PERCEPTRONICS INC, 10KSB40, 1998-06-25

PERCEPTRONICS INC
10KSB40, 1998-06-25
MISCELLANEOUS ELECTRICAL MACHINERY, EQUIPMENT & SUPPLIES

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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549

FORM 10-KSB
_______________________

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

For the fiscal year ended March 31, 1998

(_) TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from _________ to __________

Commission File number 0-12392
________________________

PERCEPTRONICS, INC.

DELAWARE 95-2577731
(State of Incorporation) (I.R.S. Employer
Identification No.)

21010 Erwin Street, Woodland Hills, California 9l367
818-884-7470

Securities registered pursuant to Section 12(b) of the Exchange Act: None

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

Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 (_) No (X)

Check if there is no disclosure of delinquent filers in response to item
405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-KSB or any amendment to this Form 10-KSB (X)

State Issuer's revenues for its most recent fiscal year: $3,541,373.

State the aggregate market value of the voting stock held by non-affiliates
computed by reference to the price at which the stock was sold, or the
average bid and asked prices of such stock, as of a specified date within the
past 60 days: As of June 02, 1998 - $2,675,679.

State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date: As of June 02, 1998 -4,526,430

Documents Incorporated by Reference: Portions of the Proxy Statement for the
1998 annual meeting of stockholders are incorporated by reference into Part III
of this report.

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PART I

ITEM 1. BUSINESS
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G E N E R A L

Perceptronics, Inc. (the "Company") specializes in developing and producing
computer-based simulation systems for training and decision support, and
serves a growing number of worldwide military and commercial clients with
low-cost, high performance systems to enhance individual and team
performance. The Company is known internationally for its ability to move
rapidly from innovative concept to a fully integrated, successfully fielded
product. Perceptronics has been a leader in the defense simulation community
in originating and applying "selective fidelity" design principles to greatly
reduce simulator costs, and in converting defense technology to commercial
applications.

Over the past twenty years, much of Perceptronics' advanced simulation
technology has come from its development and production contracts with major
U.S. defense agencies, including the prestigious Defense Advanced Research
Projects Agency (DARPA). The Company's work has focused on low-cost,
high-performance, interactive simulators for training individuals and teams
in tactical combat skills, and on software for modeling complex human-machine
interactions and for achieving high-speed communication in large networks of
simulators or equivalent devices.

The Company has fielded and continues to field a family of simulation system
products based on its advanced technology. In the defense area, these
products include the PGTS tabletop gunnery trainers for anti-tank missiles,
SIMNET networked simulator systems for combined arms tactical training, and
CombatSim simulations for command training. Commercial products include the
affordable TT150 simulators for truck driver training; PERCNET/HSI-TM- software
for modeling and analyzing the Human-System Interface, and CACE/PM-Registered
Trademark- software for modeling and simulating engineering and manufacturing
processes.

The Company is currently developing new products in the entertainment and
communications fields based on its innovative software technology for
networking large numbers of defense simulators. The entertainment product,
called InterGame-TM-, is directed toward the rapidly growing market for
multi-person, on-line games played on the Internet and other networks.
InterGame development is being funded by a series of U.S. Department of
Defense SBIR (Small Business Innovation Research) contracts and associated
equity investments.

The Company's near-term business strategy is to increase its domestic and
foreign defense contract revenue base in order to improve cash flow and
reduce outstanding liabilities. The Company's long-term growth strategy
focuses on developing and marketing commercial products derived from the
Company's defense-related technology. The Company's ability to complete
these strategies in full will depend on generating sufficient cash flow from
operations and on obtaining additional funding from private and public
investments, neither of which can be assured.

Perceptronics' business activities fall into four main areas: Training
Systems, Networked Simulation Technology, Systems Development and Software
Products.

1. TRAINING SYSTEMS - includes sale to the U.S. Government and
international customers of the Company's standard training devices and
systems, custom systems and/or components, and supporting services. During
fiscal 1995, Dragon PGTS training systems were produced for the U.S. Army and
Marine Corps under a subcontract to Lockheed Martin Fairchild (formerly Loral
Fairchild). During fiscal year 1996, the Company

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completed deliveries to the Egyptian government of 64 TOW PGTS trainers under
a contract which began in fiscal 1995. Also in fiscal year 1996, the
Company completed a $2.0 million subcontract with Wegmann & Co. of Germany
for development and production of Leopard II tank simulator systems for use
by the Swedish Army. In fiscal year 1997, the Company completed a
subcontract from FAAC, Inc., for production of TT150 truck driver simulators
to be used by the U.S. Department of Energy. Also in fiscal year 1998 and
1997, the Company had sales of $2.1 million and $1.5 million, respectively on
a subcontract for TOW PGTS simulator systems for a foreign customer. The
Company also started production in the fourth quarter of fiscal 1998, on a
contract with the Government of Egypt valued at $3.0 million for TOW PGTS
simulator systems. Training Systems accounted for 71% of revenues in fiscal
1998 and 65% in fiscal 1997.

2. NETWORKED SIMULATION TECHNOLOGY - includes sale to the U.S. Government
and other customers of the networking technology based on that pioneered in
the SIMNET program as well as technical support services. During fiscal year
1996, work in this area was performed for U.S. Army Simulation, Training and
Instrumentation Command (STRICOM) and the U.S. Defense Modeling and
Simulation Office (DMSO) under a $2.4 million contract awarded in March 1995
for wide-area communications protocols and software for distributed
interactive simulation (DIS). In fiscal 1997, work was performed on a
subcontract to a U.S. Government prime contractor for application software in
the extension of DIS to the High Level Architecture (HLA). In fiscal 1998,
work was performed on SBIR Phase I and Interim Phase contracts from STRICOM
for adaptation of HLA concepts to commercial multi-player, on-line 3D games;
this work was the predecessor for the SBIR Phase II InterGame development
program described above. Revenues in fiscal year 1998 and 1997 from network
simulation technology contracts totaled $ 0.8 million and $1.0 million,
respectively. In fiscal year 1998 and 1997, Networked Simulation Technology
sales represented 24% and 31% of revenues, respectively.

3. SYSTEM DEVELOPMENT - includes sale of specialized systems and software
in such areas as process modeling, instrumentation, neural network software,
and other advanced applications of the Company's technology in artificial
intelligence (AI), computer-based modeling and simulation and electronics.
In fiscal year 1996, the Company performed on a U.S. Air Force program to
provide advanced mannequins and related instrumentation for live fire
testing. In fiscal year 1998 and 1997, the Company worked on a contract with
a commercial company for a microelectronics data recording system for
medication dosage. In fiscal 1998, the Company was awarded a SBIR Phase I
contract from DARPA for design of COVER (Commander's Observation Vehicle for
Elevated Reconnaissance), a system concept Perceptronics has promoted for a
number of years, which is well suited to the future Army's need for improved
sensing capabilities at the small unit level. In fiscal 1998 and 1997, System
Development Programs represented 5% and 1% of revenues, respectively.

4. SOFTWARE PRODUCTS - include the sale and support of the Company's
commercial software packages, such as CACE/PM-Registered Trademark- software
for modeling and analyzing product development and manufacturing processes
and PERCNET-Registered Trademark- software for modeling and simulating
man-machine interfaces. In fiscal 1998 and 1997, Software Products
represented 1% and 1% of revenues, respectively.

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U.S. GOVERNMENT CONTRACTS

Approximately 26% and 43% of the Company's revenue in fiscal years 1998 and
1997 respectively, were derived from contracts and subcontracts involving the
U.S. Government. As is the case with many companies deriving a portion of
their revenue from defense contracts, the Company is subject to various
business risks, including changes in governmental appropriations and changes
in national defense policies and priorities. Over the past several years,
economic and budgetary constraints have caused reductions in overall defense
spending. These circumstances have had a material adverse effect on the
Company since many of the Company's U.S. Government contracts have been
curtailed or reduced, and new programs have not been initiated. See
"Backlog" and "Item 6 Management's Discussion".

The Company's U.S. Government contracts are structured on either a
cost-plus-fixed-fee (CPFF) or a firm-fixed-price (FFP) basis. Under CPFF
contracts, the Company is reimbursed periodically for allowable costs
together with a portion of the fee with certain amounts being withheld
pending the Government's determination of final fiscal year indirect rates.
Under FFP contracts, the Company generally receives progress payments of
allowable costs incurred; the remainder (including profits) is billed upon
delivery and final acceptance of the product. For work performed under FFP
contracts, the Company carries a greater burden of risk associated with cost
overruns. (See "Management's Discussion and Analysis of Financial Condition
and Results of Operations" section). In fiscal years 1998 and 1997
respectively, 83% and 73% of the Company's U.S. Government contract related
revenues were attributable to CPFF contracts and 17% and 27% of such revenues
were attributable to FFP contracts.

The Company's U.S. Government contracts and subcontracts are subject to
termination, reduction or modification in the event of changes in the
Government's requirements or budgetary constraints. Should a contract be
terminated for such reasons, the Company would be reimbursed for its
allowable costs to the date of termination and would be paid a proportionate
amount of the stipulated profits or fees attributable to the work actually
performed. During fiscal year 1998, none of the Company's U. S. Government
contracts were terminated. When the Company participates as a subcontractor,
it is also subject to the risk that the prime contractor may fail or be
unable to perform the prime contract. During fiscal year 1998, none of the
prime contractors with which the Company participates, were unable to perform
the prime contract.

The books and records of the Company are subject to audit by the Defense
Contract Audit Agency (DCAA). At March 31, 1998, the DCAA had an audit in
progress of a large multi-year contract which was completed in 1994. The
Company believes that the costs charged to this contract were proper and
should not result in a significant adjustment. The Company's overhead costs
have been audited and approved by the DCAA through fiscal year 1995. The
Company believes that it is in substantial compliance with Government
record-keeping and cost-allocation requirements, and does not expect any
significant adjustments as a result of the future audit of 1998, 1997 and
1996 overhead costs.

MARKETING AND CUSTOMERS

The Company markets its defense products and services to U.S. Department of
Defense agencies, other U.S. governmental agencies, other defense
contractors, foreign government agencies and foreign companies. The Company
submits unsolicited research and system development proposals in areas where
it has original ideas and unique capabilities, and also responds to
competitive development and production proposal requests in areas of Company
capability. The Company currently serves as a subcontractor

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to a number of defense and commercial companies. Subcontracts represented
approximately 72% and 72% of revenues in fiscal years 1998 and 1997,
respectively.

Commercial products such as CACE-Registered Trademark- and PERCNET-Registered
Trademark- software, video mapping systems, TT150 Truck Driving Simulators
and Audio Environment Simulators are marketed through a combination of direct
sales and marketing agents.

The Company has marketing arrangements for its defense and commercial
products in a number of foreign countries. During fiscal years ended March
31, 1998 and 1997 foreign sales were approximately 70% and 56% of total
Company revenues, respectively. Foreign sales are subject to risks
associated with political or economic instability of a foreign country,
currency controls, exchange rate fluctuations, changes in import/export
regulations, trade policies and tariffs. Payments to the Company on all
foreign sales are made in U. S. currency. During fiscal year 1998, 61% of the
Company's revenue was with a foreign customer that purchased TOW PGTS
systems. In fiscal 1997, 47% of the Company's revenue was with that same
customer. As mentioned in the backlog section, certain of the Company's
contracts extended to customers the option to buy additional products and
services. At March 31, 1998, the contract with this foreign customer
contained $8.4 million in unexercised contract options. During fiscal 1999,
the Company will be working on a contract with the Government of Egypt with a
contract value of $3.0 million which will fully utilize the Company's
manufacturing operation. In the event that the Company were to lose all of
its foreign customer base the Company would have to significantly reorganize
its operations.

RIGHTS TO TECHNOLOGY

Most of the Company's technology developments are the result of
customer-sponsored contracts. The Company's rights to such technology are
governed by its agreement with the customer. Under U.S. Government
contracts, the Company retains all rights to inventions discovered in the
course of performing the contract, subject to the Government's non-exclusive,
non-transferable, non-royalty bearing, worldwide license to use and sell the
invention. In addition, the Company may be obligated to grant non-royalty
bearing licenses to companies selected by the Government in competitive
procurement to use such inventions in the course of performing their
Government contracts. Unless otherwise specifically stated in the contract,
the Government retains unlimited rights to technical data and computer
software developed under the contract. Under non-Government contracts,
unless otherwise stated, the customer owns the rights to all technology and
products developed under the contract and Perceptronics may not utilize the
technology without obtaining a license from the customer.

The Company has applied for patent protection on several of its products.
While the Company generally considers its business to be primarily dependent
upon proprietary knowledge and on rapid assimilation of innovations it will
continue to seek patent protection where it is feasible.

MANUFACTURING AND SUPPLIES

The Company's manufacturing activities primarily involve the sub-system
assembly, final system assembly, integration and testing of component parts
that have been fabricated by others. Many of the purchased components are
built to the Company's engineering designs and specifications by
subcontractors. Although most materials and purchased components

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generally are available from a number of different sources, there are
situations where several suppliers are the Company's sole source of certain
component parts.

COMPETITION

The principal methods of competition are responsiveness, price, technology
expertise and product performance. Due to the decline in overall defense
spending, the Company has been experiencing intense competition for U.S. and
foreign government contracts. The Company seeks to distinguish itself from
its competitors on the basis of its ability to meet customer needs by
developing and producing innovative systems that combine low cost with high
performance, and its ability to move a system successfully from the initial
R&D concept to final fielded product. However, the Company's size and
financial condition impedes its ability to compete in many areas.

In the case of competitively bid contracts, the Company's competitors for
system development contracts include SAIC, Litton, Lockheed Martin, and TRW.
Competitors for training and command support products include General
Electric Company, ECC International, CAE, and such foreign companies as
Wegmann, SAAB and Giravions Dorand. All of these companies have substantial
financial, technological and marketing resources which enables them to bid on
larger contracts. There can be no assurance that the Company will be able to
compete successfully in the future.

STRATEGIC PARTNERING AND TEAMING AGREEMENTS

The Company seeks to improve its competitive position, particularly on larger
programs, through teaming and strategic partnering arrangements with other
companies. The Company may act as prime contractor or subcontractor under
such arrangements, depending on the situation. Examples of companies with
whom Perceptronics has teamed for specific programs are Litton, Infinity
Multimedia, Lockheed Martin, Wegmann, Kollsman, Northrop Corporation, SAIC,
TRW, McDonnell Douglas and The Harris Corporation. These programs accounted
for approximately 72% and 72% of revenues in fiscal years 1998 and 1997,
respectively.

EMPLOYEES

As of March 31, 1998, the Company had 25 full-time and part-time employees
and consultants, consisting of 4 management personnel, 1 marketing person, 5
administrative and support personnel, 9 scientific and technical personnel
and 6 production personnel. Of the Company's employees, 2 have Ph.D. degrees
and 5 have Master's degrees. None of the Company's employees are represented
by a labor union and the Company has experienced no work stoppages. The
Company believes that its employee relations are good.

ITEM 2. PROPERTIES
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The Company's primary offices are located in a 14,300 square foot leased
facility in Woodland Hills, California, a Los Angeles suburb. The total
monthly rent for this space is approximately $18,300, and the lease expires
in November 1998. During fiscal 1998, the Company sublet 5,600 square feet
of the leased space to a commercial company for a monthly rent of $6,700.
The sublease expires December of 1998.

In August 1997, the Company moved its manufacturing operation to a leased
facility of approximately 11,000 square feet in Chatsworth, California. The
monthly rent on the new manufacturing facility is approximately $6,300 and
the lease expires in October 2000. The

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Company also leases a 6,000 square foot Southern California facility for
storage purposes. The monthly rental is $3,000 and the lease expires in
January 2001.

ITEM 3. LEGAL PROCEEDINGS
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None

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------- ---------------------------------------------------
None.

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PART II

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

The Company's Common Stock is currently traded over the counter. The
following table sets forth the high and low prices for the Common Stock as
reported by the NASDAQ Bulletin Board, for the periods listed. The
over-the-counter quotations reflect inter-dealer prices, without retail
mark-up, mark-down or commissions, and may not represent actual transactions.

Fiscal Year 1998 High Low
---------------- ---- ---
<S> <C> <C>
June 30, 1997 $0.14 $0.11
September 30, 1997 0.16 0.13
December 31, 1997 0.63 0.22
March 31, 1998 0.55 0.34

Fiscal Year 1997 High Low
---------------- ---- ---
<S> <C> <C>
June 30, 1996 $0.34 $0.25
September 30 1996 0.31 0.22
December 31, 1996 0.22 0.13
March 31, 1997 0.13 0.09

</TABLE>

Common stock was issued to a private investment company on March 13, 1998.
The investor purchased 57,143 shares of common stock at a purchase price of
$20,000 or $.35 per share. The common shares are not registered under the
Securities Act in reliance on section 4 (2) thereof.

During November 1997, the Company extended the term of a warrant to purchase
common stock. The outstanding warrant which is exercisable to 50,000 shares
of common stock at the exercise price of $.32 and which is held by the
Company's export lender, had the expiration date extended to December 31,
2000. During March 1998, in conjunction with the sale of common stock to the
private investment company mentioned in the paragraph above, the Company
issued warrants to purchase 25,000 common shares at $.30 per share and 57,143
common shares at $.57. These warrants expire in March 2003. The warrants
and the common shares that would be issued upon exercise are not registered
under the Securities Act in reliance on section 4 (2) thereof.

On March 31, 1998, the Company reached a settlement with a consultant to
resolve a large past due accounts payable balance. In exchange for clearing
$120,000 of the past due accounts payable balance, the Company issued
warrants to purchase 240,000 shares of common stock at an exercise price of
$.50. The warrants vest immediately and expire March 30, 2003. The warrants
and common shares that would be issued upon exercise are not registered under
the Securities Act in reliance on section 4 (2) thereof.

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shares. The warrants vest and are issuable in amounts equal to 1% of the
Company's outstanding shares each 90 day period starting 46 days from the
date of agreement. The warrants are to have an exercise price equal to 85%
of the market value on the day prior to the date of vesting and expire five
years from date of grant. Warrants that have vested at March 31, 1998 are;

Vesting date Shares Exercise price
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<S> <C> <C>
10/31/97 44,693 $0.32
01/29/98 44,693 $0.29

</TABLE>

The warrants and common shares that would be issued upon exercise are not
registered under the Securities Act in reliance on section 4 (2) thereof.

As of March 31, 1998, the Company had approximately 369 shareholders of
record of its Common Stock.

The Company has never paid dividends and it does not expect to declare or pay
any dividends in the foreseeable future.

ITEM 6 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- ------ ---------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------

GENERAL

Perceptronics, Inc. (the "Company") designs, develops and manufactures
computer-based simulation systems for training and decision support. These
systems include both hardware and software. The Company's simulators are used
to train personnel in the use of various military and commercial equipment,
including weapons, vehicles and aircraft. In the decision support area, the
Company's computer software and systems are used to enhance command and
control operations for process modeling and simulation, and for management of
concurrent engineering activities in product development and manufacturing.
Much of the Company's business is in the foreign defense industry where the
Company has built an international reputation. The following discussion is
based on the audited consolidated financial statements contained elsewhere in
this report. The audited financial statements have been prepared in
conformity with general accepted accounting principals, which contemplate
continuation of the Company as a going concern. The financial statements do
not include any adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amounts and
classifications of the liabilities that may result from the possible
inability of the Company to continue as a going concern. See Note A of Notes
to Consolidated Financial Statements.

RESULTS OF OPERATIONS

FISCAL 1998 COMPARED TO FISCAL 1997

NET SALES. Net sales for fiscal 1998 increased by 10% or $314,000 from
fiscal 1997. Sales of training simulator systems increased $418,000 or 20% as
a result of increased export sales of TOW PGTS simulator systems. During
fiscal 1998, the Company completed a contract that was started in fiscal 1997
and delivered TOW PGTS simulator

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systems to a foreign customer. During the second quarter of fiscal 1998 the
same foreign customer awarded the Company another contract for TOW PGTS
training units valued at $1.5 million. The second contract was completed in
the fourth quarter of fiscal 1998. Sales with this foreign customer in
fiscal 1998 was 61% of total sales as compared to 47% in fiscal 1997. As
mentioned in the backlog section below, certain of the Company's contracts
extend to the customer the option to buy additional products and services.
At March 31, 1998, the contract with this foreign customer contained $8.4
million in unexercised contract options. During the fourth quarter of fiscal
1998, the Company started production on a contract with the Egyptian
government for TOW PGTS simulator systems valued at $3.0 million. Sales of
$272,000 were recorded on the contract with Egypt during fiscal 1998, with
the balance of the contract to be completed in fiscal 1999. In the event
that the Company were to lose all of it's foreign customer base the Company
would have to significantly reorganize it's operations. Science and
technology sales increased $138,000 due to a contract for the design of a
medication dispenser monitoring device. Simulation network technology and
software product sales decreased $247,000 or 22% as a result of reduced
activity on U.S. Government cost reimbursable contracts. Sales to the U.S.
Government in total were lower in fiscal 1998 ($900,000), compared to fiscal
1997 ($1,400,000). The Company has been faced with an overall slowdown in the
defense market which has resulted in many U.S. Government programs being
delayed, postponed or canceled. In addition there is increased competition
for those programs that remain active.

COST OF SALES. Cost of sales for fiscal 1998 decreased 7%, even though sales
increased 10%. Cost of sales as a percentage of sales decreased to 65% in
fiscal 1998 from 76% in fiscal 1997. The improvement in cost of sales is the
result of an on-going cost reduction program that has resulted in reductions
of direct and indirect expenses. Also having a positive effect on cost of
sales as a percentage of sales in fiscal 1998 was the higher sales of
training simulator systems which carry higher margins and the reduction in
lower margin U.S. Government contract sales.

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased 10% in fiscal 1998 compared to fiscal 1997 primarily the result of
increased foreign marketing expenses.

INTEREST EXPENSE. Interest expense increased to $246,000 in fiscal 1998. The
increase was attributable to higher borrowing levels and the related interest
charges in fiscal 1998 associated with the export credit facility required to
support the foreign contracts for TOW PGTS simulator systems.

EXTRAORDINARY GAIN FROM SETTLEMENT OF DEBT. On September 30, 1997, the
Company reached a settlement with Lockheed Martin Fairchild to settle a note
with a carrying value of $704,977 and accrued interest of $133,006 for
$500,000. Negotiations to settle the note had begun prior to March 31, 1997.
The financial statements as of March 31, 1997 reflect the recognition of the
settlement of the debt. Due to the large net operating loss carryforwards,
the extraordinary gain was not reduced for income taxes.

BACKLOG. The Company's firm contract backlog was $2.9 million at March 31,
1998 and $0.9 million at March 31, 1997. The term "firm contract backlog"
refers to the aggregate revenue remaining under contracts held by the Company
and includes both funded and unfunded amounts. Unfunded amounts were
approximately $0 million and $0 million for fiscal years 1998 and 1997,
respectively.

Subsequent to March 31, 1998, the Company has received additional contract
awards. In April 1998, the Company was awarded a contract for $500,000 by the
U.S. Government

<PAGE>

for network technology software products. In May 1998, the Company received a
contract for $100,000 for science and technology products and a contract for
$67,000 from a foreign customer for a TOW PGTS simulator system. In June
1998, the Company was awarded a U.S. Government Department of Defense SBIR
Phase II Fast Track contract for $750,000 which involves the development of
commercialized networking software products for on-line, multi-player games
involving complex 3D environments ("Intergame software"). In order for work
to begin on the contract the Company is required to obtain $375,000 in
matching equity investment from third party investors, in addition to the
contract funding of $750,000, to fund additional research and marketing
activities associated with the contract. The Company has obtained payments
and/or subscriptions from third party investors for the required equity
investment. The work is expected to start on this program by the end of June
1998.

Certain of the Company's contracts extend to customers the option to buy
additional products and services at specified prices over a specified period
of time. There is no assurance that any contract option will be exercised. At
March 31, 1998, the option backlog was $13.1 million.

LIQUIDITY AND CAPITAL RESOURCES

With unrestricted cash balances of $78,000 at March 31, 1998, the Company's
principal source of liquidity continues to be the Company's export credit
facility, vendor credit and cash flow generated from operations. The Company
had negative working capital of $500,000 at March 31, 1998, compared to
negative working capital of $379,000 at March 31, 1997. The Company has
experienced severe liquidity problems in the past and continues to have
difficulty in meeting its obligations as they come due. With respect to the
foreign contracts for TOW PGTS simulator systems, an export credit facility
is in place to provide the cash flow required to perform on these contracts.
Payments to vendors for materials needed for the contract are generally in
advance or on delivery terms and are being funded through the credit
facility. At March 31, 1998, vendor accounts totaling $316,000 are past due
and are being liquidated as positive cash flow permits. See Note A, "Basis of
Presentation", of the Notes to Consolidated Financial Statements which is
hereby incorporated herein by reference.

The Company's short-term strategy is to increase its domestic and foreign
defense contract revenue base in order to generate sufficient cash flow for
operations and to reduce outstanding current liabilities. A major part of
the Company's long-term strategy will be to focus on the development of
commercial products derived from the Company's defense related technology and
expertise in order to reduce the Company's dependence on defense contracts.
The SBIR intergame software contract, mentioned above in the backlog
section, will enable the Company to use it's defense related technology to
develop commercial software products. The Company is required to obtain
additional equity funding of approximately $375,000 to satisfy the self
funding requirements of the contract. The Company's ability to pursue its
long-term strategy will depend on generating sufficient cash flow from
operations and equity investment to finance new product development. There
can be no assurance that this strategy will be successful. The Company is
also exploring other alternatives, including potential business combinations.

The export credit facility mentioned above was obtained in October 1997 from
a commercial lender and enables the Company to borrow up to $1,666,000 to be
used in conjunction with it's export contracts. The credit facility is
guaranteed by the U.S. Small Business Administration (SBA) and the California
Export Finance Office (CEFO). The borrowings bear interest at 3.0 points
above prime rate and are secured by a lien placed on the Company's general
assets. Borrowings occur on the credit facility as work progresses

<PAGE>

on the contract. The borrowings are repaid with proceeds received from the
delivery of finished units. At March 31, 1998, borrowings outstanding against
the line totaled $1,131,000. On April 20, 1998 the Company repaid $545,000 of
the outstanding balance with proceeds received from the delivery of finished
units. On February 27, 1998, the Company entered into a short term note
payable with the same export lender for $100,000 which matures June 30, 1998
and bears interest at 14% per annum. The Company is currently using the
credit facility and the funds from the short term note to finance the
production of TOW PGTS simulator systems for the Government of Egypt.

On September 30, 1997, the Company reached a settlement with Lockheed Martin
Fairchild to pay $500,000 to discharge an unsecured note payable in full
including accrued interest. The funds required to discharge the Lockheed
Martin Fairchild unsecured promissory note were obtained from other lenders.
The Company entered into a $200,000 note with a bank which is guaranteed by
the SBA and which bears interest at prime interest rate plus 2.75 percentage
points with principal and interest payable monthly amortizing over five
years. On March 31, 1998, the outstanding balance owed on the SBA note is
$184,653. The Company also entered into a $200,000 note with an export
customer that bears interest at 12 percent. On April 21, 1998, the Company
repaid $51,032 of the outstanding balance. The Company plans to repay the
remaining outstanding balance of $148,968 within the next three months using
proceeds from the final payment on the $1.5 million TOW PGTS contract. The
Company funded $100,000 of the settlement from operating cash flow. The March
31, 1997 financial statements were prepared to reflect the fair value of the
unsecured note based on the settlement that occurred on September 30, 1997.

On March 31, 1998, the Company reached a settlement with a consultant to
resolve a past due accounts payable balance of $220,000. The Company entered
into a 24 month note payable in the amount of $100,000 that bears interest at
8% per annum. The Company also issued warrants to purchase 240,000 shares of
common stock in settlement of the remaining accounts payable balance of
$120,000.

The Company's operating activities provided cash of $620,000 in fiscal 1998
and used cash of $1,640,000 in fiscal 1997. During fiscal 1998, the improved
cash inflow resulted from net income adjusted to a cash basis, the collection
of accounts receivable associated with the TOW PGTS simulator systems export
contract and offset by the repayment of accounts payable liabilities. During
fiscal 1997, the cash outflow resulted from increases in accounts receivable
associated with the TOW PGTS simulator systems export contract, increased
prepaid expenses primarily the result of advance payments for the purchase of
materials for the export contract and repayment of accounts payable and other
current liabilities.

The Company's investing activities used cash of approximately $100,000 in
fiscal 1998 associated with capital expenditures incurred in conjunction with
the relocation to the new manufacturing facility. There were no capital
expenditures during fiscal 1997.

The Company's financing activities used cash of $310,000 in fiscal 1998
resulting from the net repayment of the export credit facility and the
repayment of long term debt. During fiscal 1997, the Company's financing
activities provided $1,490,000 which was primarily the result of net
borrowings against the export credit facility offset by repayment of long
term debt.

<PAGE>

common stock of the Company in an amount up to 5% of the Company's
outstanding shares. The warrants vest and are issuable each 90 day period
starting 46 days from the date of the agreement. The warrants are to have an
exercise price equal to 85% of the market value on the day prior to the
vesting date and expire five years from date of grant. Warrants that have
vested at March 31, 1998 are for 44,693 shares at $.32 per share and 44,693
shares at $.29 per share.

NEW ACCOUNTING PRONOUNCEMENT

Effective December 31, 1997, the Company adopted Statement of Financial
Accounting Standards No. 128, "Earnings per Share" (SFAS No. 128"). This
statement replaces the previously reported primary and fully diluted earnings
per share with basic and diluted earnings per share. Basic earnings per share
is computed by dividing net income (loss) available to common stockholders by
the weighted average number of common shares outstanding during the period.
Diluted earnings per share is very similar to the previously-reported primary
earnings per share in that it includes the effect of the additional common
shares which would have been outstanding if dilutive stock options had been
exercised. All earnings per share amounts have been restated to conform to
the SFAS No. 128 requirements.

YEAR 2000 COMPLIANCE

The year 2000 issue results from computer programs that do not differentiate
between the year 1900 and the year 2000 because they were written using two
digits rather than four to define the applicable year; accordingly computer
systems that have time-sensitive calculations may not properly recognize the
year 2000. The Company has conducted an initial review of its computer system
to identify whether the system is year 2000 compliant. The computer equipment
and software currently used by the Company is an older generation and will be
affected by the year 2000 problem. The Company is assessing current
generation systems and plans to replace the existing computer system. While
the Company does not know what the total cost associated with becoming year
2000 compliant will be the Company feels that it will not be material. By the
end of 1998, the Company plans to complete it's review of new computer
systems and to make a selection to replace the system currently in use.
However, there can be no assurance that software incompatibility with the
year 2000 issue on the part of the Company's customers and suppliers will not
cause an interruption of operations or that the Company will not have to
incur substantial cost to avoid such occurrences.

FORWARD LOOKING STATEMENTS

Except for the historical information contained herein, this report contains
forward looking statements (identified by the words "estimate," "project,"
"anticipate," "plan," "expect," "intend," "believe," "hope" and similar
expressions) which are based on Management's current expectations and speak
only as of the date made. These forward looking statements are subject to
various risks, uncertainties and factors, including, without limitation,
those described below, that could cause actual results to differ materially
from the results anticipated in the forward looking statements.

GOING CONCERN ISSUE AND SEVERE LIQUIDITY PROBLEMS. The Company's audited
financial statements for the fiscal year ended March 31, 1998 and 1997 have
been prepared in conformity with generally accepted accounting principals,
which contemplate continuation of the Company as a going concern. See the
Independent Auditors' Report

<PAGE>

and Note A of Notes to Consolidated Financial Statements contained elsewhere
herein. The financial statements do not include any adjustments to reflect
the possible future effects on the recoverability and classification of
assets or the amounts and classification of liabilities that may result from
the possible inability of the Company to continue as a going concern. The
Company has experienced a significant decline in revenues and operating
losses in recent years. As a result, the Company suffers from severe cash
shortages which restrict its ability to bid for, obtain and perform larger
contracts. At March 31, 1998, current liabilities exceeded current assets by
$500,000 and the Company has had difficulty in meeting its obligations as
they come due. Even if the Company overcomes its liquidity problems, there
can be no assurance that in the future the Company will be able to increase
revenues or operate profitably.

BUSINESS STRATEGY; INTERGAME SOFTWARE PRODUCT. A major part of the Company's
business strategy is to focus on the development of commercial products
derived from the Company's defense related technology and expertise in order
to expand its customer base and reduce its dependence on defense contracts.
As part of this strategy, the Company has obtained a U.S. Government
Department of Defense SBIR Phase II Fast Track contract for $750,000 to
develope and commercialize networking software for commercial on-line,
multi-player games involving complex 3D environments ("InterGame software").
The Company requires additional equity funding of $375,000 to satisfy
self-funding requirements under the SBIR contract; and the Company has
obtained payments and/or subscriptions for third party equity investments
sufficient to cover the $375,000 contract requirement. The Company will also
require additional funding to be able to fully commercialize, market and
exploit the InterGame software. There can be no assurance that all future
funding requirements will be obtained and at terms that will be advantageous
from an economic standpoint. Furthermore, there can be no assurance that the
Company will be successful in its development efforts, that the InterGame
software will be a commercially feasible product, or that the Company will be
able to successfully market the InterGame software.

PRODUCT DEVELOPMENT AND TECHNOLOGICAL CHANGE. The computer software and
networked game industries are characterized by rapid technological change and
are highly competitive. The Company's success is dependent on its ability to
develop new products and product enhancements to keep up with technological
advances and to meet customer needs. Any failure by the Company to
anticipate or respond adequately to technological developments and customer
requirements, or any significant delays in product development or
introduction, could have a material adverse effect on the Company's financial
condition and results of operations. The Company has limited manufacturing
and marketing capabilities and financial resources and will be dependent upon
establishing relationships with strategic and marketing partners to be able
to fully exploit the InterGame software and other commercial products. There
can be no assurance that the InterGame software or future new products will
achieve market acceptance, result in increased revenues, or be profitable.
Such products could also be subject to technological obsolescence and intense
competition from companies with greater resources than the Company.

DEPENDENCE ON FOREIGN SALES. During the fiscal years ended March 31, 1998 and
1997, foreign sales, primarily to foreign governments, represented
approximately 70% and 56% of total revenues, including sales to one foreign
customer for TOW PGTS simulator systems which represented 61% and 47% of
sales, respectively. While the Company hopes to increase its domestic
defense and commercial business, the Company anticipates that foreign
contracts will continue to account for a significant portion of its sales.
To the extent these revenues are derived from sales to foreign government
agencies they may be subject to risks similar to those set forth below under
"Dependence on Defense-Related

<PAGE>

Business." Foreign sales are also subject to risks associated with political
or economic instability of a foreign country, currency controls, exchange
rate fluctuations, changes in import/export regulations, trade policies and
tariffs.

DEPENDENCE ON DEFENSE-RELATED BUSINESS. The Company has historically derived
a substantial portion of its revenues from U.S. and foreign government
defense-related contracts. As a result, the Company's business has been
impacted by reductions in the U.S. federal defense budget and this business
will continue to be subject to risks affecting the defense industry,
including changes in governmental appropriations and changes in national
defense policies and priorities. The Company has sought to reduce its
dependence on defense-related business by developing products with commercial
applications, such as the proposed InterGame software networking products.

MANAGEMENT OF GROWTH. Successful expansion of the Company's operations will
depend on, among other things, the ability to develop and commercialize new
products, to continue to effectively market existing products, to attract and
retain skilled management and other personnel and to secure adequate sources
of capital to finance growth at reasonable terms. To manage growth
effectively, the Company will have to continue to improve its operational,
financial and management information systems, procedures and controls. As
the Company expands, it may from time to time experience constraints that
will adversely effect its ability to satisfy customer demand in a timely
fashion. Failure to manage growth effectively could adversely effect the
Company's financial condition and results of operations.

COMPETITION. The Company expects to encounter intense competition in the area
of networked on-line computer games from companies that have substantially
greater financial, manufacturing and marketing capabilities than the Company.
The Company could also experience competition from emerging companies. There
can be no assurance that the Company's products will be competitive with
existing or future products, or that the Company will be able to establish or
maintain a profitable price structure for its products. The Company also
experiences intense competition for U.S. and foreign government contracts
from companies such as SAIC, Litton, Lockheed Martin and TRW, which have
substantially greater resources than the Company. The Company's size and
financial condition impedes its ability to compete in many areas.

PROTECTION OF INTELLECTUAL PROPERTY. The Company relies on a combination of
patents, trade secrets, and other intellectual property law, nondisclosure
agreements and other protective measures to preserve its proprietary rights
pertaining to its technology and products. Such protection, however, may not
preclude competitors from developing products or technology similar or
superior to the Company's. In addition, the laws of certain foreign
countries do not protect intellectual property rights to the same extent as
the laws of the United States. Although the Company continues to implement
protective measures and intends to defend its proprietary rights, there can
be no assurance that these efforts will be successful. Furthermore, there
can be no assurance that the Company's products or technologies are not or
will not be in violation of the patent rights of third parties, or that any
of the Company's patents will not be challenged, invalidated or circumvented.

ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ------- -------------------------------------------

The Company's Consolidated Financial Statements are contained in this report
beginning at page F-l.

<PAGE>

ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
---------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------

The Company reported by form 8-K (Date of Event December 1, 1994) that on
December 1, 1994 the Company terminated the engagement of Ernst & Young as
its independent accounting firm.

The Company's financial statements for the years ended March 31, 1994, 1995
and 1996 were not audited.

On April 22, 1997, the Company retained Beckman & Associates (now Beckman
Kirkland & Whitney) as its independent accounting firm to audit its financial
statements for the year ended March 31, 1997. Beckman & Associates issued
its report on such financial statements on October 24, 1997. On April 3,
1998, the Company retained Beckman Kirkland & Whitney as its independent
accounting firm to audit its financial statements for the year ended March
31, 1998 and March 31, 1999. Their auditors report for fiscal year ended
March 31, 1998 was issued on June 8, 1998 and is included in this Form 10-KSB
at page F-1.

15
<PAGE>

PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS:
- ------- --------------------------------------------------------------
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.
--------------------------------------------------

The information required hereunder is incorporated by reference from the
section entitled "Election of Directors" and "Executive Officers" of the
Company's Proxy Statement filed in connection with its 1998 Annual Meeting of
Stockholders.

ITEM 10. EXECUTIVE COMPENSATION
- -------- ----------------------

The information required hereunder is incorporated by reference from the
section entitled "Executive Compensation" and "Election of
Directors - Compensation of Directors" of the Company's Proxy Statement
filed in connection with its 1998 Annual Meeting of Stockholders.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- -------- --------------------------------------------------------------

The information required hereunder is incorporated by reference from the
section entitled "Ownership of Common Stock" of the Company's Proxy Statement
filed in connection with its 1998 Annual Meeting of Stockholders

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- -------- ----------------------------------------------

The information required hereunder is incorporated by reference from the
section entitled "Certain Transactions" and of the Company's Proxy Statement
filed in connection with its 1998 Annual Meeting of Stockholders.

16
<PAGE>

PART IV

INDEX TO EXHIBITS

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
- -------- --------------------------------

(a) Exhibit Index (Management contracts, compensation plans and
arrangements are identified by *).

3.1 Certificate of Incorporation, as amended (4)

3.2 By-Laws, amended. (2)

* 10.1 Non-Qualified Stock Option agreements with certain
officers and directors. (2)

* 10.2 1992 Stock Option Plan (5)

* 10.3 Employment Agreement with Gershon Weltman
dated August 1, 1989 (1) and First Amendment dated
October 22, 1991. (3)

* 10.4 Form of Promissory Note and Warrant Agreement
dated December 22, 1993 between the Company
and certain officers and directors. (6)

* 10.5 Form of indemnification Agreement with Officers
and Directors. (1)

* 10.6 1988 Directors' Stock Option Plan. (5)

10.7 Settlement Agreement between Loral Fairchild Corp.
dated December 19, 1994 and Perceptronics Inc., in
connection with the PGTS Program. (7)

10.8 $1,225,000 Promissory Note dated January 3, 1995,
payable to Loral Fairchild Corp. (7)

* 10.9 Second Amendment to Employment Agreement with
Gershon Weltman dated August 27, 1996. (8)

* 10.10 Termination of Employment Agreement with Amos
Freedy effective November 14, 1996. (8)

* 10.11 Employment agreement with Thomas Lubaczewski
dated January 1, 1997. (9)

10.12 Amendment to the Agreement of January 3, 1995 between
Loral Fairchild Corp., and Perceptronics, Inc. (9)

10.13 Loan Agreement and note dated September 23, 1997
between the Company and The Pacific Bank. (10)

17
<PAGE>

10.14 Promissory Note dated September 22, 1997 between the
Company and Applied Controls Technology. (10)

21.1 Subsidiaries

23.1 Consent of Independent Accountants

27.1 Financial Data Schedule

(1) Incorporated by reference to the Company's Form 10-K for the year
ended March 31, 1990.

(2) Incorporated by reference to the Company's Form 10-K for the year
ended March 31, 1991.

(3) Incorporated by reference to the Company's Form 10-K for the year
ended March 31, 1992.

(4) Incorporated by reference to the Company's Form 8-K/A date of event
reported April 30, 1993.

(5) Incorporated by reference to the Company's Form 10-K for the year
ended March 31, 1993.

(6) Incorporated by reference to the Company's Form 10-KSB for the year
ended March 31, 1994.

(7) Incorporated by reference to the Company's Form 10-KSB for the year
ended March 31, 1995.

(8) Incorporated by reference to the Company's Form 10-KSB for the year
ended March 31, 1996.

(9) Incorporated by reference to the Company's Form 10-KSB for the year
ended March 31, 1997.

(10) Incorporated by reference to the Company's Form 10-QSB for the
quarterly period ended September 30, 1997.

<PAGE>

SIGNATURES
----------

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed
on its behalf by the undersigned, thereunto duly authorized.

Dated: June 25, 1998
-------------

PERCEPTRONICS, INC.

By: /s/ Gershon Weltman
-----------------------
Dr. Gershon Weltman
Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

Signature Title Date
--------- ----- ----

/s/ Dr. Gershon Weltman June 25, 1998
- ---------------------------
Gershon Weltman Chairman and Chief Executive
Officer (Principal Executive
Officer)

/s/ Robert E. Anderson June 25, 1998
- ---------------------------
Robert E. Anderson Senior Vice President
and Chief Financial Officer
(Principal Financial &
Accounting Officer)

/s/ Dr. John Lyman June 25, 1998
- ---------------------------
Dr. John Lyman Director

/s/ Stanley Schneider June 25, 1998
- ---------------------------
Stanley Schneider Director

/s/ Robert Parker June 25, 1998
- ---------------------------
Robert Parker Director

<PAGE>
INDEPENDENT AUDITOR'S REPORT

To the Board of Directors and
Perceptronics, Inc. and Subsidiary

We have audited the accompanying balance sheets of Perceptronics, Inc. and
Subsidiary as of March 31, 1998 and 1997, and the related statements of
operations, shareholders' equity, and cash flows for the years then ended.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audit.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Perceptronics, Inc. and
Subsidiary as of March 31, 1998 and 1997, and the results of its operations and
its cash flows for the years then ended in conformity with generally accepted
accounting principles.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As shown in the financial
statements, the Company had net income of $109,000, however, for the year
ended March 31, 1998, the Company had a working capital deficiency of
$500,000 and a net equity of $304,000. As described more fully in Note A to
the financial statements, the Company is in arrears on accounts with certain
vendor creditors which, among other things, causes the balances to become due
on demand. These conditions raise substantial doubt about the Company's
ability to continue as a going concern. The financial statements do not
include any adjustments that might result from the outcome of this
uncertainty.

Beckman Kirkland & Whitney

Woodland Hills, California
June 8, 1998

F-1

<PAGE>

PERCEPTRONICS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS

March 31,
---------
1998 1997
---- ----
ASSETS
- ------
<S> <C> <C>
CURRENT ASSETS
Cash and short-term investments ................ $ 78,411 $ 135,318
Restricted cash .............................. 299,000 35,742
Receivables
Billed - Note B................................ 263,524 326,636
Unbilled - Note B............................. 1,160,458 1,647,894
Other receivables ............................. 32,302 40,454
Inventory ...................................... 189,788 186,355
Prepaid expenses ............................... 166,982 221,919
--------- ----------
TOTAL CURRENT ASSETS........................... 2,190,465 2,594,318

EQUIPMENT & LEASEHOLD IMPROVEMENTS,
at cost Note C.................................. 810,333 706,746
Less accumulated depreciation and
amortization .................................. 712,866 695,134
-------- ----------
97,467 11,612

DEFERRED SOFTWARE DEVELOPMENT ................... - 8,874
Net of amortization of $280,316 (1998)
and $271,442 (1997)
DEFERRED TAXES - Note F.......................... 932,566 932,566
OTHER ASSETS..................................... 23,715 39,045
---------- ----------
TOTAL ASSETS $3,244,213 $3,586,415
---------- ----------
---------- ----------
</TABLE>

See notes to consolidated financial statements

F-2

<PAGE>

PERCEPTRONICS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(continued)

March 31.
---------
1998 1997
---- ----

LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
<S> <C> <C>
CURRENT LIABILITIES
Current portion of long term debt - Note D...... $ 288,778 $ 124,307
Short term debt - Note D........................ 1,281,311 1,587,569
Accounts payable ............................... 688,097 834,491
Accrued compensation ........................... 207,346 150,341
Notes to officers and directors ............... 4,000 4,000
Advance from customers.......................... -- 35,742
Other accrued liabilities 220,906 236,730
--------- ---------
TOTAL CURRENT LIABILITIES .................... 2,690,438 2,973,180

Long term debt, net of current portion - (Note D) 250,237 438,306

COMMITMENTS AND CONTINGENCIES - NOTES B & E

SHAREHOLDERS' EQUITY
Common stock - par value $.001; authorized
15,000,000 shares; 4,526,430 and 4,469,287
shares issued and outstanding 4,526 4,469
Additional paid-in capital ..................... 12,251,161 12,231,218
Accumulated deficit ............................ (11,952,149) (12,060,758)
---------- ----------
TOTAL SHAREHOLDERS' EQUITY.................... 303,538 174,929
---------- ----------
TOTAL LIABILITIES & SHAREHOLDERS'
EQUITY....................................... $ 3,244,213 $ 3,586,415
---------- -----------
---------- -----------
</TABLE>

See notes to consolidated financial statements

F-3

<PAGE>

PERCEPTRONICS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS

Year Ended March 31,
----------------------
1998 1997
---------- ----------
<S> <C> <C>
Net sales..................................... $3,541,373 $3,227,047
Cost of sales................................. 2,288,743 2,465,612
--------- ---------

Gross profit 1,252,630 761,435

Cost and expenses:
Selling, general and administrative ........... 895,462 817,323
Research and development....................... - 8,402
--------- ---------
Operating income (loss) 357,168 (64,290)

Interest expense ............................. 245,730 215,666
--------- ---------

Income (loss) before taxes and
extraordinary item........................... 111,438 (279,956)
Income tax provision - Note F 2,829 1,600
--------- ---------
Income (loss) before extraordinary item 108,609 (281,556)

Extraordinary gain from settlement
of debt - Note J - 337,983
--------- ---------
Net income $108,609 $56,427
--------- ---------
--------- ---------

Earnings (loss) per share:
Basic:
Income (loss) before extraordinary item..... $.02 $(.07)
Extraordinary item.......................... - .08
--------- ---------
Net income ................................. $.02 $.01
--------- ---------
--------- ---------

Diluted:
Income before extraordinary item............ $.02 $(.07)
Extraordinary item.......................... - .08
--------- ---------
Net income ................................ $.02 $.01
--------- ---------
--------- ---------
Weighted average common and common
equivalent shares:

Basic 4,497,859 4,166,510
--------- ---------
--------- ---------
Diluted 4,562,843 4,169,484
--------- ---------
--------- ---------

</TABLE>

See notes to consolidated financial statements
F-4

<PAGE>

PERCEPTRONICS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
Additional
----------
Common Stock Paid In Accumulated
------------ ------- -----------
Shares Amount Capital Deficit Total
------ ------ ------- ------- -----
<S> <C> <C> <C> <C> <C>
Balance at March 31, 1996 3,863,732 $3,863 $12,131,824 $(12,117,185) $18,502

Exercised Warrants and
Common Shares Issued 605,555 606 99,394 100,000
Net Income 56,427 56,427
--------- ------- ----------- ------------ --------

Balance at March 31, 1997 4,469,287 $4,469 $12,231,218 $(12,060,758) $174,929

Common Shares Issued 57,143 57 19,943 20,000
Net Income 108,609 108,609
--------- ------- ----------- ------------ --------

Balance at March 31,1998 4,526,430 $4,526 $12,251,161 $(11,952,149) $303,538
--------- ------- ----------- ------------ --------
--------- ------- ----------- ------------ --------
</TABLE>

See notes to consolidated financial statements

F-5
<PAGE>

PERCEPTRONICS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
Year Ended March 31,
-----------------------
1998 1997
---- ----
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ............................................... $108,609 $56,427
Adjustments to reconcile net income
to net cash used in operating activities:
Depreciation and amortization............................ 26,606 149,261
Extraordinary gain from settlement of note payable....... - (337,983)
Reversal of accrued interest from settlement of
note payable included in extraordinary gain............ - 133,006
Changes in assets and liabilities:
Receivables.............................................. 558,700 (1,066,845)
Inventory ............................................... (3,433) 40,307
Prepaid expenses......................................... 54,937 (117,076)
Other assets............................................. 15,330 (300)
Accounts payable......................................... (146,394) (172,733)
Accrued compensation..................................... 57,005 (59,815)
Advance from customer.................................... (35,742) (268,300)
Other accrued liabilities................................ (15,824) 7,083
-------- -------
NET CASH PROVIDED (USED)
IN OPERATING ACTIVITIES............................ 619,794 (1,636,968)

CASH FLOWS FROM INVESTING ACTIVITY:
Capital additions......................................... (103,587) -
-------- ----------
NET CASH USED IN
INVESTING ACTIVITIES................................ (103,587) -

CASH FLOWS FROM FINANCING ACTIVITIES:
Settlement of note payable................................ - (500,000)
Proceeds from short/long term debt........................ - 500,000
Cancellation of Note to Directors for exercise
of warrants............................................ - (100,000)
Issuance of common stock for warrants exercised........... - 100,000
Net proceeds (repayment) from export financing............ (306,258) 1,537,569
Payment of long term debt................................. (23,598) (47,319)
Proceeds from sale of common stock........................ 20,000 -
-------- ---------
NET CASH PROVIDED (USED) IN
FINANCING ACTIVITIES................................ (309,856) 1,490,250
-------- ---------
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS................................ 206,351 (146,718)

CASH AND CASH EQUIVALENTS AT
THE BEGINNING OF THE YEAR........................... 171,060 317,778
-------- ---------
CASH AND CASH EQUIVALENTS AT
THE END OF THE YEAR................................. $ 377,411 $ 171,060
---------- ----------
---------- ----------
CASH PAID DURING PERIOD
Interest $ 280,451 $ 32,491
Income Taxes $ 2,829 $ 1,600

</TABLE>
F-6

<PAGE>

PERCEPTRONICS, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

DESCRIPTION OF THE COMPANY: Perceptronics, Inc., the "Company" designs,
develops and manufactures computer-based simulation systems for training and
decision support.

PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the
accounts of Perceptronics Inc. (the "Company") and its wholly owned subsidiary.
All significant intercompany transactions and balances have been eliminated.

BASIS OF PRESENTATION: The accompanying financial statements have been
prepared in conformity with generally accepted accounting principles, which
contemplate continuation of the Company as a going concern. The Company has
sustained operating losses in recent years and requires substantial amounts
of working capital in its operations. At March 31, 1998, current liabilities
exceeded current assets by $500,000. The Company continues to have difficulty
in meeting its obligations as they become due, however, this condition has
improved from the previous year. Payments to vendors, totaling approximately
$316,000 at March 31,1998 are past due and certain vendors continue to
require cash in advance or on delivery terms for goods and services. The
Company's cash flow during fiscal 1998 was sufficient to meet current
operating requirements but the Company continues to have difficulty making
satisfactory progress toward liquidating its past due obligations. In order
to conserve cash, management has reduced staff, employee benefits, and other
operating expenditures. Even if the Company overcomes its short-term
liquidity problems, the ability of the Company to operate profitably and
generate sufficient positive cash flows cannot be predicted. The Company's
consolidated financial statements do not include any adjustments to reflect
the possible future effects on the recoverability and classification of
assets or the amounts and classification of liabilities that may result from
the possible inability of the Company to continue as a going concern.

CASH EQUIVALENTS: All highly liquid investments maturing in three months or
less when purchased are considered as cash equivalents.

INVENTORY: Inventory is stated at cost, which is not in excess of market.
Cost is determined principally by the first-in, first-out method.

PRECONTRACT COSTS: Costs incurred in connection with contracts which have not
been signed at the balance sheet date (but where recoverability of costs is
probable) are accounted for as precontract costs. No revenues or profits have
been recognized on these costs. There were no precontract costs deferred at
March 31, 1998 or 1997.

EQUIPMENT AND LEASEHOLD IMPROVEMENTS: Equipment and leasehold improvements
are stated at cost. Depreciation of equipment is provided for by the
straight-line method over their estimated useful lives, which range from 3 to
5 years. Amortization of leasehold improvements is provided for by the
straight-line method over the shorter of the useful lives or the terms of the
leases.

F-7

<PAGE>

PERCEPTRONICS, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DEFERRED SOFTWARE DEVELOPMENT COSTS: Deferred software development costs are
stated at the lower of cost or net realizable value. Such costs are amortized
on a product-by-product basis, commencing when a product is available for
general release to customers. The annual amortization expense is computed using
the straight-line method over the remaining estimated economic life of the
product. Deferred software development costs were fully amortized at March 31,
1998.

REVENUE RECOGNITION: During fiscal 1998 and 1997, 74% and 57% of the Company's
total revenues resulted from products sold to commercial customers which were
either foreign governments or domestic or foreign companies, respectively.
Sales of products and services related to United States Government contracts
were 26% and 43% of total revenues, respectively. Of the U.S. Government
contract sales, 83% and 73% were for contracts that provided for reimbursement
of cost plus fixed-fees and 17% and 27% were fixed price contracts. All sales
were recorded using the percentage-of-completion (cost-to-cost) method of
accounting. Under this method, sales are recorded as costs (including general
and administrative expenses) are incurred, plus a portion of the profit
expected to be realized on each contract in the ratio that costs incurred to
date bear to total estimated cost at completion.

General and administrative expenses in excess of rates billed on contracts are
recorded in the period incurred. Costs related to anticipated future losses on
contracts are accrued and charged to expense in the period when the losses are
identified.

INCOME TAXES: Provisions for federal and state income taxes are calculated on
reported financial statement income based on the current tax law. Such
provisions differ from the amounts currently payable because certain items of
income and expense, known as temporary differences, are recognized in different
tax periods for financial reporting purposes than for income tax purposes.
Deferred income taxes are the result of the recognition of tax benefits that
management expects to realize from the utilization of net operating loss
carryforwards. The amounts recorded are net of a valuation allowance and
represent management's estimate of the amount that is more likely than not to
be realized.

USE OF ESTIMATES: Company management has made a number of estimates and
assumptions relating to the reporting of assets and liabilities and the
reported amounts of revenues and expenses, in conformity with generally
accepted accounting principles. Actual amounts could differ from these
estimates.

EARNINGS (LOSS) PER SHARE: Effective December 31, 1997, the Company adopted
Statement of Financial Accounting Standards No. 128, "Earnings per Share"
("SFAS No. 128"). This statement replaces the previously-reported primary and
fully diluted earnings per share with basic and diluted earnings per share.
Basic earnings per share is computed by dividing net income (loss) available to
common stockholders by the weighted average number of common shares outstanding
during the period. Diluted earnings per share is very similar to the
previously-reported primary earnings per share in that it includes the effect
of the additional common shares which would have been outstanding if dilutive
stock options had been exercised. All earnings per share amounts have been
restated to conform to the SFAS No. 128 requirements.

F-8

<PAGE>

PERCEPTRONICS, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following table summarizes the calculation of basic and diluted earnings
per share before extraordinary item for the years ended March 31:

1998 1997
---- ----
<S> <C> <C>
Numerator:
Basic and diluted earnings
per share -- income before
extraordinary item $ 108,609 $ (281,556)
---------- -----------
---------- -----------

Denominator:
Basic earnings per share --
weighted average number of
common shares outstanding
during the year 4,497,859 4,166,510

Incremental common shares
attributable to assumed
exercise of outstanding
stock options 64,984 2,974
---------- -----------
Denominator for diluted earnings
per share 4,562,843 4,169,484
---------- -----------
---------- -----------

Basic earnings per share $ 0.02 $ (0.07)
---------- -----------
---------- -----------

Diluted earnings per share $ 0.02 $ (0.07)
---------- -----------
---------- -----------
</TABLE>

The calculations of earnings per share before extraordinary item excluded the
effect of the assumed exercise of the following numbers of outstanding common
stock options and warrants because their effect was antidilutive: 579,936 in
1998 and 513,600 in 1997.

POST-RETIREMENT BENEFITS: The Company does not provide post-retirement
health care and life insurance benefits to retirees. Therefore, FASB
Statement 106, which became effective for fiscal years beginning after
December 15, 1992, is not applicable.

F-9

<PAGE>

PERCEPTRONICS, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE B - RECEIVABLES

Billed receivables at March 31, 1998 of $263,524 and at March 31, 1997 of
$326,636 represent amounts that have been invoiced on commercial and United
States Government contracts that remain unpaid at year-end. The Company
expects to collect all amounts within one year.

Unbilled receivables at March 31, 1998 are $1,160,458 and at March 31, 1997
are $1,647,894. These balances represent amounts recognized under the
percentage-of-completion method of accounting that have not been billed
because of the billing terms of the contract. At March 31, 1998, $ 658,370
of unbilled receivables related to a subcontract to a foreign government. In
April of 1998 this receivable was collected in its entirety.

The amount of contract retentions included in unbilled receivables was
$147,000 in fiscal 1998 and $96,000 in fiscal 1997.

The books and records of the Company are subject to audit by the Defense
Contract Audit Agency (DCAA). The Company's overhead costs have been audited
and approved by the DCAA through fiscal year 1995. The Company believes that
it is in substantial compliance with Government record-keeping and
cost-allocation requirements, and does not expect any significant adjustments
as a result of the future audit of 1998, 1997 and 1996 overhead costs. As
discussed in Note E, a large multi-year contract which was completed in
fiscal 1994 remains open.

NOTE C - EQUIPMENT AND LEASEHOLD IMPROVEMENTS

Equipment and leasehold improvements consist of the following at March 31:

<TABLE>
<CAPTION>
l998 1997
-------- --------
<S> <C> <C>
Computers and other equipment $336,664 $336,664
Leasehold improvements 110,439 61,997
Machinery & equipment 320,006 264,861
Office furniture & fixtures 43,224 43,224
-------- --------
810,333 706,746
Accumulated depreciation & amortization 712,866 695,134
-------- --------
$ 97,467 $ 11,612
-------- --------
-------- --------

</TABLE>

During the fiscal year ended March 31, 1997, the Company wrote off a
substantial amount of fully depreciated assets which could no longer be
identified. No gain or loss was realized relating to these write-offs.

F-10

<PAGE>

PERCEPTRONICS, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE D - LONG-TERM DEBT AND OTHER FINANCING

Long-term debt included the following at March 31:
1998 1997
-------- --------
<S> <C> <C>
Note Payable - Small Business Administration, secured by
Company assets, payable in monthly installments of $782
including interest at 4% per annum, due November 2004. $ 54,362 $60,739

Note Payable - Small Business Administration, secured by
Company assets, payable in monthly installments of $278
including interest at 8% per annum, due December 1997. - 1,874

Unsecured Note Payable - Lockheed Martin Fairchild (LMF)
unsecured note resulting from PGTS contract settlement. - 500,000

Note Payable - Bank guaranteed by Small Business
Administration, secured by Company assets, payable in
monthly installments of $4,374 including interest at
prime rate plus 2.75 percentage points, due November 2002. 184,653 -

Note Payable - Export customer bearing interest at 12%
annually payable in monthly installments of $2,000,
principal to be repaid as described in the paragraph
that follows. 200,000 -

Note Payable - Consultant issued to resolve open accounts
payable balance. Payable in monthly installments of $4,521
including interest at 8% per annum, due April 2000. 100,000 -
-------- --------
539,015 562,613
Current portion of long-term notes payable 288,778 124,307
-------- --------
$250,237 $438,306
-------- --------
-------- --------

</TABLE>

On September 30, 1997, the Company reached a settlement with Lockheed Martin
Fairchild to pay $500,000 to discharge the unsecured note payable in full
including accrued interest. The funds required to discharge the Lockheed
Martin Fairchild unsecured promissory note were obtained from other lenders.
The Company entered into a $200,000 note with a bank which is guaranteed by
the SBA and which bears interest at prime interest rate plus 2.75 percentage
points with principal and interest payable monthly amortizing over five
years. The Company also entered into a $200,000 note with an export customer
that bears interest at 12 percent. On April 21, 1998, the Company repaid
$51,032 of the outstanding balance. The company plans to repay the remaining
outstanding balance of $148,968 within the next three months using proceeds
from the final payment on the $1.5 million TOW PGTS contract. The Company
funded $100,000 of the settlement from operating cash flow. The March 31,
1997 financial statements have been prepared to reflect the fair value of the
unsecured note based on the settlement that occurred in September 1997.

On March 31, 1998, the Company reached a settlement with a consultant to
resolve a past due accounts payable balance of $220,000. The Company entered
into a 24 month note payable in the amount of $100,000 that bears interest at
8% per annum. The Company also issued Warrants to purchase common stock in
settlement of the remaining accounts payable balance of $120,000 which is
discussed in Note H.

F-11
<PAGE>

PERCEPTRONICS, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Maturities of long-term debt are as follows:

<TABLE>
<S> <C>
March 31,
1999 $288,778
2000 96,973
2001 49,741
2002 55,015
2003 34,026
Thereafter 14,482
---------
$539,015
---------
---------
</TABLE>

Short-term debt included the following at March 31, 1998 and 1997:

As of March 31, 1997, there was an export line of credit facility with an
outstanding balance of $1,537,569 with a commercial lender. This credit
facility was guaranteed by the U.S. Small Business Administration (SBA) and
the California Export Finance Office (CEFO). The commercial lender holds a
second lien position on the general assets of the Company and a first lien on
the export inventory and accounts receivable financed under the credit
facility. The note was repaid in June of 1997 and had a variable interest
rate which was 11.5% at March 31, 1997.

The Company, on October 3, 1997 entered into an export line of credit
facility with a commercial lender. The credit facility allows the Company to
borrow up to $1,666,000 to provide working capital for export contracts to
provide TOW PGTS training systems to foreign customers. The credit facility
bears interest at prime rate plus 3.0 points and is guaranteed by the SBA and
CEFO with a second lien placed on the Company's general assets and a first
lien on the export inventory and accounts receivable financed under the
credit facility. At March 31, 1998 borrowings against the credit facility
totaled $1,131,311. The credit facility currently expires December 31, 1998.
The Company expects to have delivered all training systems under contract and
to repay the export credit facility. On February 27, 1998 the Company
entered into a short term note payable with the same export lender for
$100,000 which matures June 30, 1998 and bears interest at 14% per annum.

As of March 31,1998 and 1997, there is a loan outstanding of $50,000 with a
foreign customer, that bears interest at 6% per year. The terms of the note
required repayment by March 1, 1996, however, the Company was unable to repay
the note because of cash flow problems. The Company intends to pay off the
note as cash flow is available to do so. Interest continues to accrue at the
6% rate.

NOTE E - COMMITMENTS AND CONTINGENCIES

LEASE COMMITMENTS: Approximate future minimum payments under non-cancellable
operating leases with initial or remaining terms of one year or more at March
31, 1998 consisted of the following:
<TABLE>
<S> <C>
1999 $ 268,031
2000 125,037
2001 85,800
2002 -
2003 and beyond -
-----------
$ 478,868
-----------
-----------
</TABLE>

Rent expense was $230,054 in fiscal year 1998 and $314,004 in fiscal year 1997.

F-12

<PAGE>

PERCEPTRONICS, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DCAA - Audit: The Company's books and records are subject to audit by the
Defense Contract Audit Agency (DCAA). At March 31, 1998, there is a DCAA
audit open of a large multi-year contract which was completed in 1994. The
Company believes the costs charged to this contract were proper and should
not result in any significant adjustments. The Company has provided $200,000
and $205,000 in reserve for possible contract price adjustments at March 31,
1998 and March 31, 1997. The amount reserved is believed to be adequate and
is included in accrued liabilities.

NOTE F - INCOME TAXES

The provision (benefit) for income taxes consist of the following:
<TABLE>
<CAPTION>
Year Ended March 31,
--------------------------
<S> <C> <C>
1998 1997
Current: ---- ----
Federal $ - $ -
State 2,829 1,600
------- -------
2,829 1,600

Deferred:
(Increase) decrease in benefit
of NOL carryforwards 35,000 (103,777)
Increase (decrease) in valuation
allowance (35,000) 103,777
--------- ---------
$ 2,829 $ 1,600
--------- ---------
--------- ---------
</TABLE>

At March 31, 1998, the Company has net operating loss (NOL) carryforwards of
approximately $21,200,000 for federal income tax purposes and $1,400,000 for
state income tax purposes, respectively, expiring in varying amounts through
2010. At March 31, 1998, approximately $3,800,000 of state net operating
losses expired. The NOL carryforwards, which are available to offset future
profits of the Company and are subject to limitations should a "change in
ownership" as defined by the Internal Revenue Code occur, will begin to
expire in 2001 if not utilized. State net operating losses expire between
1999 and 2002, if not utilized.

In 1994, the Company adopted Statement of Financial Accounting Standards No.
109 (SFAS 109) "Accounting for Income Taxes." SFAS 109 is an asset and
liability approach that requires the recognition of deferred tax assets and
liabilities for the expected future tax consequences of events that have been
recognized in the Company's financial statements or tax returns. Previously,
the Company used the APB 11 approach that gave no recognition to future
events other than the recovery of assets and settlement of liabilities at
their carrying amounts. Under SFAS 109 the Company recognizes to a greater
degree the future tax benefits of expenses which have been recognized in the
financial statements.

SFAS 109 requires that the tax benefit of such NOLs be recorded using current
tax rates as an asset to the extent management assesses the utilization of
such NOLs to be more likely than not. Management has determined that future
taxable income of the Company will more likely than not be sufficient to
realize the recorded deferred tax asset of $7,070,000 net of a valuation
allowance of $6,137,000.

F-13

<PAGE>

PERCEPTRONICS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Realization of the future tax benefits of the NOL carryforwards is dependent
on the Company's ability to generate taxable income within the carryforward
period. In assessing the likelihood of utilization of existing NOL
carryforwards, management considered the historical results of continuing
operations over the last three years and the current economic environment in
which the Company operates. Management did not consider any non-routine
transactions in assessing the likelihood of realization of the recorded
deferred tax asset.

Federal income tax NOL carryforwards will expire between fiscal 2001 and 2012
and state income tax operating loss carryforwards will expire between fiscal
1999 and 2002 if not used to offset taxable income.

The following reconciles the federal statutory income tax rate to the
effective rate of the provision for income taxes.
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Federal statutory rate 34.00% 34.00%
Increase (reductions) in taxes due to:
State income taxes (net of federal benefit) 6.13% 6.13%
Valuation allowance adjustment (37.53)% (37.30)%
-------- --------
2.60% 2.83%
-------- --------
-------- --------
</TABLE>

Income taxes paid amounted to $2,829 in fiscal 1998 and $1,600 in fiscal 1997.

NOTE G - EMPLOYEE BENEFITS

The Company has a combined profit sharing and retirement/savings plan
qualifying for treatment under Internal Revenue Code Section 401(k). All
employees aged 21 and older, except those covered by a collective bargaining
agreement, are eligible following six months of employment in which at least
500 hours are paid. Under the profit sharing portion of the plan,
contributions to the plan are determined by the Board of Directors and are
allocated among eligible participants in proportion to their salaries. There
were no contributions made by the Company in fiscal 1998 and 1997. Under the
retirement/savings portion of the plan, the Company may match 75% of eligible
employees' voluntary contributions to a maximum of 4.5% of their salaries.
There were no Company matching contributions made under the
retirement/savings plan portion in fiscal 1998 and 1997.

F-14

<PAGE>

PERCEPTRONICS, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE H - SHAREHOLDERS' EQUITY

The Company's 1982 Employee Incentive Stock Option Plan, as amended,
authorized the issuance of options to purchase 690,000 shares of common stock
which may be granted to employees, including officers, of the Company. No
options may be granted under this plan after November 1992. Options to
purchase 42,800 and 61,300 shares were outstanding and exercisable under this
plan at March 31, 1998 and March 31, 1997, respectively.

In September 1992, the Company's shareholders approved the 1992 Stock Option
Plan which authorizes the issuance of incentive and non- qualified options to
purchase 300,000 shares of Common Stock which may be granted to employees,
directors, consultants and advisors. The exercise price of the incentive
options may not be less than 100% of the fair market value of the common
stock on the date of grant (110% with respect to optionees who are 10% or
more shareholders of the Company). The exercise price of non-qualified stock
options may not be less than 85% of fair market value. Options become
exercisable in installments as determined at the time of grant. Options
expire no later than ten years from date of grant (five years with respect to
incentive options granted to optionees who are 10% or more shareholders).
Options to purchase 218,500 and 35,500 shares were outstanding under this
plan at March 31, 1998 and March 1997, of which 138,100 and 23,900 shares
were exercisable.

The 1988 Directors' Option Plan authorizes the issuance of options to
purchase 100,000 shares of common stock. The options are automatically
granted on April 1 of each year and expire five years after the date of
grant. The options are fully vested and exercisable at date of grant. The
exercise prices may not be less than 100% of fair market value of the common
stock on the date of grant. Options to purchase 49,000 and 39,000 shares were
outstanding under this plan at March 31, 1998 and 1997, respectively. No
options may be granted under this plan after July 1998.

Changes in the status of options are summarized as follows for fiscal years
ended March 31:

<TABLE>
<CAPTION>
1998 1997
----------- -------------
<S> <C> <C>
Outstanding at beginning of year.......... 415,200 576,650
Granted................................... 195,500 10,000
Canceled or expired....................... (300,400) (171,450)
Exercised................................. - -
-------------- -------------
Outstanding at end of year................ 310,300 415,200
Available for grant at end of year........ 128,500 197,500
Price range of options:
Outstanding at end of year.............. $.11 - $3.00 $.23 - $3.50
Exercised............................. - -
</TABLE>

At March 31, 1998 and 1997, options for the purchase of 229,900 and 403,600
shares were exercisable.

F-15

<PAGE>

PERCEPTRONICS, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

At March 31, 1998 the following warrants to purchase common shares were
outstanding:
<TABLE>
<CAPTION>
Quantity Exercise Price Expiration Date
-------- -------------- ------------------
<S> <C> <C>
50,000 $.32 December 31, 2000
60,000 $.95 August 16, 1998
22,222 $.18 December 21, 1998
240,000 $.50 March 30, 2003
25,000 $.30 March 06, 2003
57,143 $.57 March 16, 2003
44,693 $.32 October 30, 2002
44,693 $.29 January 31, 2003
</TABLE>

On March 31, 1998, the Company reached a settlement with a consultant to
resolve a large past due accounts payable balance. In exchange for clearing
$220,000 of the past due accounts payable balance, the Company issued a two
year note payable in the amount of $100,000 which requires monthly payments
of $4,521 including interest at 8% per annum. The Company also issued
warrants to purchase 240,000 shares of common stock at an exercise price of
$.50. The Warrants vest immediately and expire March 30, 2003.

On September 15, 1997, the Company entered into an agreement with a financial
consultant. The financial consultant was retained to provide financial
management consulting and to locate and secure equity and debt financing on
behalf of the company. Under the terms of the agreement, the consultant is
to be paid $5,000 per month. In addition to the monthly retainer, the
consultant is to be granted warrants to purchase common stock of the Company
in an amount up to 5% of the Company's outstanding shares. The warrants vest
and are issuable in amounts equal to 1% of the Company's outstanding shares
each 90 day period starting 46 days from the date of the agreement. The
warrants are to have an exercise price equal to 85% of the market value on
the day prior to the date of vesting and expire five years from date of
grant. Warrants that have vested at March 31, 1998 are;
<TABLE>
<CAPTION>
Vesting date Shares Exercise price
------------ ------ --------------
<S> <C> <C>
10/31/97 44,693 $0.32
01/29/98 44,693 $0.29
</TABLE>

In addition to the monthly retainer and the warrants, the agreement calls for
other fees to be paid in cash related to the introduction of equity or debt
financing and for their involvement in any merger or acquisition transactions.

On March 13, 1998, a private investment company purchased 57,143 shares of
the Company's common stock at a purchase price of $20,000 or $.35 per share.
In conjunction with the purchase of common stock the investment company was
granted warrants to purchase an additional 57,143 shares of common at an
exercise price of $.57 and 25,000 shares at $.30. Both warrants vest
immediately and expire five years from date of issue.

F-16

<PAGE>

PERCEPTRONICS, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE I - SIGNIFICANT CUSTOMERS

During fiscal year 1998, sales to the United States Government, a foreign
customer for TOW PGTS simulator systems and the Egyptian Government for TOW
PGTS simulator systems were approximately $907,000 (26% of total sales),
$2,140,000 (61% of total sales), $272,000 (8% of total sales), respectively.
During fiscal year 1997, sales to the United States Government, a foreign
customer for TOW PGTS simulator systems and the Egyptian Government were
approximately $1,400,000 (43% of total sales), $1,500,000 (47% of total sales),
$300,000 (10% of total sales), respectively.

NOTE J - EXTRAORDINARY GAIN FROM SETTLEMENT OF DEBT

On September 30, 1997, the Company reached a settlement with Lockheed Martin
Fairchild to settle a note with a carrying value of $704,977 and accrued
interest of $133,006 for $500,000. Negotiations to settle the note had begun
prior to March 31, 1997. The financial statements as of March 31, 1997
reflect the recognition of the settlement of the debt. Due to large net
operating loss carryforwards, the extraordinary gain was not reduced for
income taxes.

F-17

<PAGE>

INDEX TO EXHIBITS

EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibit Index (Management contracts, compensation plans and
arrangements are identified by *.

3.1 Certificate of Incorporation, as amended (4)

3.2 By-Laws, amended. (2)

* 10.1 Non-Qualified Stock Option agreements with certain
officers and directors. (2)

* 10.2 1992 Stock Option Plan (5)

* 10.3 Employment Agreement with Gershon Weltman
dated August 1, 1989 (1) and First Amendment
dated October 22, 1991. (3)

* 10.4 Form of Promissory Note and Warrant Agreement
dated December 22, 1993 between the Company
and certain officers and directors. (6)

* 10.5 Form of indemnification Agreement with Officers
and Directors. (1)

* 10.6 1988 Directors' Stock Option Plan. (5)

10.7 Settlement Agreement between Loral Fairchild
Corp. Dated December 19, 1994 and Perceptronics
Inc., in connection with the PGTS Program. (7)

10.8 $1,225,000 Promissory Note dated January 3, 1995,
payable to Loral Fairchild Corp. (7)

* 10.9 Second Amendment to Employment Agreement with
Gershon Weltman dated August 27, 1996. (8)

* 10.10 Termination of Employment Agreement with Amos
Freedy effective November 14, 1996. (8)

* 10.11 Employment agreement with Thomas Lubaczewski
dated January 1, 1997. (9)

10.12 Amendment to the Agreement of January 3, 1995
between Loral Fairchild Corp., and Perceptronics, Inc. (9)

10.13 Loan Agreement and note dated September 23, 1997
between the Company and The Pacific Bank. (10)

10.14 Promissory Note dated September 22, 1997 between the
Company and Applied Controls Technology. (10)

21.1 Subsidiaries

<PAGE>

23.1 Consent of Independent Accountants

27.1 Financial Data Schedule

(1) Incorporated by reference to the Company's Form 10-K for the year ended
March 31, 1990.

(2) Incorporated by reference to the Company's Form 10-K for the year ended
March 31, 1991.

(3) Incorporated by reference to the Company's Form 10-K for the year ended
March 31, 1992.

(4) Incorporated by reference to the Company's Form 8-K/A date of event
reported April 30, 1993.

(5) Incorporated by reference to the Company's Form 10-K for the year ended
March 31, 1993.

(6) Incorporated by reference to the Company's Form 10-KSB for the year ended
March 31, 1994.

(7) Incorporated by reference to the Company's Form 10-KSB for the year ended
March 31, 1995.

(8) Incorporated by reference to the Company's Form 10-KSB for the year ended
March 31, 1996.

(9) Incorporated by reference to the Company's Form 10-KSB for the year ended
March 31, 1997.

(10) Incorporated by reference to the Company's Form 10-QSB for the quarterly
period ended September 30, 1997.

<PAGE>

EXHIBIT 21.1

PERCEPTRONICS INC., AND SUBSIDIARY
STATEMENT RE: SUBSIDIARY

Perc. Israel Ltd.,
Shaul Hamelech 35
P.O.Box 33579
Tel Aviv, Israel 62354

<PAGE>

Exhibit 23.1

CONSENT OF INDEPENDENT ACCOUNTANTS

We consent to the incorporation by reference in the Registration Statements
(Form S-8 Nos. 2-94761, 33-7976, 33-30214 and 33-41725) of Perceptronics,
Inc. of our report dated June 8, 1998, with respect to the consolidated
financial statements of Perceptronics, Inc. included in the Annual Report
(form 10-KSB) for the year ended March 31, 1998.

Beckman Kirkland & Whitney

Los Angeles, California
June 18, 1998

<PAGE>
<ARTICLE> 5

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-START> APR-01-1997
<PERIOD-END> MAR-31-1998
<CASH> 78,411
<SECURITIES> 299,000
<RECEIVABLES> 1,456,284
<ALLOWANCES> 0
<INVENTORY> 189,788
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0
0
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<EPS-PRIMARY> .02
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</TABLE>