
"believes," "expects," "anticipates," "plans," "projects," and similar
expressions.

These forward-looking statements include, but are not limited to, the
following statements:

- the successful execution of the Big 6 programs by the end of 2002;

- we will generate $5 million of cash per quarter and will be profitable in
the second half of 2002;

- projections of sales and net income and issues that may affect sales or
net income;

- projections of capital expenditures;

- plans for future operations;

- financing needs or plans;

- plans relating to our products and services;

- Simulation Group will experience growth in its markets as simulation
training increases in value as