Back to GetFilings.com

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-K

(Mark One)

For the fiscal year ended March 31, 2003

OR

Commission File Number 333-13105

Firearms Training Systems, Inc.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (770) 813-0180

Name of exchange on which registered:

None

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

Class A Common Stock, $0.000006 par value per share

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 the 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.    x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).    Yes  ¨    No  x

The aggregate market value of the 9,853,598 shares of Common Stock held by non-affiliates of the registrant computed by reference to the last sale price on the Over-The-Counter Bulletin Board as of September 30, 2002 (the last business day of the registrant’s most recently completed second fiscal quarter) was $5,123,870.

As of June 25, 2003, there were issued and outstanding 70,153,139 shares of Common Stock, par value $0.000006 per share.

DOCUMENTS INCORPORATED BY REFERENCE

Part III—The Registrant’s definitive Proxy Statement for its Annual Meeting of Shareholders’ presently scheduled to be held in August 2003, is incorporated by reference in Part III to the extent described therein.

PART I

This Annual Report modifies and supersedes documents filed prior to this Annual Report. The SEC allows us to “incorporate by reference” information that we file with them, which means that we can disclose important information to you by referring you directly to those documents. Information incorporated by reference is considered to be part of this Annual Report. In addition, information that we file with the SEC in the future will automatically update and supersede information contained in this Annual Report.

You should carefully review the information contained in this Annual Report, and should particularly consider any risks and other factors that we set forth in this Annual Report and in other reports or documents that we file from time to time with the SEC. In this Annual Report, we state our expectations as to future events and our future financial performance. In some cases, you can identify those so-called “forward-looking statements” by words such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue” or the negative of those words and other comparable words. You should be aware that those statements are only our predictions, which are being made as of the date hereof. Actual events or results may differ materially. In evaluating those statements, you should specifically consider various factors, including the risks outlined below. Those factors may cause our actual results to differ materially from any of our forward-looking statements. We undertake no obligation to update any forward looking statements, whether as a result of new information, future events or otherwise.

Factors that may cause our actual results to differ materially from any of our forward-looking statements presented in this Annual Report include, but are not limited to:

Item 1.     Business

Company Overview

Over its 19-year history, FATS^® has developed over 300 variations of simulated weapons, manufactured and delivered over 35,000 simulated weapons, developed over 1,000 training scenarios, and delivered over 5,200 simulators to 50 countries. FATS is a world leader in the development and production of interactive simulation systems designed to provide training for and in the use of small and supporting arms for dismounted and mounted military operations, and training for judgmental use of force for law enforcement and military peacekeeping activities. The Company has broadened its array of products to accommodate the current tactics,

2

training and equipment available to both law enforcement and military communities. Examples include the provision of simulators and courseware to support indirect fire, less than lethal weapon applications, and multiple room engagements. Every system features embedded capabilities to support customer authoring of scenarios and comprehensive performance evaluation. Keeping pace with national and international concerns, FATS has added improvements to courseware and software that focus on situations that require extraordinary judgment including operations in peace keeping/making, crowd control and hostage negotiations. Additional emphasis has been placed on night operations in all environments in most cases allowing the customers to utilize their organic night vision equipment.

FATS’ software and hardware technologies have evolved along with advances in the computer industry. Recognizing that commercial technological capabilities are moving faster than any one company can replicate, the Company takes advantage of commercially available off the shelf (COTS) components that ensure reuse and upgrade capability as well as commonality and the ability to integrate with other simulation systems. This philosophy seeks to provide each customer the best technical and economical solutions for its training needs while providing options for life cycle management of their systems. FATS also partners with each customer to ensure that each training solution is complete, integrated and functional from the embedded technology and courseware to the unique language requirements. The goal is to ensure that each simulated firearm or weapons system is integrated and compatible with the customer’s training programs and replicates precise weapon ballistic data, desired environmental effects, and target damage realism.

FATS uses a unique approach to sales and marketing that utilizes subject matter experts (“SMEs”). SMEs are ex-military and/or law enforcement professional trainers and weapons specialists with expertise in developing weapons training systems requirements and customizing hardware, software, and weapon designs to meet specific customer training requirements. SMEs establish an interactive dialogue with decision-makers and system end-users who generally have comparable backgrounds and experiences, enabling the SMEs to communicate customer requirements to the Company’s design engineers. Through this interaction, the Company strives to ensure that training scenarios are realistic and that simulated weapons maintain the fit, form, and feel of live weapons. The average tenure of FATS’ seven SMEs is over eight years.

The Company has focused its sales efforts for small arms simulators primarily in the U.S. and international military and law enforcement market through its principal facilities near Atlanta, Georgia. Larger gunnery simulation systems are developed and manufactured by its Canada based subsidiary, Simtran Technologies, Inc. (Simtran) located in Montreal, Canada. Simtran contracts to develop and deliver five unique products: an air defense missile trainer; an appended armored vehicle crew trainer; a stand-alone armored vehicle crew trainer: and, an appended light armored vehicle crew trainer. Other smaller subsidiaries located in the United Kingdom, the Netherlands, Singapore and Australia provide sales, service and limited manufacturing support.

Industry Overview

The firearms simulation training sector is comprised of simulation systems and weaponry that are used by domestic and international military and law enforcement organizations to hone a variety of skills, including individual marksmanship, squad tactical engagement, indirect fire and combined arms, and judgmental lethal and non-lethal use of force. Firearms simulation training is currently a small part of the overall worldwide training market. Within the overall training market, simulation training accounted for approximately $2.3 billion in 2001, of which U.S. Military forces accounted for approximately one half. The small and supporting arms category, which includes products offered by FATS, has an estimated value of approximately $450 million.

In light of the recent war in Iraq, the President has asked Congress for additional defense budget funding initiatives. This initial request calls for additional funds of $74.7 billion to subsidize the cost of both the war in Iraq and the continuing fight against terrorism.

In the aftermath of the attacks of September 11th, the U.S. government has demonstrated a significant commitment to homeland security in terms of financial and human resources. Current homeland security

3

functions are being redefined, reorganized, and redeployed. Requirements for homeland security applications have not been finalized; however, the Company anticipates that future homeland security training will include judgmental, analytical, and situational training applications for law enforcement, first responders, firefighters, and security personnel. The Company can, however, provide no assurance the Company’s operations and financial position will benefit from anticipated increases in homeland security resources.

Military organizations have historically embraced simulation for larger weapon systems such as winged aircraft, helicopters, and tanks, but have traditionally depended on live firing ranges for small arms and supporting arms training. Over the last decade, military and law enforcement organizations have increasingly embraced firearms simulation training as an important supplement to live fire training. The Company believes the following factors favor the use of simulated firearms training systems:

Judgmental Training:  Homeland security assignments and the rising number of non-traditional law enforcement and military missions, such as joint-force peacekeeping, peacemaking actions, and urban warfare situations require a heightened level of judgment regarding the appropriate use of measured force. Training in simulation enables law enforcement and military organizations to test and hone judgment and demonstrate appropriate responses to simulated complex situations. In addition, simulated training systems are portable and mobile, which is a key advantage in serving peace-keeping operations that typically necessitate rapid deployment of troops to troubled regions around the globe.

The Company can, however, provide no assurance the Company’s operations and financial position will benefit from anticipated increased reliance on simulation training.

Many companies in simulation technology have principally been focused on large weapon systems such as flight simulators and large, expensive mainframe computing simulations. FATS has focused on the application of affordable technology for individual and small unit gunnery and use of force requirements. FATS has developed low cost simulators with high fidelity graphics that provide training in realistic environments. During the last few years, rapid advancements in commercial computer technology have allowed replacement of FATS-proprietary approach with commercial technology that supports the need to meet contemporary combat training objectives. FATS simulators use highly interactive three-dimensional computer-generated scenarios that allow simulated battles to take place in virtual environments with computer-generated semi-automated forces.

Products

FATS developed and sold the first interactive small arms simulation system and strives to continue to set the standard for innovation, quality, and service within the simulated training marketplace.

FATS’ product offering represents a comprehensive set of training systems, weapons, and courseware. Technology advancements have enabled FATS to build on the basic fundamentals of marksmanship training. FATS technology and weapons enable military leaders to progress from basic weapons skills to directing entire

4

units in virtual battle scenarios while a forward observer calls for and adjusts artillery, naval, and mortar fire. The combination of the ability to conduct tactical planning on digitized terrain databases that represent real world mission locations and the technically advanced features embedded in FATS training systems result in the opportunity for military organizations to conduct meaningful simulation training that leads to advanced readiness.

The Company’s technology strategy is based on creating training platforms designed around a combination of COTS and proprietary technologies that customers can easily customize to meet their distinctive specifications and requirements. Faster processors and smaller computer parts and chips are enabling FATS to create training devices that eliminate the current requirement that weapons be tethered to the system, affording personnel freedom of movement in the training space while retaining all current data feedback and system training features. As a result of these capabilities, we expect thatforce escalation, de-escalation training with various devices such as OC spray, simulated TASER^® stun guns, and firearms will be greatly improved as law enforcement personnel are able to move freely.

The following table illustrates the progression of the Company’s training platforms from its FATS I system developed in 1984 to the planned release of FATS V in FY2005.

Evolution of FATS^® Training Platforms

While the FATS V platform is scheduled for release in our 2005 fiscal year, we can currently give no assurance that that schedule will actually be accomplished or that it will incorporate all of the features identified above.

The following sections detail the Company’s product offering, which is divided into four major groups: simulators, weaponry, training software, and related products. The product offering detail is followed by a discussion of additional products and service opportunities.

Simulators

The Company’s simulators represent the core of FATS’ product set. Simulators are integrated training systems that combine COTS components and technologies, such as Intel Pentium^®-based computers running the Microsoft Windows^® operating system, 3D graphics, digital video encoding and decoding technologies, and LCD projectors, with FATS proprietary technologies such as hit detection cameras and software and computer hardware to create a versatile training solution. Each FATS IV-based simulator enables end-users to train using either computer generated imagery (“CGI”) or combined video and graphics scenarios. Instructors using the Instructor Control Station (“ICS”) have real-time control of scenario events and after-action review.

5

The following table details the simulators offered within each of the Company’s target markets followed by a discussion of each of FATS’ simulation systems.

Simulator Product Offerings by Target Market

Small Arms Trainer (“SAT”):  The SAT, FATS’ principal product, enables customers to hone skills ranging from individual marksmanship to collective training incorporating weapons ranging from pistols to anti-tank missiles. The SAT is a versatile trainer offering individual, team, and leadership training for lethal force applications, less-than-lethal force applications (e.g., chemical spray, TASER^®, baton), and part-task training (e.g., safety, fire discipline, and fire coordination).

Indirect Fire Trainer (“IFT”):  Designed for artillery and mortar units, the IFT is designed to portray the call for fire procedures and effects of all artillery, mortars, naval gunfire, close air support, and attack helicopter supporting arms. These systems may be integrated into a combined arms battle space, including howitzer and mortar crews, while conducting direct fire engagements against simulated forces. In addition, the IFT provides capabilities for command post and fire direction center personnel to become full participants in an indirect fire scenario. FATS CGI (3D graphics) software can provide a combined arms collective training environment in a 3D virtual world, which allows small arms gunners, mortar gunners, and forward observers to be trained on the same system, in the same virtual battlefield, at the same time. This combined arms training capability is a unique feature offered only by FATS.

Live Fire Trainer (“LFT”):  The system enables an organization to employ its own service weapons in a wide variety of scenarios offering a complete spectrum of potential force responses. The system displays the impact point of live rounds on a specially designed, self-healing screen, and is capable of branching to different outcomes depending upon the student’s actions, reactions, and effectiveness.

Law Enforcement Trainer:  The Law Enforcement Trainer provides training for the individual patrolman, team and/or section, and SWAT teams through the entire force continuum. Weapons include small arms, semi-automatic weapons, shotguns, and non-lethal alternatives such as chemical spray, the simulated TASER^® stun gun, and batons. Law enforcement courseware spans the spectrum of conflicts that an officer may encounter, from basic marksmanship to hostage negotiations and rescue and domestic disturbances, in each case requiring judgment and measured response. Systems include complete diagnostics and data feedback.

Gunnery Crew Training:  FATS produces light armor vehicle and gunnery crew training systems, including a stand-alone classroom armored vehicle trainer, the Cougar Crew Gunnery Trainer, the TOW Video Interactive Gunnery Simulator, the Javelin Detachment Trainer, and an appended light armored vehicle crew trainer. The Company provides appended and stand-alone versions of these products, and is the sole-source provider of the embedded training software solutions for the U.S. Army STRYKER Program. In addition, FATS

6

provides contract software development and programming services. Historically, FATS has not emphasized its armored vehicle simulation capabilities. Management, however, is exploring current demand for gunnery crew training systems.

Motion Integrated Training Systems (“MITS”):  The MITS provides a unique environment to develop the trainee’s ability to operate weapons on a motion platform replicating engagement conditions in a moving environment, such as on a ship. FATS first delivered a motion platform system to the Singapore Coast Guard in 1997. The motion is derived from an accurate mathematical motion cue model to produce a realistic sensation of motion for the student. The motion model can be easily adjusted to simulate the motion of a ship, land-based vehicle, or an aircraft.

Weaponry

FATS produces sophisticated and realistic simulated training weapons. FATS provides realistic weaponry by retrofitting real, live fire weapons with simulation technology to deliver the true form, fit, and feel of a live fire weapon. FATS offers a broad set of weapons, from small to supporting arms.

FATS simulated weapons offer a number of training advantages over live fire training. The Company’s weapons provide diagnostic information not available with live fire weapons, such as trigger pressure, barrel movement, weapon cant, and butt pressure, supplying instructors with a rich set of performance data. In addition, since FATS simulated weapons do not fire live rounds, they experience far less stress than live fire weapons and therefore have a life cycle that is significantly longer than weapons used for live fire training. For example, an actual M-16 has a field life of approximately 5,000 rounds before rebuild, while the FATS simulated M-16 is designed to fire 50,000 rounds before requiring service.

FATS weapons designers are able to replace firing elements from live weapons with pneumatics, electronics, lasers, and sensors without altering a weapon’s mechanical functions (safety switch, loading, etc.), center of gravity, balance, or weight.

Weapons are available with various levels of sensor diagnostics and can be custom-designed and manufactured for each customer’s specific installation. Additionally, the Company’s weapons are offered with radio frequency (“RF”) wireless capability, utilizing a backpack that contains electronics and compressed air containers to enable FATS weapons to function under system control and provide diagnostic capabilities. Currently the Company is developing wireless weapons using Bluetooth RF technology. The objective is to embed all components of the weapon system, including electronic circuits and compressed air containers, into the weapon itself. While the Bluetooth technology is currently under development, we can give no assurance that full integration of the technology will actually be accomplished.

The Company’s arsenal includes simulated revolvers; semi-automatic pistols; shotguns; bolt-action, semi-automatic, and automatic rifles; submachine and machine guns; anti-tank/anti-personnel rocket launchers; single-shot and automatic grenade launchers; automatic cannons; and mortars. FATS also provides a customer-installed weapons simulation conversion kit that enables customers to modify their own weapons to function like FATS simulated weapons. These kits, which are easily removed for live fire training, lower the total system cost to customers and represent the only simulated weapons conversion kit available in the industry.

Training Software

The Company’s training software provides interactive engagements to meet specific training objectives using real-world imagery or CGI. FATS’ scenario library includes terrain scenes derived from National Imagery and Mapping Agency (“NIMA”) data sets; realistic targets (both friendly and threatening); realistic human images; and various time of day, weather, and lighting conditions.

7

FATS has developed thousands of customized scenario programs. The Company offers a comprehensive set of scenarios covering basic and advanced marksmanship, judgmental/measured response, collective and combined arms training, and numerous other training requirements. The following table provides a list of selected scenarios and courseware developed by FATS.

Training Software

Related Products and Services

FATS offers additional products that enhance the basic platform capability, including a video authoring station, which enables customers to develop, edit, modify, and/or customize their own training video scenarios; a hostile fire return simulator that propels simulated ammunition in the direction of a trainee, reinforcing proper cover techniques; selected military and law enforcement equipment such as a remote trigger device, flashlight, night vision filters for customer-owned devices, simulated binoculars for use during indirect fire training, simulated laser range finders used during forward air controller training, and a MILES^™ shoot-back device that trains military personnel to react to hostile fire simulated by an electronic laser.

FATS has developed other products that have not yet penetrated the market, such as the Company’s Motion Integrated Training System, which combines FATS core firearms simulation technology with a dynamic motion platform to simulate numerous air-based and sea-borne weapons at a considerably reduced cost. This system is currently in use by a limited number of the Company’s customers, but management believes that focused marketing efforts may stimulate demand for future installations of the motion platform product.

Management is exploring opportunities to provide turnkey training services to military and law enforcement organizations worldwide. Expanding the Company’s turnkey training services would provide a recurring revenue stream for FATS.

Management is also exploring opportunities to provide operator refresher training and advanced system operator training. FATS recently instituted a five-day, in-plant, operator and instructor course, and courses are scheduled throughout the upcoming fiscal year.

Additionally, as the Company’s customer base increases, so does the potential for additional revenue from the sale of extended maintenance and service contracts.

The Company can, however, provide no assurance the Company’s operations and financial position will benefit from any of the anticipated products or services.

Target Markets

The Company currently targets three principal market components: (i) international which includes military and law enforcement authorities outside the U.S. or its territories; (ii) U.S. military; and (iii) U.S. law

8

enforcement. The following table sets forth dollar amounts (in thousands) and percentages of sales for each of the Company’s major markets on an historic basis.

International.

The Company has sold FATS systems to customers in more than 50 countries across six continents.

The international firearms simulation marketplace is comprised of national military organizations and police organizations of foreign nations. International law enforcement organizations have a broader, more militaristic scope than domestic law enforcement organizations, are structured comparably to military organizations, and in many countries are organized within the same structure as the military. International military and law enforcement organizations therefore both demand applications that mirror those of domestic military markets. International customers typically utilize small arms trainers, judgmental trainers, and indirect fire trainers. The same forces that impact the U.S. military and law enforcement markets drive global military and law enforcement trends.

International military organizations have procurement structures similar to that of domestic military organizations. Most international law enforcement organizations are national in nature, and therefore employ centralized procurement organizations, in contrast to the local procurement protocol of domestic law enforcement. In some foreign countries, law enforcement and military organizations share the same procurement structure.

Training requirements, procurement processes, and customers vary widely among countries. FATS has secured exclusive agreements with strategic sales agents to provide a local presence in markets in which such a presence is essential to the Company’s success.

For fiscal 2003, 48.6% of the Company’s total revenues were attributable to sales to military and law enforcement authorities outside the U.S. See Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 7 of Notes to Consolidated Financial Statements.

Domestic Military.

The domestic military market consists of all U.S. active and reserve armed forces. Military organizations demand marksmanship-oriented simulation training applications that provide diagnostic feedback and comprehensive after-action review capability, as well as judgmental, indirect fire and combined arms, collective battle shooting, and other simulated training applications.

Domestic military customers recognize training simulation as a viable teaching method and means of preparation for live fire training. Simulation training’s inherent advantages in cost, flexibility, diagnostics, safety, and diminished environmental impact are recognized attributes by military organizations.

The two principal methods used by U.S. Military organizations to procure training equipment are purchasing programs defined in the U.S. Government’s budget and discretionary spending. The Company has a compelling track record of success on both large-scale competitive procurements and discretionary purchases.

9

For fiscal 2003, 42.4% of the Company’s total revenues and 82.5% of the Company’s U.S. revenues were attributable to sales to U.S. military authorities. See Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Domestic Law Enforcement.

FATS divides the domestic law enforcement segment into four principal categories:

There are over 17,000 law enforcement departments in the United States, and management estimates that approximately 3,600 of these organizations employ more than 25 officers. FATS has delivered approximately 1,100 systems to domestic law enforcement departments.

Law enforcement agencies use simulation training primarily for judgmental applications that address force escalation and de-escalation decision-making in high stress situations. Domestic law enforcement agencies have been early adopters of simulation training, given the need for more realistic means to teach these critical skills.

Federal agencies within the domestic law enforcement segment feature procurement processes that generally follow the centralized structures of domestic military organizations. The other three sub-segments of the domestic law enforcement market (state and local law enforcement, colleges and universities, and correctional facilities) represent a diverse collection of independent organizations with discrete procurement systems and unique training demands.

For fiscal 2003, 8.6% of the Company’s total revenues and 16.8% of the Company’s U.S. revenues were attributable to sales to U.S. law enforcement authorities. See Managements Discussion and Analysis of Financial Condition and Results of Operations.

Homeland Security

Homeland security is a sub-segment of both the domestic military and law enforcement markets. The President has proposed a homeland security budget which is expected to support increased training for law enforcement and military organizations responsible for domestic security. Management expects judgmental and small arms training to be integral components of this training, given the complex nature of homeland security assignments. FATS is the leading provider of judgmental use of force and small arms simulation training, and management believes it is well-positioned to capitalize on increasing training opportunities.

Gunnery Crew Training

FATS has recently won commitments for the embedded training system of the interim armored vehicle (“STRYKER IAV”), and has received indications that the Army will expand the order. In addition to working with GM Defense-Delco Systems (“GM Defense”) on the STRYKER program, FATS is also working as a subcontractor to Saab Bofors Dynamics on a light anti-tank weapon program. Management anticipates that the increased visibility of the Company’s gunnery crew trainers in these high-profile programs stimulate demand for its heavy weapons simulators.

The Company can, however, provide no assurance the Company’s operations and financial position will benefit from additional spending for either homeland security or gunnery crew training.

10

Hunter and Sports Training.

The Company has reduced its focus on the hunter and sports training components of the market in the United States. The customers for firearms training in this market component include state and federal hunting agencies, various state agencies and several conservation associations.

For fiscal 2003, 0.4% of the Company’s total revenues were attributable to sales in the hunter and sports training component of the market. See Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Sales and Marketing

FATS’ sales and marketing organization is structured around its customer segments, with separate sales forces for domestic military, international military and law enforcement, and domestic law enforcement.

FATS’ sales and marketing strategy includes identifying customer simulation training needs at an early stage and obtaining sole-source contracts with multi-year procurement potential by providing customized solutions. FATS’ SMEs, through their depth of experience and critical links to key customer contacts, bolster the Company’s sales and marketing efforts and reinforce the FATS^® brand in its end-markets. The average tenure of FATS’ seven SMEs is over eight years, reflecting a commitment to maintaining customer relationships and their intimate familiarity with the capabilities of FATS’ systems.

FATS’ longstanding history in military simulation training is a primary key to FATS’ success with domestic military organizations. Seasoned FATS managers, with significant experience in the markets they cover, oversee the Company’s domestic military sales and marketing efforts. FATS deploys three full-time sales managers to address the following market segments:

These three sales managers are supported by field sales representatives, the FATS engineering staff, a core staff of SMEs, and six program managers. This team is charged with maintaining a continuous customer dialogue to uncover potential sales leads and to ensure customer satisfaction. FATS’ field sales representatives visit potential domestic military customer locations to maintain close, on-the-ground contact with end-users and decision-makers. SMEs partner with FATS sales representatives and engineers to scope and design a customized, realistic product to meet the needs of particular customers. Additionally, SMEs collect customer feedback to ensure that future FATS installations meet or exceed customer expectations.

Program managers are charged with serving current FATS customers. Program managers provide a contact with each FATS customer to ensure that customers receive technical assistance, product maintenance support, and information about new FATS products. The Company’s program managers also probe for new training requirements and upcoming procurements to position the Company to provide upgrades and replacement training systems.

The Company approaches international markets with a single structure covering both foreign military forces and law enforcement organizations. FATS’ international sales effort is led by two sales managers and supported by the Company’s network of sales agents. These agents provide the Company with a critical local presence in international markets that have unique procurement processes, customs, and training requirements.

FATS’ relationships with its customers abroad are facilitated by exclusive international sales agents who represent the Company in local markets to uncover simulation training requirements and opportunities for FATS to provide system upgrades and maintenance services.

11

FATS serves the domestic law enforcement market (including Canada) primarily on a regional basis. Because each domestic local and national law enforcement has discrete decision-making processes, budget cycles, and training requirements, the Company deploys seven dedicated in-house regional managers charged with developing relationships and creating opportunities within their respective territories. In addition, FATS has one in-house sales representative responsible for opportunities at Federal law enforcement agencies such as the FBI, DEA, Postal Service, and Government Services Administration Protective Service.

Management believes that its sales agents’ experience in the simulation industry, weapons and product expertise, and longstanding relationships with key law enforcement decision-makers in their territories enable the Company to maintain its market position. Each domestic law enforcement regional manager, including the Company’s federal account manager, is supported by a service technician who provides technical support and expertise to current and potential customers. Regional managers are equipped with digitized product catalogs, sophisticated solution pricing software, and vehicles outfitted with the latest FATS products to facilitate on-site demonstrations.

Customers

The Company’s principal customers historically have been in the public sector of the U.S., including the federal, state and local governments, and in the public sectors of a number of other countries. Approximately 48.6% of the Company’s revenues for fiscal 2003 were attributable to sales to military and law enforcement authorities internationally, 42.4% were attributable to sales to military authorities in the U.S. and 8.6% were attributable to sales to law enforcement authorities in the U.S. Sales to public sector customers are subject to a multiplicity of detailed regulatory requirements and public policies. Such contracts may be conditioned upon the continuing availability of public funds, which in turn depends upon lengthy and complex budgetary procedures, and may be subject to certain pricing constraints. Moreover, U.S. government contracts and those of many international government customers may generally be terminated for a variety of factors when it is in the best interests of the government. There can be no assurance that these factors or others unique to government contracts will not have a material adverse effect on the Company’s future results of operations and financial condition.

12

The following table lists certain of the Company’s customers in each of its principal market components:

In fiscal 2003, the Company’s five largest customers accounted for approximately 49.7% of the Company’s revenues, with two customers accounting for more than 10% of revenues. In fiscal 2002, the Company’s five largest customers accounted for approximately 50.5% of the Company’s revenues, with four customers accounting for more than 10% of revenues. Given the nature of the Company’s contracts, revenues attributable to specific customers are likely to vary from year to year, and a significant customer in one year may not be a significant customer in a subsequent year. In order to reach its growth objectives, the Company will be required to seek contracts from new domestic and international customers as well as orders from existing customers for additional types of simulated firearms or increased quantities of previously ordered systems and simulated weapons. A significant decrease in demand by or the loss of one or more significant customers could have a material adverse effect on the Company’s results of operations or financial condition. See Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 7 of Notes to Consolidated Financial Statements.

Research and Development

Research and development expenditures totaled approximately $6.8 million, $5.6 million and $5.4 million in fiscal 2003, 2002, and 2001, respectively. Of these amount, approximately $4.0 million, $1.5 million and $0.7 million was funded under customer contracts, resulting in net research and development expenses of $2.8 million, $4.1 million and $4.8 million in fiscal 2003, 2002, and 2001, respectively to the Company.

FATS has a proven track record of developing new technologies to create more realistic and effective simulated training environments. In addition, FATS makes a substantial investment in the continuous improvement of existing systems and products, which drive upgrades. Weapons expertise and customer

13

understanding provided by SMEs are key ingredients in the Company’s research and development efforts. SMEs work with engineers to develop technology based on specific customer desires and needs.

In order to maintain its market position, the Company is engaging in research and development in the following areas:

The Company’s research and development efforts are divided into four separate disciplines: mechanical, electrical, training, and audio-visual.

Manufacturing Operations

The Company’s manufacturing operations are conducted primarily at its Suwanee headquarters near Atlanta, Georgia, and to a limited extent at the facility of its U.K. subsidiary, Firearms Training Systems Ltd. in Lincolnshire, England. Simtran’s products are manufactured at its facility in Montreal, Canada. Atlanta manufacturing operations are divided into two groups, systems manufacturing and weapons manufacturing.

Systems Manufacturing

Systems manufacturing, the assembly of FATS’ simulator components, houses the manufacturing personnel to assemble approximately 30 primary simulation computers and other unique simulator components per month on a single-shift basis. As components are assembled and completed, testing is performed for both function and durability, and systems are subjected to a comprehensive ISO 9000 certified, quality assurance program.

14

Weapons Manufacturing

Weapons manufacturing involves the production of simulated firearms and non-lethal simulators by either removing firing mechanisms and other devices from live weapons or assembling simulators from conversion kits. The assembly process encompasses the fitting of modified weapons or kits with the Company’s pneumatic and electrical components, followed by the functional testing of the completed assembly.

 </