See accompanying notes to unaudited condensed financial statements.

VIRTRA, INC.

CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)

See accompanying notes to unaudited condensed financial statements.

VIRTRA, INC.

CONDENSED BALANCE SHEETSSTATEMENT OF STOCKHOLDERS’ EQUITY

(Unaudited)

See accompanying notes to unaudited condensed financial statements.

VIRTRA, INC.

CONDENSED STATEMENTS OF OPERATIONSCASH FLOWS

(Unaudited)

See accompanying notes to unaudited condensed financial statements.

VIRTRA, INC.

CONDENSED STATEMENT OF STOCKHOLDERS’ EQUITY

(Unaudited)

See accompanying notes to unaudited condensed financial statements.

VIRTRA, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

See accompanying notes to unaudited condensed financial statements.

VIRTRA, INC.

Notes To CONDENSED Financial Statements

(Unaudited)

NOTE 1.ORGANIZATION, BUSINESS OPERATIONS and significant accounting policies

VirTra, Inc. (the “Company” or “VirTra”), located in Tempe, Arizona, is engaged in the sale and development of judgmental use of force training simulators and firearms training simulators for law enforcement, military and commercial uses. The Company sells simulators and related products worldwide through a direct sales force and international distribution partners. The original business started in 1993 as Ferris Productions, Inc. In September 2001, Ferris Productions, Inc. merged with GameCom, Inc. to ultimately become VirTra Systems, Inc., a Texas corporation.

Effective as of October 1, 2016, (the “Effective Date”), the Company completed a conversion from a Texas corporation to a Nevada corporation pursuant to a Redomestication Plan of Conversion (the “Plan of Conversion”)plan that was approved by the Company’s Board of Directors on June 23, 2016 and by its shareholders on September 16, 2016. On the Effective Date, 7,927,774   shares of common stock of VirTra Systems, Inc., a Texas corporation, were converted into 7,927,774 shares of common stock of VirTra Systems, Inc., a Nevada corporation. No shareholders exercised appraisal rights or dissenters’ rights for such shares in accordance with the Texas Business Organization Code.

As part of the Plan of Conversion, the Company filed Articles of Incorporation in Nevada, whereby it changed its name from VirTra Systems, Inc. to VirTra, Inc. and revised its capitalization. The Company’s Articles of Incorporation filed in Nevada authorized the Company to issue 62,500,000 shares, of which (1) 60,000,000 shares are common stock, par value $0.0001 per share (the “common stock”), of which (a) 50,000,000 shares are common stock, par value $0.0001, (b) 2,500,000 shares are Class A common stock, par value $0.0001 per share (the “Class A common stock”), and (c) 7,500,000 shares are Class B common stock, par value $0.0001 per share (the “Class B common stock”) and (2) 2,500,000 shares are preferred stock, par value $0.0001 per share, which may, at the sole discretion of the Board of Directors, be issued in one or more series (the “Preferred Stock”). The Company also adopted new bylaws as part of the Plan of Conversion.

Effective October 20, 2016, the Company effected a 1-for-10 reverse stock split of its issued and outstanding common stock and effective February 12, 2018, the Company effected a 1-for-2 reverse stock split of its issued and outstanding common stock (together, the “Reverse Stock Splits”). All references to shares of the Company’s common stock in this report refer to the number of shares of common stock after giving effect to the Reverse Stock Splits.

Basis of Presentation

The accompanying unaudited condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information. Certain information and note disclosures normally included in complete annual financial statements prepared in accordance with GAAP have been condensed or omitted. However, the Company believes that the disclosures included in these unaudited condensed financial statements are adequate to make the information presented not misleading. In the opinion of management, the accompanying unaudited condensed financial statements reflect all adjustments, which include normal recurring adjustments, considered necessary for a fair presentation of such interim results. The results for the three and nine months ended March 31,September 30, 2018 are not necessarily indicative of the results for any subsequent period. These unaudited condensed financial statements should be read in conjunction with the audited financial statements and notes for the year ended December 31, 2017 included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, as filed with the Securities and Exchange Commission (the “SEC”) on March 30, 2018.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant accounting estimates in these financial statements include valuation assumptions for share-based payments, the allowance for doubtful accounts receivable and notes receivable, reserves of obsolete and slow-moving inventory, the accrual for warranty reserves, the carrying value of long-lived assets, the income tax valuation allowance and the carrying value of cost basis investments.

Reclassifications

Certain reclassifications have been made to the 2017 financial statements to conform to the 2018 financial statement presentation. These reclassifications had no effect on net earnings or cash flows as previously reported.

Significant Accounting Policies

Aside from the adoption of ASUthe Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) Topic 606, “Revenue from Contracts with Customers,” as described below, there have been no other material changes to the significant accounting policies or recent accounting pronouncements previously disclosed in the annual financial statements in the Company’s Form 10-K for the fiscal year ended December 31, 2017.

Revenue Recognition

The Company records revenue from contractcontracts with customers in accordance with Accounting Standards Codification (ASU)ASC Topic 606, “Revenue from Contracts with Customers.” Under ASUUnder ASC 606, the Company must identify the contract with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when (or as) the Company satisfies a performance obligation.

The Company’s primary sources of revenue are derived from simulator and accessories sales, training and installation, the sale of customizedcustomizable software and the sale of extended warranties. Sales discounts and bad debt allowance are presented in the Financial Statementsfinancial statements as reductions in determining net revenues. Credit sales are recorded as current assets. Prepaid deposits received at the time of sale and extended warranties purchased are recorded as current liabilities until earned. The following briefly summarizes the nature of our significant provisions:performance obligations and revenue recognition:

Disaggregation of Revenue

Under ASUASC 606, disaggregated revenue from contracts with customers depicts the nature, amount, timing, and uncertainty of revenue and cash flows affected by economic factors. The Company has evaluated revenues, contract assets and liabilities associated with the revenue recognized and the following table illustrates the disaggregation disclosure by customer’s location and performance obligation.

Adoption of New Accounting Standards

Between May 2014 and December 2016, the Financial Accounting Standards Board (the “FASB”)FASB issued several Accounting Standards Updates (each, an “ASU” and collectively, “ASUs”) on Revenue from Contracts with Customers (Topic 606). These ASUs supersede nearly all existing revenue recognition guidance under current GAAP and requires an entity to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. The standards are effective for annual periods beginning after December 15, 2017, and interim periods therein, and permit the use of either the full retrospective or modified retrospective transition method. This standard was adopted on January 1, 2018 and the Company elected to use the modified retrospective transition method which requires application of ASU 2014-09 to uncompleted contracts at the date of adoption. The adoption of the ASUs under 2014-09 did not have a material impact on the financial statements.

In January 2016, the FASB issued ASU 2016-01, Financial“Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial LiabilitiesLiabilities” (“ASU 2016-01”), which requires that equity investments, except for those accounted for under the equity method or those that result in consolidation of the investee, be measured at fair value, with subsequent changes in fair value recognized in net income. However, an entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. ASU 2016-01 also impactsThis standard was adopted on January 1, 2018, including all interim reporting periods within the presentation and disclosure requirements for financial instruments.fiscal year. The Company wrote-down its Investmentinvestment in That’s Eatertainment Corp. (“TEC”), f/k/a Modern Round Entertainment Corp. (“MREC”), a related party, to fair value in 2017,2017. The Company believes the adoption of ASU 2016-01 did not have a material impact on its financial statements. Upon adoption, the Company has elected to utilize the cost minus impairment approach as the investment in Modern RoundTEC does not have a readily determinable fair value as of the reporting date. See Note 6. Collaboration Agreement.

In November 2016, the FASB issued ASU No. 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash (a consensus of the FASB Emerging Issues Task Force),” to provide guidance on the presentation of restricted cash or restricted cash equivalents in the statement of cash flow.flows. The amendments should be applied using a retrospective transition method, and are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The adoption of this statement2016-18 did not have a material impact on the Company’s financial statement presentation.

In February 2017, the FASB issued ASU No. 2017-05, “Other Income—Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets,” to clarify the scope of Subtopic 610-20, “Other Income—Gains and Losses from the Derecognition of Nonfinancial Assets,” and to add guidance for partial sales of nonfinancial assets. Subtopic 610-20, which was issued in May 2014 as a part of ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606),” provides guidance for recognizing gains and losses from the transfer of nonfinancial assets in contracts with noncustomers. The amendments are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, which is the same time as the amendments in ASU No. 2014-09, and early adoption is permitted. The adoption of 2017-05 did not have a material impact on the financial statements.

In May 2017, the FASB issued ASU No. 2017-09, “Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting,” to provide clarity and reduce both (1) diversity in practice and (2) cost and complexity when applying the guidance in Topic 718, “Compensation—Stock Compensation,” to a change to the terms or conditions of a share-based payment award. The ASU provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Accounting Standards Codification (“ASC”)ASC 718. The amendments are effective for fiscal years beginning after December 15, 2017 and should be applied prospectively to an award modified on or after the adoption date. The Company doesadoption of 2017-09 did not expect this amendment to have a material impact on itsthe financial statements.

Recent AccountingPronouncements

In February 2016, the FASB issued ASU No. 2016-02 – “Leases (Topic 842),”, which requires lessees to put most leases on their balance sheets by recognizing lease assets and lease liabilities for those leases classified as operating leases under previous guidance. This ASU will be effective for the Company on January 1, 2019, with early adoption permitted. TheWhile the Company is currently in the process of assessingevaluating the impact, adoption of this ASU 2016-02 is expected to have a significant impact on the Company’s Condensed Balance Sheet with no material impact to its financial statements.Condensed Statement of Operations.

In July 2017, the FASB issued ASU No. 2017-11 – “Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815)” Part I. Accounting for Certain Financial Instruments with Down Round Features and II. Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception.” Part I applies to entities that issue financial instruments such as warrants, convertible debt or convertible preferred stock that contain down round features. Part II. SimplyII simply replaces the indefinite deferral for certain mandatorily redeemable noncontrolling interests and mandatorily redeemable financial instruments of nonpublic entities contained within ASC Topic 480 with a scope exception and does not impact the accounting for these mandatorily redeemable instruments. This ASU is effective for public companies for the annual reporting periods beginning after December 15, 2018, and interim periods within those annual periods. Earlyperiods, with early adoption is permitted. The Company does not expect this amendment2017-11 to have a material impact on itsthe financial statements.

In June 2018, the FASB issued ASU No. 2018-07, “Compensation–Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting” to simplify the accounting for nonemployee share-based payment transactions resulting from expanding the scope of Topic 718, Compensation-Stock Compensation, to include share-based payment transactions for acquiring goods and services from nonemployees. The amendments also clarify that Topic 718 does not apply to share-based payments used to effectively provide (1) financing to the issuer or (2) awards granted in conjunction with selling goods or services to customers as part of a contract accounted for under Topic 606, Revenue from Contract with Customers. The amendments are effective for public business entities for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year, with early adoption permitted. The Company does not expect 2018-07 to have a material impact on the financial statements.

In July 2018, the FASB issued ASU No. 2018-11, “Leases (Topic 842): Targeted Improvements,” which provides another transition method in addition to the existing transition method by allowing entities to initially apply the new leases standard at the adoption date (such as January 1, 2019, for calendar-year-end public business entities) and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption consistent with preparers’ requests. This additional transition method changes only “when” an entity is required to initially apply the transition requirements of the new lease standard; it does not change “how” those requirements apply. For entities that have not adopted Topic 842 before the issuance of this ASU, the effective date and transition requirements for the amendments are the same as the effective date and transition requirements in ASU 2016-02. The Company does not expect 2018-11 to have a material impact on the financial statements.

NOTE 2. NOTENOTES RECEIVABLE

An unsecured promissory note was executed on March 23, 2018 by a customer converting theirits past-due trade receivable from the sale of goods and services in the amount of $400,906.$400,906 due in full on or before February, 2020. The note bears interest at the rate of ten percent (10%) per annum and requiresrequired installment payments of $20,000 principal and interest are due monthly on the 21^st, including late fees. The principal and accrued interest due as of September 30, 2018 was $384,237. The current portion of the note receivable is collectible in one year or less with the remainderincluding accrued interest was $212,522. The remaining portion of the note separately classified as long-term.long-term was $171,715. No allowancesreserve for doubtful accountsuncollectability has been recorded for the three and nine months ended September 30, 2018.

The Company accepted an unsecured convertible promissory note (the “Convertible Note”) from TEC in the amount of $292,138 for a portion of their minimum royalty payment due as of MarchMay 31, 2018. The note bears interest at the rate of five percent (5%) per annum and contains a provision requiring remittance of not less than 20% of the net proceeds of any private or public offering of its securities in reduction of the Convertible Note. The note has a conversion right, at the sole discretion of the Company, to convert the outstanding balance of principal and accrued interest at any time for shares of common stock of TEC. Prior to the due date, the Company may elect to convert the Convertible Note for shares of common stock in TEC at a twenty-five percent (25%) discount to the price of shares sold to the public in a public offering in connection with a go-public transaction. The issuance of common stock upon conversion shall be made without charge to the Company. No fractional shares shall be issued upon conversion and in lieu of fractional shares, TEC will pay the Company the amount of any obligation that is not converted. Any unpaid balance of principal and accrued interest becomes due and collectible on the earlier of (i) August 1, 2019 (maturity date), or (ii) if declared due and payable in the event of Default. The note principle and accrued interest due as of September 30, 2018 was $294,573, both are classified as current. No reserve for uncollectability has been recorded for the three and nine months ended September 30, 2018.

See Note 6.

NOTE 3. INVENTORY

Inventory, net consisted of the following as of:

NOTE 4.Property and Equipment

Property and equipment, net consisted of the following as of:

Depreciation expense was $68,619$74,746 and $68,385$65,570 for the three months ended March 31,September 30, 2018 and 2017, respectively. Depreciation expense was $217,952 and $204,527 for the nine months ended September 30, 2018 and 2017, respectively.

NOTE 5.Accrued Expenses

Accrued compensation and related costs consisted of the following as of:

Accrued expenses and other current liabilities consisted of the following as of:

NOTE 6.Collaboration Agreement

On January 16, 2015, the Company entered into a Co-Venture Agreement (the “Co-Venture Agreement”) with Modern Round, LLC (“Modern Round”MR”), a wholly ownedwholly-owned subsidiary of Modern Round Entertainment Corporation (“MREC”),TEC, formerly MREC, a related party. MRECTEC is a restaurant and entertainment concept centered on its indoor virtual reality shooting experience. The Co-Venture Agreement provides Modern RoundTEC access to certain software and equipment relating to the Company’s products in exchange for royalties.

The Company received 1,365,789 units, representing a 5% ownership interest in Modern Round on the date of the Co-Venture Agreement. The Company recorded the investment at the estimated fair value of the units and which were valued at $0.10 per unit based on Modern Round’s other membership unit sales.The Co-Venture Agreement also provides the Company with conditional warrants to purchase an additional 5% of Modern Round as of the date of that agreement, at an exercise price of $0.25.

On April 14, 2015, Modern Round issued the Company an option to purchase 125,000 units of Modern Round. The option fully vested and became exercisable on the date of grant at an exercise price equal to $0.50 per unit and terminates on the tenth anniversary of the date of grant, if not earlier pursuant to the terms of the option.

On December 31, 2015, Modern Round merged with a subsidiary of MREC pursuant to a Plan of Merger (the “Merger Agreement”) andeach unit of Modern Round issued and outstanding as of the effective time of the merger automatically converted into the right to receive approximately 1.2277 shares of MREC common stock. As a result of the Merger Agreement, the Company held 1,676,748 shares of MREC common stock, options to purchase 153,459 shares of MREC common stock at an exercise price of $0.41 per share, and conditional warrants to purchase 1,676,747 shares of MREC common stock at an exercise price of $0.20 per share.

On October 25, 2016, the Company exercised the conditional warrant and purchased 1,676,747 shares of MREC common stock for $335,349, resulting in the Company’s aggregate holdings of MREC increasing to3,353,495 common shares representing approximately 8.9% of the issued and outstanding common shares of MREC. The MREC equity securities have been recorded as a cost method investment as the Company does not have the ability to exercise significant influence over MREC.

As part of the Co-Venture Agreement, the Company granted 459,691 conditional warrants to affiliates of MREC to purchase 5% of the Company’s capital stock on a fully diluted basis as of the date of the Co-Venture Agreement. The conditional warrants are exercisable commencing at the earlier of the first anniversary of MREC opening its first range facility utilizing VirTra technology or after MREC opening its first range facility utilizing VirTra technology and the payment to the Company of all required U.S./Canada minimum royalty payments during the first 12-month period. MREC opened its first location on June 1, 2016.

The Company also granted 459,691 of additional conditional warrants to affiliates of MREC to purchase another 5% of the Company’s capital stock on a fully diluted basis as of the Agreement date. These conditional warrants are exercisable any time subsequent to MREC’s payment of $2.0 million in cumulative license fees (royalty). Both conditional warrant issuances are for a period of five years with an exercise price of $2.72.

These conditional warrants were considered contingent consideration for the equity investment as they did not meet the definition of a derivative under ASC 815. Thus, the contingent consideration was not included in the cost of the equity investment until the contingency was resolved and the warrant became exercisable.

On June 1, 2017, the warrants related to the opening of the facility vested and became exercisable at an exercise price equal to $2.72 per unit. On June 1, 2017, these warrants were recorded at the Black-Scholes Merton fair value using annual volatility of 91.5%, an annual risk-free rate of 1.76%, expected term of five years and a fair value of $4.28 a share for a fair value of $1,516,246 as an additional investment in MREC. As of June 1, 2017, the total investment in MREC approximated $1,988,800. During the year ended December 31, 2017, the Company recognized an impairment loss of $613,241 and is accounting for the investment utilizing the cost minus impairment approach.

On July 28, 2017, the Company received Notices of Exercise for all 459,691 warrants then exercisable (the “Tranche 1 Warrants”) from all the MREC affiliate holders electing to purchase warrants pursuant to the terms of the net exercise provision set forth in the Warrant Agreement. Mr. Saltz (a member of our Board of Directors who is also Chairman of the Board of Directors of MREC, as well as a majority stockholder of MREC) held 398,122 of the Tranche 1 Warrants prior to the assignment of the warrants to MREC on August 11, 2017. Under the net exercise provision, in lieu of exercising the warrant for cash, the holder may elect to receive shares equal to the value of the warrant (or the portion thereof being exercised) by surrender of the warrant and the Company issuing to holder the number of computed shares. Using the July 28, 2017 OTCQX closing price at $4.36 as fair value and the $2.72 warrant exercise price, upon conversion the 459,691 warrants entitled the holders to receive 172,912 shares of the Company’s Common Stock without payment of any additional consideration pursuant to the net exercise terms of the Tranche 1 Warrants that are currently exercisable.

Effective August 16, 2017, the Company and the MREC affiliate holders entered into an agreement (the “Warrant Buyout Agreement”) whereby the Company acknowledged that the affiliates of MREC had assigned the Tranche 1 Warrants to MREC and the Company agreed to repurchase them at a price of $3.924 per share of Common Stock issuable by the Company pursuant to the net exercise terms of the Warrants for a total of $678,505.

In addition, the Company agreed to repurchase from MREC an additional 459,691 warrants held by MREC that are not currently exercisable (the “Tranche 2 Warrants”). Mr. Saltz held 364,122 of the Tranche 2 Warrants prior to their assignment to MREC on August 11, 2017. The Warrant Buyout Agreement amended the Tranche 2 Warrants to provide for the immediate exercise on a net exercise basis of 24,208 shares of the Company’s Common Stock. The aggregate purchase price for the Tranche 2 Warrants is $94,990 based on a price of $3.924 per share of Common Stock issuable on a net exercise basis and based on 24,208 shares of the Company’s Common Stock. The aggregate purchase price of the Tranche 1 Warrants and the Tranche 2 Warrants was $773,495.

In addition, on August 16, 2017, we entered into an amendment to the Co-Venture Agreement to permit MREC to sublicense the VirTra Technology to third party operators of stand-alone location-based entertainment companies. MREC agreed to pay us royalties for any such sublicenses in an amount equal to 10% of the revenue paid to MREC in cases where MREC pays for the cost of the equipment for such location or 14% of the revenue paid to MREC in cases where it does not pay for the cost of the equipment.

The Co-Venture Agreement grants MRECTEC an exclusive non-transferrable license to use the Company’s technology solely for use at locations to operate the concept, as defined in the Co-Venture Agreement. The license would become non-exclusive if the first U.S. location is not opened within 24 months of the effective date and at least one location is opened outside the U.S. and Canada within five years of the Co-Venture Agreement date, the respective milestone dates. Throughout the duration of the Co-Venture Agreement, MRECTEC will pay the Company a royalty based on gross revenue, as defined and subject to certain minimum royalties commencing with the first twelve-month period subsequent to the respective milestone date of June 1, 2017. If the total royalty payments for locations in the United States and Canada together do not total at least the minimum royalty amount specified in the agreement, MRECTEC may pay to VirTra the difference between the amount of total royalty payments and the minimum specified in the agreement to maintain exclusivity. TheOn August 16, 2017, the Company recognized $45,968entered into the first amendment to the Co-Venture Agreement to permit TEC to sublicense the VirTra Technology to third party operators of stand-alone location-based entertainment companies. TEC agreed to pay the Company royalties for any such sublicenses in an amount equal to 10% of the revenue paid to TEC in cases where TEC pays for the cost of the equipment for such location or 14% of the revenue paid to TEC in cases where it does not pay for the cost of the equipment. For the three months ended September 30, 2018 and $43,812 for2017, respectively, the Company recognized license fee income (royalties) forfrom TEC of $41,038 and $40,852. For the threenine months ended March 31,September 30, 2018 and 2017, respectively, the Company recognized license fee income (royalties) from TEC of $512,545 and $245,082.

As a result of entering into the Co-Venture Agreement and related amendment, the Company holds, as of September 30, 2018, 3,353,495 shares of TEC common stock representing approximately 8.4% of the issued and outstanding common shares of TEC. The investment generally would be categorized within Level 3 of the fair value hierarchy. The Company determined a bona fide offer by TEC to sell investments for an amount less than the carrying amount of the Company’s investment occurred and an impairment loss of $134,140 was taken in June, 2018, to write-down the TEC investment to the estimated fair value. The Company recorded its investment at the estimated fair value of $1,240,793 and $1,374,933 at September 30, 2018 and December 31, 2017, respectively. During the three and nine months ended September 30, 2018, the Company recognized an impairment loss on its investment in TEC of $134,140 as operating expense.

In addition, at September 30, 2018, the Company holds a warrant to purchase 153,459 shares of TEC common stock at an exercise price of $0.41 per share. This warrant became exercisable on the date of grant and expires on the tenth anniversary of the date of grant, if not earlier pursuant to the terms of the option.

On July 23, 2018, the Company entered into the second amendment to the Co-Venture Agreement with TEC to (i) confirm the minimum royalty deficiency benefit due for the royalty period ended May 31, 2018; (ii) establish payment terms for the minimum royalty deficiency benefit due, to include both cash and promissory note; (iii) clarify the exclusivity provisions of the Agreement; and (iv) amend the minimum royalty calculations to only TEC branded facilities.

Note 7. Related Party Transactions

During the three and nine months ended March 31September 30, 2018 and 2017, respectively, the Company issued 13,750 stockthe following options to purchase shares of the Company’s common stock to the Company’s CEO, COO, and members of the Board of Directors to purchase shares of common stock at a weighted average purchase price of $5.03.and senior staff. All options are exercisableexpire within seven years of grant date. No stock options were granted during the three months ended March 31, 2018.

During the three and nine months ended March 31,September 30, 2018 and 2017, respectively, the Company redeemed stock options from the CEO, COO and COOan Executive Vice President that had previously been awarded. No such redemptions occurred duringAs a result, the three months ended March 31, 2018. The Company recorded additional compensation expense as follows:

Mr. Mitch Saltz,

During the three and nine months ended September 30, 2018 and 2017, respectively, the CEO exercised stock options that had previously been awarded. As a member of the Company’s Board of Directors, is also Chairman of the Board of Directors and a majority stockholder of MREC. The Company entered into the Co-Venture Agreement with MREC as disclosed in Note 5. Through the terms of that agreement,result, the Company owns 3,353,495 shares of MREC common stock representing approximately 9.3% of the issued and outstanding shares of MREC common stock. Mr. Saltz has a beneficial ownership in the Company of less than 1% and MREC has 0% ownership in the Company.recorded additional equity as follows:

Note 8. Commitments and Contingencies

The Company’s operatingCompany currently leases its machine shop building located at 2169 East Fifth St., Tempe, Arizona 85284. The current lease obligations relateobligation expires in November, 2018. The Company plans to relocate its machine shop from the Fifth St. location to the leasing ofsame complex that its corporate office is located. On May 18, 2018, the Company’sCompany executed a lease amendment for its existing corporate office space located at 7970 South Kyrene Road, Tempe, Arizona 85284, which expires in Aprilto extend its lease obligation from September 2019 unless renewed andto September 2023. Under the leasingterms of the lease amendment, the Company also leased a new machine shop building located at 2169 East Fifth St.,7910 South Kyrene Road, Tempe, Arizona 85284 which expires into become effective upon completion of leasehold improvements on or after October 1, 2018 with a lease obligation to September 2018, unless renewed.2023.

Future minimum lease payments as of September 30, 2018 under non-cancelable operating leases are as follows:

The Company has a deferred rent liability of $63,028$34,352 and $75,444 as of March 31,September 30, 2018 and December 31, 2017, respectively, relative to the increasing future minimum lease payments. Rent expense, including pro-rata share of common area charges was $87,345$120,655 and $97,391$117,068 for the three months ended March 31,September 30, 2018 and 2017, respectively. Rent expense, including pro-rate share of common are charges was $356,513 and $352,899 for the nine months ended September 30, 2018 and 2017, respectively.

General or Threatened Litigation

From time to time, the Company is notified of threatened litigation or that a claim is being made against it. The Company evaluates contingencies on an on-going basis and has established loss provisions for matters in which losses are probable and the amount of loss can be reasonably estimated.

As of September 30, 2018, the financial statement issuance date, there were no claims or pending litigation.Company has initiated a declaratory judgment actionin the Superior Court of the State of Arizona. A former customer has raised allegations of breach of contract and breach of warranty and the Company seeks relief and clarification from the Superior Court regarding the allegations and the Company’s obligations under the contract with the former customer. Management believes that the declaratory judgment action will not have a material adverse effect on our results of operations and the Company will vigorously defend against any allegations raised by the former customer. The Company has established a probable and estimated loss contingency of $40,000 as of September 30, 2018.

Note 9. Stockholders’ Equity

Stock Options

The Company periodically issuespreviously issued non-qualified incentive stock options to key employees, officers and directors under a Stock Option Compensation plan approved by the Board of Directors in 2009. The plan remains in effect for ten (10) years from the Effective Date or unless terminated earlier by the Company. Terms of the option grants are at the discretion of the Board of Directors but historically have been seven years. During

See Note 7. Related Party Transactions for discussion of the three months ended March 31, 2017, the Company issued 13,750issuance of stock options with a weighted average exercise pricefor shares of $5.20 per share. Nothe Company’s common stock options were granted during the three and nine months ended March 31, 2018.September 30, 2018 and 2017.

2017 Equity Incentive Plan

On August 23, 2017 and October 6, 2017, respectively, the board of directors and shareholders approved the 2017 Equity Incentive Plan (the “Equity Plan”). The Equity Plan is intended to make available incentives that will assist us to attract, retain and motivate employees, including officers, consultants and directors. We may provide these incentives through the grant of stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares and units and other cash-based or stock-based awards.

A total of 1,187,500 shares of our common stock was initially authorized and reserved for issuance under the Equity Plan. This reserve will automatically increase on January 1, 2018 and each subsequent anniversary through 2027, by an amount equal to the smaller of (a) 3% of the number of shares of common stock issued and outstanding on the immediately preceding December 31, or (b) an amount determined by the board. On January 1, 2018, the amount authorized and reserved increased to 1,424,630 shares.

Awards may be granted under the Equity Plan to our employees, including officers, directors or consultants or those of any present or future parent or subsidiary corporation or other affiliated entity. All awards will be evidenced by a written agreement between us and the holder of the award and may include any of the following: stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares and performance units and cash-based awards and other stock-based awards. To date, there have been no awards granted under this plan.

The assumptions used in the Black-Scholes-Merton model for the periods ended March 31,September 30, 2018 and 2017, and the resulting estimates of weighted-average fair value per share of options granted during those periods, are as follows:

The following table summarizes all compensation plan stock options as of March 31:for the three and nine months ended September 30:

Stock compensation expense related to vesting and granting of stock options was $69,163$1,796 and $42,376 for the three months ended March 31, 2017. No suchSeptember 30, 2018 and 2017, respectively. Stock compensation expense occurred duringwas $6,656 and $160,351 for the threenine months ended March 31, 2018.September 30, 2018 and 2017, respectively. There are 10,000658 non-vested stock options and unrecognized stock-based compensation expense of $5,264 as of March 31,September 30, 2018 that will vest inbe fully vested and expensed by October 2018.

Note 10. SUBSEQUENT EVENTS

On October 23, 2018, the Company executed a lease addendum for the 2169 E. Fifth Street location to extend the lease term for two (2) additional months to January 31, 2019, with all other lease terms remaining the same. See Note 8. Commitments and Contingencies.

On October 29, 2018, the Company redeemed from an employee 10,000 previously awarded expiring stock options for cash total $29,500, of which $14,000 had previously been expensed in 2011, with the balance of $15,500 being recognized as additional compensation cost in October 2018. See Note 9. Stockholder’s Equity.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited financial statements and related notes included in this Quarterly Report on Form 10-Q and the audited financial statements and notes thereto as of and for the year ended December 31, 2017 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, filed with the Securities and Exchange Commission (the “SEC”) on March 30, 2018.

Forward-Looking Statements

The information in this discussion contains forward-looking statements and information within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, (the “Exchange Act”), which are subject to the “safe harbor” created by those sections. The words “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “will,” “should,” “could,” “predicts,” “potential,” “continue,” “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements that we make. The forward-looking statements are applicable only as of the date on which they are made, and we do not assume any obligation to update any forward-looking statements. All forward-looking statements in this Quarterly Report on Form 10-Q are made based on our current expectations, forecasts, estimates and assumptions, and involve risks, uncertainties and other factors that could cause results or events to differ materially from those expressed in the forward-looking statements. In evaluating these statements, you should specifically consider various factors, uncertainties and risks that could affect our future results or operations. These factors, uncertainties and risks may cause our actual results to differ materially from any forward-looking statement set forth in this Quarterly Report on Form 10-Q. You should carefully consider these risk and uncertainties described and other information contained in the reports we file with or furnish to the SEC before making any investment decision with respect to our securities. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this cautionary statement.

OVERVIEW

We develop, sell and support use of force training and marksmanship firearms training systems and accessories for law enforcement, military or civilian use. Our simulators use software, hardware and content to create uniquely effective and realistic training that does not require live ammunition or less-than-lethal munitions, which can both save money and provide certain training capabilities unavailable to live fire exercises. We have developed a higher standard in simulation training including capabilities such as: multi-screen video-based scenarios, unique scenario authoring ability, superior training scenarios, the patented Threat-Fire™ shoot-back system, powerful gas-powered simulated recoil weapons, and more.

We also are engaged in licensing our technology to Modern Round, LLC, a wholly-owned subsidiary of That’s Eatertainment Corp. (“TEC”), formerly known as Modern Round Entertainment Corporation (“MREC”), a developer and operator of a combined dining and entertainment concept centered on an indoor shooting experience.

Simulator Product Offerings

Our simulator products include the following:

RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED MARCH 31,SEPTEMBER 30, 2018 versusAND 2017

Revenues.Revenues were $3,244,190$3,546,586 for the three months ended March 31,September 30, 2018, compared to $4,209,288$4,686,445 for the same period in 2017, a decrease of $965,098 net of discounts and allowance for bad debt. The decrease in revenue was primarily$1,139,859, or 24%, due to lower deliveryreduced sales of simulator productsimulators, accessories, and scenarios. For the nine months ended September 30, 2018, revenues were $15,495,697 compared to $14,147,297 for the same period in 2017, an increase of $1,348,400, or 10% due to additional sales of simulators, accessories, of which simulator revenue decreased by $715,310 and accessories revenue decreased by $379,131, partially offset by increases in other revenue of $129,343 for scenarios,licensing fees, warranties and licensing fees, net of discounts and bad debt.other services.

Cost of Sales.Cost of sales was $1,026,156were $1,461,754 for the three months ended March 31,September 30, 2018, compared to $1,778,945$1,573,384 for the same period in 2017. A proportional2017, a decrease wasof $111,630, or 7%, due to reduced sales during the reduction in revenue resulting in reduced direct materials, direct travel, and direct production supplies. A non-proportional reduction inperiod. For the nine months ended September 30, 2018, cost of sales also resultedwere $5,452,906, compared to $4,853,796 for the same period in reduced2017, an increase of $599,110, or 12% due to additional sales volume, partially offset by a reduction in costs from the Company’s increased use of its own machine shopproduction facilities for the manufacturing of system and product components, and reduction in materials costs due to favorable supplier pricing of both raw materials and systems components in 2018 compared to the same period in 2017.

Gross Profit.Gross profit was $2,218,034$2,084,832 for the three months ended March 31,September 30, 2018, compared to $2,430,343$3,113,061 for the same period in 2017, with a gross profit margin of 68%59% for the three months ended March 31,September 30, 2018 compared to 58%66% for the same period in 2017. Gross profit was $10,042,791 for the nine months ended September 30, 2018, compared to $9,293,501 for the same period in 2017, with a gross profit margin of 65% for the nine months ended September 30, 2018 compared to 66% for the same period in 2017. The gross profit improvementvariation in each period was a result of a reductiondifferences in the costtype and quantity of sales expense, as well as, the revenue of higher margin product mix.systems and accessories sold.

Operating Expenses. Operating expense was $2,376,247expenses were $2,005,294 for the three months ended March 31,September 30, 2018, compared to $1,956,688$2,361,243 for the same period in 2017, a decrease of $355,949, or 15%, primarily due to reduced accounting, legal, and consultant expenses quarter over quarter. Operating expense was $7,164,860 for the nine months ended September 30, 2018, compared to $6,447,409 for the same period in 2017, an increase of $419,559. SG&A$717,451, or 11% due to year over year increases in general and administrative expenses resulted from 1)(i) expanding staffing levels and increases in payroll and benefit costs; and 2)(ii) professional servicesservice increases in annual audit, accounting and legal fees, public company expense and other fees, licenses, subscriptions and other professional services. Additionally, the nine months ended September 30, 2018, an impairment loss on investment in TEC was recorded as operating expense. The year-over-year increase in professional services included approximately $132,000 of non-recurring legal and public company expense directly related to the Company’s qualification and completion of its Regulation A+ offering, completion of SEC registration and Nasdaq listing.listing in March, 2018.

Income Tax Expense.The amount of income tax expense is a function of our pre-tax income. DeferredOur tax rate is affected by tax rates in each different multi-state jurisdictions that we do business, which is not consistent year over year. Our deferred tax assets reflect current statutory income tax rates in effect for the current period in which the deferred tax assets are expected to be realized. As changes in tax laws or statutory tax rates are enacted, deferred tax assets and liabilities are adjusted through the provision offor income taxes. As of March 31,September 30, 2018, the Company does not believe that there are any uncertain tax positions and does not believe a valuation allowance was necessary. For the three months ended March 31,September 30, 2018 and 2017, the Company recognized income tax expense of $36,000 and $24,285, respectively, an increase of $11,715, or 48%. For the nine months ended September 30, 2018 and 2017, the Company recognized an income tax benefitexpense of $29,194$871,747 and $102,285, respectively, an increase of $769,462, or 752%. This increase was primarily due to the reversal of the Company’s income tax valuation allowance and reporting of deferred tax assets relating to federal income tax net operating loss carryforwards (NOL’s) in accordance with ASC 740.

Net Income.Net income was $61,000 for the three months ended September 30, 2018 compared to net income tax expense of $78,000$742,125 for the same period in 2017, a decrease of $107,194. This$681,125, or -92%. The decrease was primarily due to the net loss in the current period compared to net income results from the explanations of changes in the prior period. 

revenue, cost of sales, operating expense and income tax expense as noted above. Net Income/Loss.Net lossincome was $85,787$2,088,150 for the threenine months ended March 31,September 30, 2018 compared to net income of $401,888$2,792,104 for the same period in 2017.2017, a decrease of $703,954, or -25%. The decrease in net income resultedprimarily results from decreases in revenue, partially offset by anthe $769,462 increase in income tax expense for the gross margin and increases in operating expenses as noted above.nine months ended September 30, 2018.

Adjusted Earnings Before Interest, Taxes, Depreciation and AmortizationEBITDA

Explanation and Use of Non-GAAP Financial Measures:

Adjusted earnings before interest, income taxes, depreciation and amortization and before other non-operating costs and income (“Adjusted EBITDA”) is a non-GAAP financial measure. Adjusted EBITDA also includes non-cash stock option expense.expense and impairment loss on investments. Other companies may calculate Adjusted EBITDA differently. The Company calculates its Adjusted EBITDA to eliminate the impact of certain items it does not consider to be indicative of its performance and its ongoing operations. Adjusted EBITDA is presented herein because management believes the presentation of Adjusted EBITDA provides useful information to the Company’s investors regarding the Company’s financial condition and results of operations and because Adjusted EBITDA is frequently used by securities analysts, investors and other interested parties in the evaluation of companies in the Company’s industry, several of which present a form of Adjusted EBITDA when reporting their results. Adjusted EBITDA has limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of the Company’s results as reported under GAAP.accounting principles generally accepted in the United States of America (“GAAP”). Adjusted EBITDA should not be considered as an alternative for net (loss) income, cash flows from operating activities and other consolidated income or cash flows statement data prepared in accordance with GAAP or as a measure of profitability or liquidity. A reconciliation of net income to Adjusted EBITDA is provided in the following table:

RECONCILIATION OF NET INCOME TO ADJUSTED EBITDA

Liquidity and Capital Resources

Liquidity is the ability of an enterprise to generate adequate amounts of cash to meet its needs for cash requirements.obligations as they become due. The Company had $4,517,620$7,873,980 and $5,080,445 in cash as of March 31,September 30, 2018 and December 31, 2017, respectively.respectively, an increase of $2,793,535, or 55%. The working capital was $5,292,016$9,267,305 and $5,710,483$6,311,490 as of March 31,September 30, 2018 and December 31, 2017, respectively.respectively, an increase of $2,955,815, or 47%.

Net cash used by operating activities was $395,335 for the three months ended March 31, 2018, and net cash provided by operating activities was $955,017$3,164,012 and $2,549,964 for the threenine months ended March 31,September 30, 2018 and 2017, respectively, resulting from a decrease indecreased net income andoffset by significant changes in accounts receivable, unbilled revenue, inventory, prepaid expense and other current assets, accounts payable, and other accrued expenses.expenses, and deferred revenue and deferred rent.

Net cash used in investing activities was $167,490$292,827 and $46,775$83,410 for the threenine months ended March 31,September 30, 2018 and 2017, respectively, resulting from an increase inincreased purchases of property and equipment.

Net cash used in financing activities was $48,500$77,650 and $1,063,928 for the threenine months ended March 31,September 30, 2018 and 2017, respectively, resulting from the cancellationrepurchase of treasury stock, stock options, and debt payment offset by cash received from the exercise of stock options  . No cash was used in financing activities during the three months ended March 31, 2018.options.

Our management believes that our current capital resources will be adequate to continue operating our companyCompany and maintaining our current business strategy for more than 12 months.