**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

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**FORM 10-Q**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**For the quarterlyperiod ended September 30, 2006**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**For the transitionperiod from                             to                              **

**Commission file number 1-8533**

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|  |
|--|

 

**DRS Technologies, Inc.**

(Exact name of registrantas specified in its charter)

| **Delaware**                                                     |   | **13-2632319**                     |
|------------------------------------------------------------------|--------|------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | (IRS Employer Identification  No.) |
| **5 Sylvan Way, Parsippany, New Jersey 07054**                   |
| (Address of  principal executive offices)                        |
| **(973) 898-1500**                                          |
| (Registrant’s  telephone number, including area code)       |

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Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities and Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past90 days. Yes x    No o

Indicate by check markwhether the Registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

|  | Large Accelerated  filer x | Accelerated Filer  o | Non-accelerated  filer o |
|--|----------------------------|----------------------|--------------------------|

 

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

Indicate the number of shares outstanding of each ofthe issuer’s classes of common stock, as of the latest practicable date.

| **Class**                       |   | **Outstanding at November 3, 2006** |
|---------------------------------|--------|------------------------------------------|
| Common Stock -  $0.01 par value |   | 40,262,002                               |

 

 

 

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**DRS TECHNOLOGIES,INC. AND SUBSIDIARIES**

**Indexto Quarterly Report on Form 10-QFor the Quarter Ended September 30, 2006**

|                                             | ** **                                                                                            | **Page** |
|---------------------------------------------|-------------------------------------------------------------------------------------------------------|----------|
| **PART I—FINANCIAL  INFORMATION** |                                                                                                  |
|                                        |                                                                                                  |     |
| Item  1.                                    | Financial  Statements (unaudited)                                                                     |     |
|                                        | Consolidated Balance Sheets—September 30, 2006  and March 31, 2006                     | 1        |
|                                        | Consolidated Statements of Earnings—Three and Six  Months Ended September 30, 2006 and 2005 | 2        |
|                                        | Consolidated Statements of Cash Flows—Six Months Ended  September 30, 2006 and 2005         | 3        |
|                                        | Notes  to the Consolidated Financial Statements                                                       | 4        |
| Item 2.                                     | Management’s Discussion and Analysis of Financial  Condition and Results of Operations           | 34       |
| Item 3.                                     | Quantitative and Qualitative Disclosure about Market  Risk                                            | 48       |
| Item 4.                                     | Controls and Procedures                                                                               | 48       |
|                                        |                                                                                                  |     |
| **PART II—OTHER  INFORMATION**    |                                                                                                  |
|                                        |                                                                                                  |     |
| Item  1.                                    | Legal  Proceedings                                                                                    | 49       |
| Item 1A.                                    | Risk Factors                                                                                          | 51       |
| Item 4.                                     | Submissions of Matters to a Vote of Security Holders                                                  | 51       |
| Item 6.                                     | Exhibits                                                                                              | 52       |
| Signatures                                  | 53                                                                                                    |

 

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**PART I -FINANCIAL INFORMATION**

**Item 1. FinancialStatements**

**DRS TECHNOLOGIES, INC. AND SUBSIDIARIESConsolidated Balance Sheets(in thousands, except share and per-share data)(Unaudited)**

| ** **                                                                                                                                                                         | ** ** | **September 30,** | ** ** | **March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|--------------------|------------|
| ** **                                                                                                                                                                         | ** ** | **2006**               | ** ** | **2006**           | ** ** |
| **Assets**                                                                                                                                                                         | ** ** |                   | ** ** | ** **         |       | ** ** | ** ** |
| Current assets                                                                                                                                                                     |       |                   |       | ** **         |       |   |   |
| Cash and cash equivalents                                                                                                                                                          |       |                   | $          | 34,862             | ** ** |   | $ | 1,293 |   |
| Accounts receivable, net of allowance for doubtful  accounts of $1,714 and $1,668 as of September 30, 2006 and  March 31, 2006, respectively                             |       |                   | 505,865    | ** **         |       | 432,678 |   |
| Inventories, net                                                                                                                                                                   |       |                   | 327,105    | ** **         |       | 331,206 |   |
| Prepaid expenses, deferred income taxes and other  current assets                                                                                                                  |       |                   | 116,514    | ** **         |       | 135,613 |   |
| Total current  assets                                                                                                                                                              |       |                   | 984,346    | ** **         |       | 900,790 |   |
| Property, plant  and equipment, less accumulated depreciation of $160,368 and $138,324 at  September 30, 2006 and March 31, 2006, respectively                           |       |                   | 223,479    | ** **         |       | 220,506 |   |
| Acquired  intangible assets, net                                                                                                                                                   |       |                   | 215,698    | ** **         |       | 231,139 |   |
| Goodwill                                                                                                                                                                           |       |                   | 2,624,514  | ** **         |       | 2,608,068 |   |
| Deferred income  taxes and other noncurrent assets                                                                                                                                 |       |                   | 59,354     | ** **         |       | 58,616 |   |
| **Total  assets**                                                                                                                                                                  |       |                   | $          | 4,107,391          | ** ** |   | $ | 4,019,119 |   |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                     | ** ** |                   | ** ** | ** **         |       | ** ** | ** ** |
| Current liabilities                                                                                                                                                                |       |                   |       | ** **         |       |   |   |
| Current  installments of long-term debt                                                                                                                                            |       |                   | $          | 5,278              | ** ** |   | $ | 4,622 |   |
| Accounts payable                                                                                                                                                                   |       |                   | 222,298    | ** **         |       | 224,673 |   |
| Accrued expenses  and other current liabilities                                                                                                                                    |       |                   | 463,473    | ** **         |       | 471,068 |   |
| Total current  liabilities                                                                                                                                                         |       |                   | 691,049    | ** **         |       | 700,363 |   |
| Long-term debt, excluding current installments                                                                                                                                     |       |                   | 1,866,438  | ** **         |       | 1,828,771 |   |
| Other liabilities                                                                                                                                                                  |       |                   | 144,782    | ** **         |       | 138,405 |   |
| **Total  liabilities**                                                                                                                                                             |       |                   | 2,702,269  | ** **         |       | 2,667,539 |   |
| Commitments and  contingencies                                                                                                                                                     |       |                   |       | ** **         |       |   |   |
| Stockholders’ equity                                                                                                                                                          |       |                   |       | ** **         |       |   |   |
| Preferred stock,  $10 par value per share. Authorized 2,000,000 shares none issued at  September 30, 2006 and March 31, 2006                                             |       |                   | —     | ** **         |       | — |   |
| Common Stock,  $.01 par value per share. Authorized 100,000,000 shares; issued 40,168,182  and 39,912,541 shares at September 30, 2006 and March 31, 2006,  respectively |       |                   | 402        | ** **         |       | 399 |   |
| Additional  paid-in capital                                                                                                                                                        |       |                   | 1,077,142  | ** **         |       | 1,076,786 |   |
| Retained earnings                                                                                                                                                                  |       |                   | 321,789    | ** **         |       | 277,706 |   |
| Accumulated other  comprehensive earnings                                                                                                                                          |       |                   | 5,789      | ** **         |       | 3,885 |   |
| Unamortized stock  compensation                                                                                                                                                    |       |                   | —     | ** **         |       | (7,196 | ) |
| **Total  stockholders’ equity**                                                                                                                                               |       |                   | 1,405,122  | ** **         |       | 1,351,580 |   |
| **Total liabilities and  stockholders’ equity**                                                                                                                               |       |                   | $          | 4,107,391          | ** ** |   | $ | 4,019,119 |   |

 

See accompanying Notes to Consolidated Financial Statements.

1

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIESConsolidated Statements of Earnings(in thousands, except per-share data)(Unaudited)**

| ** **                                                 | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                 | ** ** | **September 30,**           | ** ** | **September 30,**         | ** ** |
| ** **                                                 | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenue:                                                   |       |                             |       |                           |       |   |   |   |   |
| Products sales                                             |       | $                                | 512,597    |                           | $          | 330,840 |   | $ | 988,488 |   | $ | 636,823 |   |
| Services                                                   |       | 198,941                          |       | 31,090                         |       | 353,315 |   | 63,566 |   |
| Total revenues                                             |       | 711,538                          |       | 361,930                        |       | 1,341,803 |   | 700,389 |   |
| Costs and  expenses                                        |       | 639,650                          |       | 323,353                        |       | 1,204,930 |   | 626,754 |   |
| Operating income                                           |       | 71,888                           |       | 38,577                         |       | 136,873 |   | 73,635 |   |
| Interest income                                            |       | 322                              |       | 2,068                          |       | 498 |   | 3,945 |   |
| Interest and  related expenses                             |       | 30,619                           |       | 12,290                         |       | 60,521 |   | 24,501 |   |
| Other expense,  net                                        |       | 54                               |       | 337                            |       | 72 |   | 312 |   |
| Earnings before non-controlling interest and income  taxes |       | 41,537                           |       | 28,018                         |       | 76,778 |   | 52,767 |   |
| Non-controlling  interest                                  |       | 485                              |       | 502                            |       | 958 |   | 1,082 |   |
| Earnings before income taxes                               |       | 41,052                           |       | 27,516                         |       | 75,820 |   | 51,685 |   |
| Income taxes                                               |       | 15,821                           |       | 8,562                          |       | 29,331 |   | 18,713 |   |
| Net earnings                                               |       | $                                | 25,231     |                           | $          | 18,954 |   | $ | 46,489 |   | $ | 32,972 |   |
| **Net  earnings per share of common stock:**               | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic earnings per share:                                  |       | $                                | 0.64       |                           | $          | 0.68 |   | $ | 1.17 |   | $ | 1.20 |   |
| Diluted earnings per share:                                |       | $                                | 0.62       |                           | $          | 0.66 |   | $ | 1.14 |   | $ | 1.15 |   |
| **Dividends  per common share**                            |       | $                                | 0.03       |                           | $          | 0.03 |   | $ | 0.06 |   | $ | 0.06 |   |

 

See accompanying Notes to Consolidated Financial Statements.

2

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIESConsolidated Statements of Cash Flows(in thousands)(Unaudited)**

| ** **                                                                      | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                      | ** ** | **September 30,**         | ** ** |
| ** **                                                                      | ** ** | **2006**                       | ** ** | **2005** | ** ** |
| **Cash Flows from Operating  Activities**                                       | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Net Earnings                                                                    |       | $                              | 46,489     |   | $ | 32,972 |   |
| Adjustments to reconcile  net earnings to cash flows from operating activities: |       |                           |       |   |   |
| Depreciation and  amortization                                                  |       | 38,363                         |       | 20,941 |   |
| Share-based  compensation                                                       |       | 6,050                          |       | 1,104 |   |
| Deferred income  taxes                                                          |       | 4,083                          |       | (498 | ) |
| Inventory reserve  and provision for doubtful accounts                          |       | 451                            |       | 1,455 |   |
| Amortization and  write-off of deferred financing fees                          |       | 2,946                          |       | 1,904 |   |
| Other, net                                                                      |       | (136                           | )          | (749 | ) |
| Changes in assets  and liabilities, net of effects from business combinations:  |       |                           |       |   |   |
| (Increase)  decrease in accounts receivable                                     |       | (71,820                        | )          | 4,523 |   |
| Increase in  inventories                                                        |       | (12,211                        | )          | (15,720 | ) |
| Decrease  (increase) in prepaid expenses and other current assets               |       | 21,524                         |       | (480 | ) |
| (Decrease) increase  in accounts payable                                        |       | (2,673                         | )          | 8,653 |   |
| Decrease in  accrued expenses and other current liabilities                     |       | (24,333                        | )          | (23,553 | ) |
| Increase in  customer advances                                                  |       | 23,587                         |       | 4,054 |   |
| Decrease in pension  and postretirement benefit liabilities                     |       | 1,007                          |       | (228 | ) |
| Other, net                                                                      |       | (998                           | )          | 611 |   |
| **Net  cash provided by operating activities**                                  |       | 32,329                         |       | 34,989 |   |
| **Cash  Flows from Investing Activities**                                       | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Capital  expenditures                                                           |       | (27,218                        | )          | (16,254 | ) |
| Payments pursuant  to business combinations, net of cash acquired               |       | (9,255                         | )          | (52,549 | ) |
| Disposition of  property, plant and equipment                                   |       | 335                            |       | 909 |   |
| Other, net                                                                      |       | 60                             |       | (69 | ) |
| **Net  cash used in investing activities**                                      |       | (36,078                        | )          | (67,963 | ) |
| **Cash  Flows from Financing Activities**                                       | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Return of  advanced interest on senior subordinated notes                       |       | —                         |       | (1,986 | ) |
| Debt issuance  costs                                                            |       | —                         |       | (191 | ) |
| Borrowings of  long-term debt                                                   |       | 40,467                         |       | — |   |
| Repayment of  long-term debt                                                    |       | (2,173                         | )          | (21,355 | ) |
| Excess tax  benefit realized from share-based payment arrangements              |       | 97                             |       | — |   |
| Proceeds from  stock option exercises                                           |       | 1,304                          |       | 7,737 |   |
| Dividends paid                                                                  |       | (2,405                         | )          | (1,664 | ) |
| Other                                                                           |       | 245                            |       | — |   |
| **Net  cash provided by (used in) financing activities**                        |       | 37,535                         |       | (17,459 | ) |
| **Effect  of exchange rates on cash and cash equivalents**                      |       | (217                           | )          | 835 |   |
| **Net  increase (decrease) in cash and cash equivalents**                       |       | 33,569                         |       | (49,598 | ) |
| **Cash  and cash equivalents, beginning of period**                             |       | 1,293                          |       | 306,852 |   |
| **Cash and cash equivalents, end  of period**                                   |       | $                              | 34,862     |   | $ | 257,254 |   |

 

See accompanying Notes to Consolidated Financial Statements.

3

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Unaudited)**

**1.   Descriptionof Business**

DRS Technologies, Inc. its wholly-owned andmajority-owned subsidiaries and a partnership of which DRS owns an 80%controlling interest (hereinafter, DRS or the Company) is a supplier of defenseelectronic products, systems and military support services. The Companyprovides high-technology products and services to all branches of the U.S.military, major aerospace and defense prime contractors, governmentintelligence agencies, international military forces and industrial markets.The Company focuses on several key areas of importance for the U.S. Departmentof Defense (DoD), such as intelligence, surveillance, reconnaissance, powermanagement, advanced communications and network systems. DRS is a provider ofthermal imaging devices, combat display workstations, electronic sensorsystems, power systems, battlefield digitization systems, air combat trainingsystems, mission recorders, deployable flight incident recorders, environmentaland telecommunication systems, aircraft loaders, military trailers and shelters.The Company also provides support services to the military, including securityand asset protection system services, telecommunication and informationtechnology services, training and logistics support services for all branchesof the U.S. armed forces, and certain foreign militaries, homeland securityforces and selected government and intelligence agencies.

At September 30, 2006,the Company operated in three principal operating segments on the basis ofproducts and services offered. Each operating segment is comprised of separateand distinct businesses. At September 30, 2006, DRS’s segments were: theCommand, Control, Communications, Computers and Intelligence (C4I) Group, theSurveillance & Reconnaissance (SR) Group and the Sustainment Systems &Services (S3) Group. All other operations, primarily our CorporateHeadquarters, were grouped in Other. On October 2, 2006, the Companyimplemented a new organization structure, that realigned its three operatingsegments into four operating segments (See Note 18).

**2.   Basis ofPresentation**

The accompanying unaudited consolidated financialstatements include all wholly-owned and majority-owned subsidiaries and acontrolling interest in a partnership of DRS. The financial statements havebeen prepared in accordance with accounting principles generally accepted inthe United States of America and with the instructions to Form 10-Qand Article 10 of Regulation S-X. In the opinion of the Company, theinterim consolidated financial information provided herein reflects alladjustments (consisting of normal and recurring adjustments) necessary for afair presentation of the Company’s consolidated financial position as of September 30,2006, the results of its operations for the three- and six-month periods ended September 30,2006 and 2005, and its cash flows for the six-month periods ended September 30,2006 and 2005. The results of operations and cash flows for the interim periodsended September 30, 2006 are not necessarily indicative of the results tobe expected for the full year. Certain fiscal 2006 amounts have beenreclassified to conform to the fiscal 2007 presentation. These interimConsolidated Financial Statements should be read in conjunction with theConsolidated Financial Statements of the Company for the fiscal year ended March 31,2006, included in the Company’s filing on Form 10-K for the yearended March 31, 2006.

The fiscal year-endconsolidated balance sheet data was derived from the Company’s auditedfinancial statements, but does not include all disclosures required by accountingprinciples generally accepted in the United States of America.

4

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

 

**3.   ESSI Acquisition**

On January 31, 2006, DRS completed itsacquisition of Engineered Support Systems, Inc. (ESSI) for $1.93 billionin cash and DRS common stock. In the transaction, a wholly-owned subsidiary ofDRS was merged with ESSI, with the ESSI operating units initially forming DRS’sthird operating segment—the S3 Group (See Note 18). ESSI, formerlyheadquartered in St. Louis, Missouri, is a supplier of integrated militaryelectronics, support equipment and technical services focused on advancedsustainment and logistics support solutions for all branches of the U.S. armedservices, major prime defense contractors, certain international militaries,homeland security forces and selected government and intelligence agencies.ESSI also produces specialized equipment and systems for commercial andindustrial applications. The results of ESSI have been included in ourfinancial statements since the date of acquisition.

Inaccordance with EITF 95-3, “Recognition of Liabilities in Connection witha Purchase Business Combination”, the Company recorded a $5.7 million liabilityin the preliminary purchase price allocation in connection with a plan toinvoluntarily terminate approximately 190 employees of ESSI, as well as exitcertain leased facilities. The Company anticipates finalizing its plans in thethird quarter of fiscal 2007 with the payments being substantially complete bythe fourth quarter of fiscal 2007.

| ** **                                   | ** ** | **Balance at**     | ** ** | **Six Months Ended**   | ** ** | **Balance at**    | ** ** |
|----------------------------------------------|------------|-------------------------|------------|----------------------------------|------------|------------------------|------------|
| ** **                                   | ** ** | **March 31,**      | ** ** | **September 30, 2006** | ** ** | **September 30,** | ** ** |
| ** **                                   | ** ** | **2006**                | ** ** | **Additions**                    | ** ** | **Payments**           | ** ** | **2006** | ** ** |
| ** **                                   | ** ** | **(in thousands)** | ** ** |
| Employee severance and  termination benefits |       |                    | $          | 5,129                            |       |                   |       | $ | — |   |   |   | $ | (3,750 | ) |   |   | $ | 1,379 |   |   |
| Facility and other exit  costs               |       |                    | —     |                             |       |                   | 554        |   |   |   | — |   |   |   | 554 |   |   |
| Total                                        |       |                    | $          | 5,129                            |       |                   |       | $ | 554 |   |   |   | $ | (3,750 | ) |   |   | $ | 1,933 |   |   |

 

The Company is in theprocess of finalizing a third-party valuation of certain assets andliabilities, including acquired intangible assets and finalizing its owninternal assessment of the purchase price allocation; thus, the preliminaryallocation of purchase price will change, and such change could be material tothe consolidated balance sheet. Our preliminary purchase price allocation as ofSeptember 30, 2006 has not changed materially from the allocation includedin Note 2 to the Company’s consolidated financial statements for the fiscalyear ended March 31, 2006 (see Note 6). The Company anticipatescompleting the purchase price allocation in the third quarter of fiscal 2007.

**4.   Share-BasedCompensation**

**Adoption of SFAS 123R**   In December 2004,the Financial Accounting Standards Board (FASB) issued SFAS No. 123(revised 2004), “Share-Based Payment” (SFAS 123R). SFAS 123R replaces SFAS No. 123,“Accounting for Stock-Based Compensation” (SFAS No. 123), and supercedesAccounting Principles Board Opinion No. 25, “Accounting for Stock Issuedto Employees” (APB No. 25). SFAS 123R addresses the accounting fortransactions in which an enterprise receives employee services in exchange for (a) equityinstruments of the enterprise or (b) liabilities that are based on thefair value of the enterprise’s equity instruments or that may be settled by theissuance of such equity instruments. SFAS 123R requires companies to recognizecompensation cost in an amount equal to the fair value of share-based awardsexpected to vest.

5

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

 

On April 1, 2006, DRS adopted SFAS 123R using themodified prospective method. Under this method, the Company is required torecord compensation cost for the unvested portion of previously granted awardsthat were outstanding as of April 1, 2006. Results for prior periods havenot been restated. The Company previously accounted for share-basedcompensation under the recognition and measurement principle of APB No. 25and related interpretations. Prior to adopting SFAS 123R, no share-basedcompensation cost was reflected in net income for stock options, as stockoptions granted had an exercise price equal to the market value of theunderlying common stock on the date of the grant. Also, prior to the SFAS 123Radoption, compensation cost for restricted stock and restricted stock units(collectively “non-vested stock”) was recorded based on the closing marketvalue on the last trading day prior to the date of grant and forfeitures wereaccounted for as they occurred. Compensation cost for non-vested stock wascharged to unamortized stock compensation in Stockholders’ equity and amortizedto expense over the requisite vesting periods. With the adoption of SFAS 123Ron April 1, 2006, unamortized stock compensation relating to previousgrants of non-vested stock of $7.2 million was credited to additional paid-incapital and forfeitures of non-vested stock are estimated at the date of grantand adjusted as circumstances warrant. Additionally, prior to the adoption ofSFAS 123R, the Company presented all tax benefits of deductions resulting fromthe exercise of stock options as operating cash flows in the ConsolidatedStatement of Cash Flows. SFAS 123R requires excess tax benefits (i.e., the taxbenefit recognized upon exercise of stock options in excess of the benefitrecognized as compensation cost for those options) to be classified asfinancing cash flows in the Consolidated Statement of Cash Flows. Pursuant toSFAS 123R, tax benefits resulting from the exercise of stock options, whichhave been presented as operating cash flows prior to the adoption of SFAS 123Rare not reclassified to financing activities, but rather continue to bepresented as operating cash flows.

The adoption of SFAS 123R resulted in a non-cashcredit to Other income (expense), net, for the cumulative effect of a change inaccounting principle of $0.2 million related to the recognition of estimatedforfeitures on non-vested stock, which was recorded in the three-month periodended June 30, 2006. The cumulative effect credit is immaterial forpurposes of separate presentation on the Consolidated Statement of Earnings.

As a result of the application of SFAS 123R in the three-and six-month periods ended September 30, 2006, we recorded total share-basedcosts related to stock options and non-vested stock of $3.4 million and $6.1 million,respectively. Such amount was recognized in the consolidated financialstatements as follows:

Amounts recognized in the financial statements for share-basedcompensation are as follows:

| ** **                                                                      | ** ** | **Three Months Ended**                                                 | ** ** | **Six Months Ended**                                                   | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| ** **                                                                      | ** ** | **September 30,**                                                           | ** ** | **September 30,**                                                           | ** ** |
| ** **                                                                      | ** ** | **      2006      ** | ** ** | **      2005      ** | ** ** | **      2006      ** | ** ** | **      2005      ** | ** ** |
| ** **                                                                      | ** ** | **(in thousands)**                                                          | ** ** |
| Total cost of  share-based payment plans                                        |       |                                                                             | $          | 3,406                                                                            |       |   |   | $ | 859 |   |   |   | $ | 6,050 |   |   |   | $ | 1,104 |   |   |
| Amounts capitalized in  inventory                                               |       |                                                                             | $          | 1,442                                                                            |       |   |   | $ | 859 |   |   |   | $ | 2,272 |   |   |   | $ | 1,104 |   |   |
| Amounts charged against  income for amounts previously capitalized in inventory |       |                                                                             | $          | 830                                                                              |       |   |   | $ | 245 |   |   |   | $ | 1,790 |   |   |   | $ | 410 |   |   |
| Amounts charged against  income before income tax benefit                       |       |                                                                             | $          | 2,794                                                                            |       |   |   | $ | 245 |   |   |   | $ | 5,568 |   |   |   | $ | 410 |   |   |

 

6

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

 

As a result of applying SFAS 123R to the Company’sstock options, the Company’s earnings before income taxes and net earnings forthe three months ended September 30, 2006 were $2.0 million and $1.2 millionlower, respectively, and for the six months ended September 30, 2006 were$3.8 million and $2.3 million lower, respectively, than if it hadcontinued to account for share-based compensation under APB No. 25. Basicand diluted earnings per share for the three months ended September 30,2006 would have been $0.67 per share and $0.65 per share, respectively, and forthe six months ended September 30, 2006 would have been $1.23 per shareand $1.20 per share, respectively, if the Company had not adopted SFAS 123R. Reportedamounts for the three months ended September 30, 2006 were $0.64 per basicshare and $0.62 per diluted share, and for the six months ended September 30,2006 were $1.17 per basic share and $1.14 per diluted share.

**Prior Period Pro FormaInformation**   Prior to April 1,2006, the Company applied the intrinsic-value-based method of accountingprescribed by APB 25, and its related interpretations. Compensation expense forstock options granted to an employee or director was recognized in earningsbased on the excess, if any, of the quoted market price of DRS common stock atthe date of grant, or other measurement date, over the amount an employee ordirector must pay to acquire the common stock. When the exercise price of theoption granted to an employee or director equaled or exceeded the quoted marketprice of DRS common stock at the date of grant, the Company did not recognizecompensation expense. Compensation cost for nonvested stock was recorded basedon the market value of DRS common stock on the date of grant.

7

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

 

The table below compares the “as reported” netearnings and earnings per share to the “pro forma” net earnings and earningsper share for the three- and six-month periods ended September 30, 2005,that the Company would have reported if it had elected to recognizecompensation expense in accordance with the fair-value-based method ofaccounting of SFAS No. 123. For purposes of determining the pro formaeffects of SFAS No. 123, the estimated fair value of options granted wascalculated using the Black-Scholes option pricing valuation model. Optionforfeitures were accounted for as they occurred and no amount of stock optionexpense was capitalized into inventory or other assets, but instead wereconsidered period expenses.

| ** **                                                                                                           | ** ** | **Three Months**                                     | ** ** | **Six Months**           | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                                                           | ** ** | **Ended  September 30,**                             | ** ** | **Ended  September 30,** | ** ** |
| ** **                                                                                                           | ** ** | **2005**                                                  | ** ** | **2005**                      | ** ** |
| ** **                                                                                                           | ** ** | **(in thousands, except  per-share data)** | ** ** |
| Net earnings, as  reported                                                                                           |       |                                                      | $          | 18,954                        |       |   |   | $ | 32,972 |   |   |
| Add: Stock-based  compensation expense included in reported net earnings, net of taxes                               |       |                                                      | 519        |                          |       |   | 667 |   |   |
| Less: Total  stock-based compensation expense determined under fair-value-based method for  all awards, net of taxes |       |                                                      | (2,832     | )                             |       |   | (4,259 | ) |   |
| Pro forma net  earnings                                                                                              |       |                                                      | $          | 16,641                        |       |   |   | $ | 29,380 |   |   |
| Earnings per share:                                                                                                  |       |                                                      |       |                          |       |   |   |   |   |
| Basic—as reported                                                                                               |       |                                                      | $          | 0.68                          |       |   |   | $ | 1.20 |   |   |
| Basic—pro forma                                                                                                 |       |                                                      | $          | 0.60                          |       |   |   | $ | 1.07 |   |   |
| Diluted—as  reported                                                                                            |       |                                                      | $          | 0.66                          |       |   |   | $ | 1.15 |   |   |
| Diluted—pro forma                                                                                               |       |                                                      | $          | 0.58                          |       |   |   | $ | 1.03 |   |   |

 

**Share-based CompensationPlans**   On August 7, 1996,the stockholders approved the 1996 Omnibus Plan (1996 Plan). Under the terms ofthe Omnibus Plan, which expired on June 16, 2006, options could be grantedto key employees, directors and consultants of the Company. The 1996 Planinitially was limited to 500,000 shares of DRS common stock and was ultimatelyincreased, with stockholder approval, to 5,875,000 shares of DRS common stock.Awards under the 1996 Plan were at the discretion of the Executive CompensationCommittee and could be made in the form of incentive stock options,non-qualified stock options, stock appreciation rights, restricted stock andrestricted stock units, phantom stock, stock bonuses and other awards. TheCompany has historically utilized newly issued shares of DRS common stock tosatisfy its equity-based compensation awards.

On August 3, 2006, the stockholders approved the2006 Omnibus Plan (2006 Plan) which has similar terms to that of the 1996 OmnibusPlan. The 2006 Omnibus Plan provides for the issuance of up to 4.0 millionshares of DRS common stock.

***Stock Options  ***Unless the Executive CompensationCommittee expressly provides otherwise, options granted under the Omnibus Planhave a contractual term of ten years and generally are not exercisable prior toone year after the date of grant, with 25% of the options granted exercisableon each of the first four anniversaries of the date of grant. On July 6,2005, the Company granted 209,500 stock options that 

8

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

 

***fully vested on March 31, 2006. In accordance with the July 6,2005 stock option grant, recipients are required to hold any shares acquiredupon exercise of the options prior to March 31, 2008 (net of any sharessold or withheld to pay the exercise price and any applicable statutory minimumfederal, state and local tax requirements) for a period of one year following thedate of exercise. The Company’s decision to modify its traditional vestingterms for the July 6, 2005 stock option grant was made pursuant tomanagement’s evaluation of the Company’s overall incentive compensationstrategy. As a part of the evaluation, management considered the amount ofcompensation expense that would otherwise have been recognized in the Company’sresults of operations in future periods under SFAS 123R. The July 6, 2005stock option grant had a $4.8 million impact on the Company’s fiscal 2006 proforma pre-tax compensation expense.***

During fiscal 1999, the Compensation Committee of Boardof Directors issued options to purchase 250,000 shares of DRS common stock withvesting terms similar to awards issued under the 1996 Plan at exercise pricesin excess of the market price on the date of grant. The options expire infiscal 2009.

The stock options exercised during fiscal 2000included 50,000 shares, which are being held by the Company in “book entry”form. Book entry shares are not considered issued or outstanding and areexcluded from the tables below. However, these shares are included in theCompany’s diluted earnings per share calculations for the three- and six-monthperiods ended September 30, 2006 and 2005.

The following tablesummarize information regarding the Company’s stock option activity and amountsas of and for the six-month period ended September 30, 2006.

| ** **                                             | ** ** | **Number of  Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term (years)** | ** ** | **Aggregate  Intrinsic  Value (In  Thousands)** | ** ** |
|--------------------------------------------------------|------------|-----------------------------|------------|----------------------------------------|------------|------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| Outstanding at  March 31, 2006                         |       | 2,913,358                   |       |                                   | $          | 29.08                                                            |       |                                                 |       |   |   |   |   |   |   |   |
| Granted                                                |       | 227,172                     |       |                                   | $          | 49.53                                                            |       |                                                 |       |   |   |   |   |   |   |   |
| Exercised                                              |       | (42,956                     | )          |                                   | $          | 30.37                                                            |       |                                                 |       |   |   |   |   |   |   |   |
| Forfeited/cancelled                                    |       | (60,784                     | )          |                                   | $          | 33.75                                                            |       |                                                 |       |   |   |   |   |   |   |   |
| Outstanding at  September 30, 2006                     |       | 3,036,790                   |       |                                   | $          | 30.50                                                            |       |                                                 |       | 6.3 |   |   |   | $ | 42,887 |   |   |
| Vested and expected to vest at September 30, 2006  (1) |       | 3,006,744                   |       |                                   | $          | 30.43                                                            |       |                                                 |       | 6.2 |   |   |   | $ | 42,647 |   |   |
| Exercisable at  September 30, 2006                     |       | 1,949,469                   |       |                                   | $          | 27.26                                                            |       |                                                 |       | 5.3 |   |   |   | $ | 33,561 |   |   |

----

(1)          Represents outstandingoptions reduced by expected forfeitures.

The aggregate intrinsic value, disclosed in the table’sabove, represent the difference between DRS’s closing stock price on the lasttrading day of the second quarter (September 30, 2006) and the exerciseprice, multiplied by the number of in-the-money stock options outstanding.

The total intrinsic value of stock options exercised,based on the difference between DRS’s stock price at the time of exercise andthe related exercise price, during the six months ended September 30, 2006and 2005, was $0.8 million and $11.3 million, respectively. Totalcompensation expense related to stock options was $2.0 million and $3.8million, for the three- and six-month periods ended September 30, 2006, 

9

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

 

respectively. At September 30,2006, unrecognized compensation costs related to stock options was $12.0million ($7.2 million after income taxes), which is expected to be recognizedover a weighted average remaining period of 2.4 years.

The estimated weighted average grant date fair valueof each stock option awarded was $22.22 and $21.56 for the three-and six-monthperiods ended September 30, 2006, respectively, and $23.51 for thethree-and six-month periods ended September 30, 2005.

**Stock Option Fair Value Estimation Assumptions**   For purposes of estimating the fair value provisionsof SFAS 123R, the Company estimates the fair value of its stock options at thedate of grant using the Black-Scholes option-pricing valuation model. TheCompany’s valuation model is impacted by DRS’s stock price as well as weightedaverage assumptions for a number of subjective variables described below.

·       *Expected Holding Period  *The expectedholding period of stock options granted represents the period of time thatstock options granted are expected to be outstanding until they are exercised,cancelled or forfeited. The Company uses historical data to estimate stockoption exercise data and employee terminations within the valuation model.

·       *Expected Volatility  *Expectedvolatility is based on historical daily volatility of DRS common stock over theexpected holding period.

·       *Expected Dividend Yield  *Expecteddividend yield is based on DRS’s expected payments.

·       *Risk-Free Interest Rate  *Therisk-free interest rates for stock options are based on the U.S. Treasury yieldcurve in effect at the time of grant for maturities similar to the expectedholding period of the stock options.

·       *Forfeiture Rate  *The forfeiture rateis based on the historical forfeiture experience and prospective analysis ofdifferent pools of employees. We monitor share option exercise and employeetermination patterns of each pool to estimate forfeiture rates within thevaluation model.

Changes in assumptions can materially impact theestimated fair value of stock options. The weighted average assumptions used inthe valuation model are presented in the table below.

| ** **                                      | ** ** | **Six Months  Ended  September 30,** | ** ** |
|-------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                      | ** ** | **2006**                                       | ** ** |
| Expected holding  period (in years)             |       |                                           | 5.7        |   |   |
| Expected  volatility                            |       |                                           | 39.04      | % |   |
| Expected dividend  yield                        |       |                                           | 0.24       | % |   |
| Risk-free  interest rate                        |       |                                           | 4.95       | % |   |
| Weighted-average fair  value of options granted |       |                                           | $          | 21.56 |   |   |
|                                                 |            |                                                |            |  |  |  |

 

**Restricted Stock andRestricted Stock Units**   Restrictedstock awards are granted to certain employees, as permitted under the 2006 Planin the name of the employee, who has all the rights of a stockholder, subjectto certain restrictions. The restricted stock cliff vests three years from thedate of grant. Restricted stock units are granted in the name of the employee;however, the participant has no 

10

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

 

**rightsas a stockholder. These restricted stock units are redeemed for DRS commonstock once a three year cliff vesting period has been satisfied. The cost ofthe grants, as determined by the market prices of the common stock at the grantdates (excluding expected forfeitures), is recognized over the vesting periods.**

Compensation cost for non-vested stock for the threemonths ended September 30, 2006 and 2005 was $1.4 million and $0.9 million,respectively, and $2.3 million and $1.1 million for the six months ended September 30,2006 and 2005, respectively. As of September 30, 2006, total unrecognizedcompensation costs related to non-vested stock awards was $16.1 million andthat amount is expected to be recognized over a weighted average remainingperiod of 2.4 years.

The following tabledetails the activity in non-vested stock awards for the six months ended September 30,2006.

| ** **                                    | ** ** | **Six Months Ended  September 30, 2006** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                    | ** ** | **Number of  Shares**                                   | ** ** | **Weighted  Average Grant  Date Fair Value** | ** ** |
| Nonvested—Balance  at March 31, 2006     |       |                                                         | 281,590    |   |   |   | $ | 40.81 |   |   |
| Granted                                       |       |                                                         | 241,872    |   |   |   | $ | 49.91 |   |   |
| Vested                                        |       |                                                         | —     |   |   |   | $ | — |   |   |
| Forfeited/cancelled                           |       |                                                         | (20,295    | ) |   |   | $ | 48.26 |   |   |
| Nonvested—Balance at  September 30, 2006 |       |                                                         | 503,167    |   |   |   | $ | 45.10 |   |   |

 

**5.   Inventories**

Inventoriesare summarized as follows:

| ** **                                             | ** ** | **September 30,**  | ** ** | **March 31,** | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|--------------------|------------|
| ** **                                             | ** ** | **2006**                | ** ** | **2006**           | ** ** |
| ** **                                             | ** ** | **(in thousands)** | ** ** |
| Work-in-process                                        |       |                    | $          | 411,339            |       |   | $ | 368,991 |   |
| General and  administrative costs                      |       |                    | 65,223     |               |       | 63,836 |   |
| Raw material and  finished goods                       |       |                    | 43,696     |               |       | 66,706 |   |
|                                                   |       |                    | 520,258    |               |       | 499,533 |   |
| Less: Progress  payments and certain customer advances |       |                    | 183,941    |               |       | 158,967 |   |
| Inventory reserve                                      |       |                    | 9,212      |               |       | 9,360 |   |
| Total                                                  |       |                    | $          | 327,105            |       |   | $ | 331,206 |   |

 

Inventoried contract costs for the Company’sbusinesses that are primarily government contractors include certain generaland administrative (G&A) costs, including internal research and developmentcosts (IRAD) and bid and proposal costs (B&P). G&A, IRAD and B&Pcosts are allowable, indirect contract costs under U.S. government regulations.The Company allocates these costs to government contracts and accounts for themas product costs at the majority of the Company’s operating units, not asperiod expenses.

11

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

 

The table below presents a summary of G&A, IRADand B&P costs included in inventoried contract costs and changes to them,including amounts used in the determination of costs and expenses. The costdata in the table below does not include the G&A, IRAD and B&P costsfor the Company’s lines of businesses that are not primarily contracted withthe U.S. government, such costs are expensed as incurred.

| ** **                                   | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                   | ** ** | **September 30,**           | ** ** | **September 30,**         | ** ** |
| ** **                                   | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                   | ** ** | **(in thousands)**          | ** ** |
| Balance in  inventory at beginning of period |       | $                                | 65,447     |                           | $          | 47,509 |   | $ | 63,836 |   | $ | 47,365 |   |
| Add: Incurred costs                          |       | 106,305                          |       | 52,095                         |       | 175,061 |   | 105,273 |   |
| Less: Amounts included in costs and expenses |       | (106,529                         | )          | (48,791                        | )          | (173,674 | ) | (101,825 | ) |
| Balance in inventory at  end of period       |       | $                                | 65,223     |                           | $          | 50,813 |   | $ | 65,223 |   | $ | 50,813 |   |

 

Total expenditures forIRAD amounted to approximately $14.3 million and $11.5 million for thethree-month periods ended September 30, 2006 and 2005, respectively, and$25.3 million and $20.7 million, respectively, for the six-month periods thenended.

**6.   Goodwilland Intangible Assets**

The following disclosure presents certain informationregarding the Company’s acquired intangible assets as of September 30,2006 and March 31, 2006. All acquired intangible assets are beingamortized over their estimated useful lives, as indicated below, with noestimated residual values.

| **Acquired Intangible Assets** | ** ** | **Weighted  Average  Amortization  Period** | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net Balance** | ** ** |
|------------------------------------------|------------|---------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|----------------------|------------|
| ** **                               | ** ** | **(in thousands)**                     | ** ** |
| **As of September 30, 2006**             | ** ** |                                        | ** ** | ** **                      |       |                          | ** ** | ** **           |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Technology-based intangibles             |       |                                        | 18 years   | ** **                      |       |                          | $          | 47,861               |       |   |   | $ | (15,540 | ) |   |   | $ | 32,321 | ** ** |   |
| Customer-related intangibles             |       |                                        | 11 years   | ** **                      |       |                          | 217,215    |                 |       |   | (33,838 | ) |   |   | 183,377 | ** ** |   |
| Total                                    |       |                                        |       | ** **                      |       |                          | $          | 265,076              |       |   |   | $ | (49,378 | ) |   |   | $ | 215,698 | ** ** |   |
| **As of  March 31, 2006**                | ** ** |                                        | ** ** | ** **                      |       |                          | ** ** | ** **           |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Technology-based intangibles             |       |                                        | 18 years   | ** **                      |       |                          | $          | 47,861               |       |   |   | $ | (14,100 | ) |   |   | $ | 33,761 | ** ** |   |
| Customer-related intangibles             |       |                                        | 11 years   | ** **                      |       |                          | 217,190    |                 |       |   | (19,812 | ) |   |   | 197,378 | ** ** |   |
| Total                                    |       |                                        |       | ** **                      |       |                          | $          | 265,051              |       |   |   | $ | (33,912 | ) |   |   | $ | 231,139 | ** ** |   |

 

The aggregate acquired intangible asset amortizationexpense for the three-month periods ended September 30, 2006 and 2005 was$7.7 million and $2.1 million, respectively, and for the six-month periodsended September 30, 2006 and 2005 was $15.5 million and $4.2 million,respectively. The acquired intangible amortization expense, based on grosscarrying amounts at September 30, 2006, is estimated to be $30.7 millionfor fiscal 2007, $30.6 million per year for fiscal 2008, $29.6 million forfiscal 2009, $28.8 million for fiscal 2010 and $25.7 million for fiscal 2011.

The table below reconciles the change in the carryingamount of goodwill by operating segment for the period from March 31, 2006to September 30, 2006.

12

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

| ** **                              | ** ** | **C4I  Group**          | ** ** | **SR  Group** | ** ** | **S3  Group** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|-------------------------|------------|---------------|------------|---------------|------------|-----------|------------|
| ** **                              | ** ** | **(in thousands)** | ** ** |
| Balance as of  March 31, 2006           |       | $                       | 472,230    |          | $          | 354,809       |       | $         | 1,781,029  |   | $ | 2,608,068 |   |
| ESSI acquisition (see Note 15)     |       | —                  |       | —        |       | 14,547        |       | 14,547    |       |
| Codem acquisition earn-out              |       | 838                     |       | —        |       | —        |       | 838       |       |
| WalkAbout acquisition earn-out          |       | 226                     |       | —        |       | —        |       | 226       |       |
| Night Vision Equipment earn-out         |       | —                  |       | 1,047         |       | —        |       | 1,047     |       |
| Transfer of operating unit (A)          |       | (4,929                  | )          | —        |       | 4,929         |       | —    |       |
| Other adjustments                       |       | (1,921                  | )          | —        |       | —        |       | (1,921    | )          |
| Foreign currency translation adjustment |       | 1,643                   |       | —        |       | 66            |       | 1,709     |       |
| Balance as of September  30, 2006       |       | $                       | 468,087    |          | $          | 355,856       |       | $         | 1,800,571  |   | $ | 2,624,514 |   |

 

----

(A)       OnApril 1, 2006, DRS Technical Services, Inc. (TSI), an operating unitof the C4I Group, was consolidated into an operating unit of the S3 Group toachieve certain operating synergies. For the three- and six-month periods endedSeptember 30, 2005, the TSI operating unit recorded $5.1 million and $10.4million in revenues, respectively, and $0.1 million and $0.4 million ofoperating income, respectively, and had $10.7 million of assets at September 30,2005, which was considered immaterial for purposes of restating prior yeargoodwill balances and segment information for both the C4I Group and the S3Group.

**7. Product Warranties**

Product warranty costs are accrued when the coveredproducts are delivered to the customer. Product warranty expense is recognizedbased on the terms of the product warranty and the related estimated costs,considering historical claims expense. Accrued warranty costs are reduced asthese costs are incurred and as the warranty period expires, and may beotherwise modified as specific product performance issues are identified andresolved. The table below presents the changes in the Company’s accrual forproduct warranties for the six months ended September 30, 2006 and 2005,which are included in accrued expenses and other current liabilities.

| ** **                                                | ** ** | **Six Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                | ** ** | **2006**                                           | ** ** | **2005** | ** ** |
| ** **                                                | ** ** | **(in thousands)**                            | ** ** |
| Balance at  beginning of period                           |       | $                                                  | 29,869     |   | $ | 21,839 |   |
| Acquisitions during the period                            |       | —                                             |       | 360 |   |
| Accruals for product warranties issued during the  period |       | 9,217                                              |       | 4,593 |   |
| Settlements made during the period                        |       | (8,219                                             | )          | (5,273 | ) |
| Other                                                     |       | 126                                                |       | 46 |   |
| Balance at end of the  period                             |       | $                                                  | 30,993     |   | $ | 21,565 |   |

 

13

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

**8.Debt**

| ** **                                                         | ** ** | **September 30,2006** | ** ** | **March 31, 2006** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------|------------|------------------------------|------------|
| ** **                                                         | ** ** | **(in thousands)**    | ** ** |
| Credit Facility                                                    |       |                       |       |                         |       |   |   |   |   |
| Revolving line of credit                                           |       |                       | $          | 80,000                       |       |   |   | $ | 40,000 |   |   |
| Term Loan                                                          |       |                       | 273,625    |                         |       |   | 275,000 |   |   |
| Canadian Term  Loan                                                |       |                       | 9,798      |                         |       |   | 9,853 |   |   |
| 65¤8%  Senior Notes due 2016                                  |       |                       | 350,000    |                         |       |   | 350,000 |   |   |
| 2.00% Convertible  Senior Notes due 2026                           |       |                       | 345,000    |                         |       |   | 345,000 |   |   |
| 75¤8%  Senior Subordinated Notes due 2018                     |       |                       | 250,000    |                         |       |   | 250,000 |   |   |
| 67¤8%  Senior Subordinated Notes due 2013                     |       |                       | 550,000    |                         |       |   | 550,000 |   |   |
| Unamortized bond  premium on 67¤8%  Senior Subordinated Notes |       |                       | 8,019      |                         |       |   | 8,585 |   |   |
| Other obligations                                                  |       |                       | 5,274      |                         |       |   | 4,955 |   |   |
|                                                               |       |                       | 1,871,716  |                         |       |   | 1,833,393 |   |   |
| Less:                                                              |       |                       |       |                         |       |   |   |   |   |
| Current  installments of long-term debt                            |       |                       | 5,278      |                         |       |   | 4,622 |   |   |
| Total long-term  debt                                              |       |                       | $          | 1,866,438                    |       |   |   | $ | 1,828,771 |   |   |

 

The weighted average interest rate on the Company’sterm loan borrowings was 6.9% as of September 30, 2006 (6.3% as of March 31,2006). The weighted average interest rate under the revolving line of creditborrowings was 6.8% at September 30, 2006 (6.2% as of March 31,2006).

From time to time, the Company enters into standbyletters-of-credit and bank guarantee agreements with financial institutions andcustomers, primarily relating to the guarantee of its future performance oncertain contracts to provide products and services and to secure advancepayments it has received from its customers. As of September 30, 2006,$44.9 million was contingently payable under letters of credit and bankguarantees. Of this amount, approximately $0.9 million and $0.4 million inletters of credit and bank guarantees, respectively, as of September 30,2006, were issued under a previous credit agreement and by a bank agreement forthe Company’s U.K. subsidiary, respectively, and are not considered whendetermining the availability under the Company’s revolving line of credit. At September 30,2006, the Company had $276.4 million of availability under its revolving lineof credit.

On March 29, 2006, DRS Technologies CanadaCompany (DRS Canada) established a five-year senior secured term loan forapproximately $9.9 million (C$11.5 million), maturing on April 1, 2011.The weighted average interest rate on the term loan was 6.0% as of September 30,2006 (5.5% as of March 31, 2006). The carrying value of the Canadian termloan increased $0.5 million during the six months ended September 30,2006, as a result of the strengthening of the Canadian dollar compared to theU.S. dollar during that period.

Accrued interest expense at September 30, 2006and March 31, 2006 was $25.9 million and $27.3 million, respectively.

The Company’s indebtednessis more fully described in Note 8 to the Company’s Consolidated FinancialStatements for the year ended March 31, 2006.

14

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

**9. Earnings per Share**

Basicearnings per share (EPS) is computed by dividing net earnings by the weightedaverage number of shares of common stock outstanding during each period. Thecomputation of diluted earnings per share includes the effect of shares fromthe assumed exercise of dilutive stock options, restricted stock and restrictedstock units. The following table presents the components of basic and dilutedearnings per share:

| ** **                                 | ** ** | **Three Months Ended  September 30,**          | ** ** | **Six Months Ended  September 30,** | ** ** |
|--------------------------------------------|------------|---------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                 | ** ** | **2006**                                                      | ** ** | **2005**                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                 | ** ** | **(in thousands, except per-share data)** | ** ** |
| **Basic  EPS computation**                 |       |                                                          |       |                                               |       |   |   |   |   |
| Net earnings                               |       | $                                                             | 25,231     |                                               | $          | 18,954 |   | $ | 46,489 |   | $ | 32,972 |   |
| Weighted average common shares outstanding |       | 39,684                                                        |       | 27,676                                             |       | 39,674 |   | 27,578 |   |
| Basic earnings per share                   |       | $                                                             | 0.64       |                                               | $          | 0.68 |   | $ | 1.17 |   | $ | 1.20 |   |
| **Diluted  EPS computation**               |       |                                                          |       |                                               |       |   |   |   |   |
| Net earnings                               |       | $                                                             | 25,231     |                                               | $          | 18,954 |   | $ | 46,489 |   | $ | 32,972 |   |
| Diluted common shares outstanding          |       |                                                          |       |                                               |       |   |   |   |   |
| Weighted average common shares outstanding |       | 39,684                                                        |       | 27,676                                             |       | 39,674 |   | 27,578 |   |
| Stock options and restricted stock         |       | 826                                                           |       | 1,041                                              |       | 967 |   | 982 |   |
| Diluted common  shares outstanding         |       | 40,510                                                        |       | 28,717                                             |       | 40,641 |   | 28,560 |   |
| Diluted earnings per  share                |       | $                                                             | 0.62       |                                               | $          | 0.66 |   | $ | 1.14 |   | $ | 1.15 |   |

 

At September 30, 2006and 2005, there were 454,108 options and 22,500 options outstanding,respectively, that were excluded from the diluted EPS calculation because theirinclusion would have had an antidilutive effect on EPS. For the three- and six-monthperiods ended September 30, 2006, DRS’s 2% Convertible Senior Notes had noimpact on EPS because the average stock price during the period was below$59.70 per share, and the convertible notes, if converted, would require onlycash at settlement.

**10. Comprehensive Earnings**

The components of comprehensive earnings for thethree- and six-month periods ended September 30, 2006 and 2005 consistedof the following:

| ** **                                                                                | ** ** | **Three Months Ended  September 30,** | ** ** | **Six Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                | ** ** | **2006**                                             | ** ** | **2005**                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                                | ** ** | **(in thousands)**                              | ** ** |
| Net earnings                                                                              |       | $                                                    | 25,231     |                                               | $          | 18,954 |   | $ | 46,489 |   | $ | 32,972 |   |
| Other comprehensive  earnings:                                                            |       |                                                 |       |                                               |       |   |   |   |   |
| Foreign currency translation adjustments                                                  |       | 139                                                  |       | 2,157                                              |       | 2,581 |   | 845 |   |
| Minimum pension liability, net of income tax                                              |       | (59                                                  | )          | —                                             |       | (657 | ) | — |   |
| Unrealized net gains on hedging instruments arising  during the period, net of income tax |       | (20                                                  | )          | —                                             |       | (20 | ) | — |   |
| Amortization of unrealized gain on terminated  instruments, net of income taxes           |       | —                                               |       | (46                                                | )          | — |   | (92 | ) |
| Comprehensive earnings                                                                    |       | $                                                    | 25,291     |                                               | $          | 21,065 |   | $ | 48,393 |   | $ | 33,725 |   |

 

15

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

**11. Pensions and OtherEmployee Benefits**

Thefollowing table summarizes the components of net periodic benefit cost for theCompany’s pension and postretirement benefit plans for the three- and six-monthperiods ended September 30, 2006 and 2005. These plans are more fullydescribed in Note 12 to the Company’s Consolidated Financial Statements for theyear ended March 31, 2006.

| ** **                                       | ** ** | ** **                                               | ** ** | ** **             | ** ** | **Unfunded**              | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------------|------------|------------------------|------------|---------------------------|------------|
| ** **                                       | ** ** | **Funded**                                               | ** ** | **Postretirement**     | ** ** | **Supplemental**          | ** ** |
| ** **                                       | ** ** | **Pension Plans**                                   | ** ** | **Benefit Plans** | ** ** | **Retirement Plans** | ** ** |
| ** **                                       | ** ** | **Three Months Ended September 30,** | ** ** |
| ** **                                       | ** ** | **2006**                                                 | ** ** | **2005**               | ** ** | **2006**                  | ** ** | **2005** | ** ** | **  2006  ** | ** ** | **  2005  ** | ** ** |
| ** **                                       | ** ** | **(in thousands)**                                  | ** ** |
| Service cost                                     |       | $                                                        | 1,834      |                   | $          | 988                       |       | $ | 146 |   | $ | 150 |   |   | $ | 143 |   |   |   | $ | 136 |   |   |
| Interest cost                                    |       | 3,243                                                    |       | 1,511                  |       | 320                       |       | 241 |   |   | 318 |   |   |   | 279 |   |   |
| Expected return  on plan assets                  |       | (3,490                                                   | )          | (1,769                 | )          | (56                       | )          | (42 | ) |   | — |   |   |   | — |   |   |
| Amortization of  unrecognized loss (gain)        |       | 117                                                      |       | 43                     |       | (8                        | )          | (2 | ) |   | 47 |   |   |   | 42 |   |   |
| Amortization of  transition obligation           |       | —                                                   |       | —                 |       | 28                        |       | 27 |   |   | — |   |   |   | — |   |   |
| Amortization of  unrecognized prior-service cost |       | 39                                                       |       | 2                      |       | (6                        | )          | — |   |   | 194 |   |   |   | 194 |   |   |
| Net periodic benefit  cost                       |       | $                                                        | 1,743      |                   | $          | 775                       |       | $ | 424 |   | $ | 374 |   |   | $ | 702 |   |   |   | $ | 651 |   |   |

 

| ** **                                       | ** ** | ** **                         | ** ** | ** **         | ** ** | **Unfunded**         | ** ** |
|--------------------------------------------------|------------|------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                                       | ** ** | **Funded**                         | ** ** | **Postretirement** | ** ** | **Supplemental**     | ** ** |
| ** **                                       | ** ** | **Pension Plans**                  | ** ** | **Benefit Plans**  | ** ** | **Retirement Plans** | ** ** |
| ** **                                       | ** ** | **Six Months Ended September 30,** | ** ** |
| ** **                                       | ** ** | **2006**                           | ** ** | **2005**           | ** ** | **2006**             | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                       | ** ** | **(in thousands)**            | ** ** |
| Service cost                                     |       | $                                  | 3,668      |               | $          | 1,976                |       | $ | 292 |   | $ | 299 |   | $ | 286 |   | $ | 272 |   |
| Interest cost                                    |       | 6,486                              |       | 3,021              |       | 640                  |       | 482 |   | 636 |   | 558 |   |
| Expected return  on plan assets                  |       | (6,980                             | )          | (3,539             | )          | (112                 | )          | (84 | ) | — |   | — |   |
| Amortization of  unrecognized loss (gain)        |       | 234                                |       | 86                 |       | (16                  | )          | (5 | ) | 94 |   | 84 |   |
| Amortization of  transition obligation           |       | —                             |       | —             |       | 56                   |       | 54 |   | — |   | — |   |
| Amortization of  unrecognized prior-service cost |       | 78                                 |       | 5                  |       | (12                  | )          | — |   | 388 |   | 389 |   |
| Net periodic benefit  cost                       |       | $                                  | 3,486      |               | $          | 1,549                |       | $ | 848 |   | $ | 746 |   | $ | 1,404 |   | $ | 1,303 |   |

 

The Company expects tocontribute $7.9 million and $2.3 million to its pension and postretirementplans, respectively, during the fiscal year ended March 31, 2007, of which$3.5 million and $1.2 million, were contributed during the six-month periodended September 30, 2006.

**12. Operating Segments**

The following information is presented in theoperating structure that was in effect at September 30, 2006.

The C4I Group is comprised of the following businessareas: Command, Control and Communications (C3), which includes naval displaysystems, ship communications systems, radar systems, technical support,electronic manufacturing and system integration services, and secure voice anddata communications; Power Systems, which includes naval and industrial powergeneration, conversion, propulsion, distribution and control systems;Intelligence Technologies, which includes signals intelligence, 

16

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

communicationsintelligence, data collection, processing and dissemination equipment; andTactical Systems, which includes battle management tactical computer systemsand peripherals.

The SR Group is comprised of the following businessareas: Reconnaissance, Surveillance & Target Acquisition (RSTA), whichdevelops and produces electro-optical sighting, targeting and weapon sensorsystems, aircraft weapons alignment systems and image intensification (I2 ) night vision, combat identification andlaser aimers/illuminator products, and provides electronic manufacturingservices; Training & Control Systems, which develops and produces aircombat training, electronic warfare and network systems, high-speed digitaldata and imaging systems, unmanned vehicles and mission and flight recorders;and Test & Energy Management, which develops and produces electronictest, diagnostics and vehicle electronics.

The S3 Group is comprised of the following businessareas: Sustainment Systems, which designs, engineers and manufacturesintegrated military electronics and other military support equipment, primarilyfor the U.S. Department of Defense, as well as related heat transfer and airhandling equipment and power generation and distribution equipment for domesticcommercial and industrial users; and Support Services, which providesengineering services, logistics and training services, advanced technologyservices, asset protection systems and services, telecommunication systemsintegration and information technology services, and vehicle armor kits formilitary, humanitarian, disaster recovery and emergency responder applications.

Other includes the activities of DRS CorporateHeadquarters and certain non-operating subsidiaries of the Company.

Transactions betweensegments generally are negotiated and accounted for under terms and conditionsthat are similar to other government and commercial contracts; however, theseintercompany transactions are eliminated in consolidation. The Companyevaluates segment-level performance based on revenues and operating income, aspresented in the Consolidated Statements of Earnings. Operating income, asshown, includes amounts allocated from DRS Corporate operations using anallocation methodology prescribed by U.S. government regulations for governmentcontractors.

17

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

 

| ** **                                      | ** ** | **C4I Group**      | ** ** | **SR Group** | ** ** | **S3 Group** | ** ** | **Other** | ** ** | **Total** | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|-------------------|------------|-------------------|------------|-----------|------------|-----------|------------|
| ** **                                      | ** ** | **(in thousands)** | ** ** |
| **Three Months Ended  September 30, 2006** |       |                    |       |              |       |              |       |      |       |      |       |
| Total revenues                                  |       | $                       | 196,688    |              | $          | 225,885           |       | $         | 292,118    |      | $          | — |   | $ | 714,691 |   |
| Intersegment revenues                           |       | (1,730                  | )          | (738              | )          | (685              | )          | —    |       | (3,153    | )          |
| External revenues                               |       | $                       | 194,958    |              | $          | 225,147           |       | $         | 291,433    |      | $          | — |   | $ | 711,538 |   |
| Operating income                                |       | $                       | 22,551     |              | $          | 22,990            |       | $         | 25,045     |      | $          | 1,302 |   | $ | 71,888 |   |
| Total assets                                    |       | $                       | 859,166    |              | $          | 796,134           |       | $         | 2,314,636  |      | $          | 137,455 |   | $ | 4,107,391 |   |
| Depreciation and  amortization                  |       | $                       | 3,971      |              | $          | 6,141             |       | $         | 7,883      |      | $          | 1,243 |   | $ | 19,238 |   |
| Capital expenditures                            |       | $                       | 6,493      |              | $          | 4,591             |       | $         | 2,540      |      | $          | 514 |   | $ | 14,138 |   |
| **Three  Months Ended September 30, 2005** |       |                    |       |              |       |              |       |      |       |      |       |
| Total revenues                                  |       | $                       | 194,849    |              | $          | 167,757           |       | $         | —     |      | $          | — |   | $ | 362,606 |   |
| Intersegment revenues                           |       | (429                    | )          | (247              | )          | —            |       | —    |       | (676      | )          |
| External revenues                               |       | $                       | 194,420    |              | $          | 167,510           |       | $         | —     |      | $          | — |   | $ | 361,930 |   |
| Operating income (loss)                         |       | $                       | 19,719     |              | $          | 21,077            |       | $         | —     |      | $          | (2,219 | ) | $ | 38,577 |   |
| Total assets                                    |       | $                       | 854,658    |              | $          | 715,899           |       | $         | —     |      | $          | 301,411 |   | $ | 1,871,968 |   |
| Depreciation and  amortization                  |       | $                       | 3,656      |              | $          | 5,916             |       | $         | —     |      | $          | 952 |   | $ | 10,524 |   |
| Capital expenditures                            |       | $                       | 3,570      |              | $          | 4,692             |       | $         | —     |      | $          | 1,656 |   | $ | 9,918 |   |
| **Six  Months Ended September 30, 2006**   |       |                    |       |              |       |              |       |      |       |      |       |
| Total revenues                                  |       | $                       | 392,407    |              | $          | 419,317           |       | $         | 535,805    |      | $          | — |   | $ | 1,347,529 |   |
| Intersegment revenues                           |       | (3,457                  | )          | (1,212            | )          | (1,057            | )          | —    |       | (5,726    | )          |
| External revenues                               |       | $                       | 388,950    |              | $          | 418,105           |       | $         | 534,748    |      | $          | — |   | $ | 1,341,803 |   |
| Operating income                                |       | $                       | 42,488     |              | $          | 43,739            |       | $         | 49,731     |      | $          | 915 |   | $ | 136,873 |   |
| Total assets                                    |       | $                       | 859,166    |              | $          | 796,134           |       | $         | 2,314,636  |      | $          | 137,455 |   | $ | 4,107,391 |   |
| Depreciation and  amortization                  |       | $                       | 7,712      |              | $          | 12,439            |       | $         | 15,669     |      | $          | 2,543 |   | $ | 38,363 |   |
| Capital expenditures                            |       | $                       | 11,709     |              | $          | 8,000             |       | $         | 4,886      |      | $          | 2,623 |   | $ | 27,218 |   |
| **Six Months Ended  September 30, 2005**   |       |                    |       |              |       |              |       |      |       |      |       |
| Total revenues                                  |       | $                       | 385,878    |              | $          | 316,281           |       | $         | —     |      | $          | — |   | $ | 702,159 |   |
| Intersegment revenues                           |       | (968                    | )          | (802              | )          | —            |       | —    |       | (1,770    | )          |
| External revenues                               |       | $                       | 384,910    |              | $          | 315,479           |       | $         | —     |      | $          | — |   | $ | 700,389 |   |
| Operating income (loss)                         |       | $                       | 39,207     |              | $          | 36,865            |       | $         | —     |      | $          | (2,437 | ) | $ | 73,635 |   |
| Total assets                                    |       | $                       | 854,658    |              | $          | 715,899           |       | $         | —     |      | $          | 301,411 |   | $ | 1,871,968 |   |
| Depreciation and  amortization                  |       | $                       | 7,092      |              | $          | 11,990            |       | $         | —     |      | $          | 1,859 |   | $ | 20,941 |   |
| Capital expenditures                            |       | $                       | 5,873      |              | $          | 8,110             |       | $         | —     |      | $          | 2,271 |   | $ | 16,254 |   |

 

18

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

**13. Supplemental Cash Flow Information**

| ** **                                                                                 | ** ** | **Six Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2006**                                           | ** ** | **2005** | ** ** |
| ** **                                                                                 | ** ** | **(in thousands)**                            | ** ** |
| Cash paid for:                                                                             |       |                                               |       |   |   |
| Income taxes                                                                               |       | $                                                  | 29,038     |   | $ | 20,742 |   |
| Interest                                                                                   |       | $                                                  | 59,452     |   | $ | 21,411 | * |
| Supplemental disclosure  of significant non-cash  investing and financing activities: |       |                                               |       |   |   |
| Acquisition costs for business combinations, net                                           |       | $                                                  | —     |   | $ | 202 |   |
| Acquisition earn-out—Night Vision Systems, Inc.                                  |       | $                                                  | 1,047      |   | $ | — |   |
| Acquisition earn-out—WalkAbout                                                        |       | $                                                  | 226        |   | $ | — |   |
| Contribution of fixed assets to joint venture                                              |       | $                                                  | 1,000      |   | $ | — |   |

----

*                    Excludesthe advanced interest of $2.0 million that was repaid in conjunction with thesemi-annual interest payments on the 67¤8%senior subordinated notes. See Note 8 to the Company’s Consolidated FinancialStatements for the year ended March 31, 2006.

**14. Cash Dividendson DRS Common Stock**

On August 3, 2006,the Board of Directors declared a $0.03 per common share cash dividend, payableon September 29, 2006 to stockholders of record as of September 15,2006. Cash dividends paid for the three-and six-month periods ended September 30,2006 were  $1.2 million and $2.4 million,respectively. On November 2, 2006, the Board of Directors declared a $0.03per common share cash dividend, payable on December 29, 2006 tostockholders of record as of December 15, 2006.

**15. Contingenciesand Related Party Transactions**

**Contingencies****—**Various legal actions, claims, assessmentsand other contingencies arising in the normal course of the Company’s business,including certain matters described below, are pending against the Company andcertain of its subsidiaries. These matters are subject to many uncertainties,and it is possible that some of these matters could be ultimately decided,resolved or settled adversely. The Company has recorded accruals totaling $4.4 millionand $4.3 million at September 30, 2006 and March 31, 2006,respectively, for losses related to those matters that it considers to beprobable and that can be reasonably estimated (certain legal and environmentalmatters are discussed in detail below). Based on the Company’s ongoing analysisof various factual, legal and equitable considerations it has recorded anaccrual of $11.8 million against goodwill reflecting the probable income taximpact of information uncovered in our ongoing internal investigation ofhistorical ESSI stock option practices. Although the ultimate amount ofliability at September 30, 2006 that may result from those matters forwhich the Company has recorded accruals is not ascertainable, the Companybelieves that any amounts exceeding the Company’s recorded accruals should notmaterially affect the Company’s financial condition or liquidity. It ispossible, however, that the ultimate resolution of those matters could resultin a material adverse effect on the Company’s results of operations and/or cashflows from operating activities for a particular reporting period.

19

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

Some environmental laws, such as the Comprehensive EnvironmentalResponse, Compensation and Liability Act of 1980 (also known as CERCLA or theSuperfund law) and similar state statutes, can impose liability for the entirecost of the clean up of contaminated sites upon any of the current or formersite owners or operators (or upon parties who send waste to these sites),regardless of the lawfulness of the original activities that led to thecontamination. In July 2000, prior to its acquisition by IDT, and prior toDRS’s acquisition of IDT, Tech-Sym Corporation received a Section 104(e) Requestfor Information from the National Park Service (NPS), pursuant to CERCLA,regarding a site known as the Orphan Mine site in the Grand Canyon NationalPark, Arizona, which is the subject of an NPS investigation regarding thepresence of residual radioactive materials and contamination. A corporation ofwhich Tech-Sym is an alleged successor operated this uranium mine from 1956 to1967. In 1962, the land was sold to the U.S. government and the allegedpredecessor of Tech-Sym was given a 25-year mining lease. In 1967, themining rights were transferred to a third party by a trustee in bankruptcy, andthe Company believes that the mine was operated by such third party untilapproximately 1969. The Company understands that there are other companies inthe chain of title to the mining rights subsequent to Tech-Sym’s allegedpredecessor, and, accordingly, that there are other potentially responsibleparties (PRPs) for the environmental conditions at the site, including the U.S.government as owner, operator and arranger at the site. During its period ofownership, IDT retained a technical consultant in connection with this matter,who conducted a limited, preliminary review of site conditions and communicatedwith the NPS regarding actions that may be required at the site by all of thePRPs. On February 6, 2005, the NPS sent the Company an EngineeringEvaluation/Cost Analysis Work Plan (the “NPS EE/CA”) under CERCLA (the ‘‘CERCLALetter’’) with regards to Operable Unit 1 of the Orphan Mine site. In theCompany’s view, the NPS EE/CA included additional clean up not covered byCERCLA. The CERCLA Letter also requested (a) payment of $0.5 million forcosts incurred by the NPS related to the Orphan Mine, and (b) a ‘‘goodfaith offer’’ to conduct the response activity outlined by the NPS and toreimburse the NPS for future costs. The NPS advised that a similar letter hasbeen sent to another PRP. The Company initiated discussions with the other PRPand with NPS, and engaged a technical consultant to evaluate the existingdocumentation and the site in depth. As a result, on September 29, 2005,the technical consultant submitted to the NPS, on behalf of the Company and theother PRP, an alternative Engineering Evaluation/Cost Analysis Work Plan (the “alternativeEE/CA”) with regards to Operating Units 1 and 2 of the Orphan Mine site.

In December 2005 and August 2006, the PRPsand NPS met to discuss the technical merits of the alternative EE/CA and waysto resolve certain differences between the alternative EE/CA and the NPS EE/CAprovided with the CERCLA Letter. Since late 2005, the parties have alsodiscussed certain legal issues relating to the process for implementing analternative EE/CA and entering into a settlement agreement that would memorializethe parties’ intent. The potential liability associated with implementation ofthe EE/CA can change substantially due to such factors as additionalinformation on the nature or extent of contamination, methods of remediationthat might be recommended or required, changes in the apportionment of costsamong the responsible parties and other actions by governmental agencies orprivate parties.

In connection with the ESSI acquisition, the Companyhas been made aware of certain legal actions, claims, assessments and othercontingencies, certain of which are described below.

In December 2004, ESSI was notified by theEnforcement Division of the SEC of the issuance of a formal order directing aprivate investigation captioned *In the Matter ofEngineered Support Systems, Inc.*

20

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

and was notified that theSEC had issued subpoenas to various individuals associated with ESSI to producecertain documents. The SEC staff also requested that ESSI produce certaindocuments in connection with the investigation. The subpoenas related totrading in ESSI stock around ESSI’s earnings releases in 2003 and to theadequacy of certain disclosures made by ESSI regarding related-partytransactions in 2002 and 2003 involving insurance policies placed by ESSIthrough an insurance brokerage firm in which an ESSI director was a principalat the time of the transactions.

On or about September 23, 2005, the SEC staffadvised ESSI’s counsel that it had issued a subpoena directed to ESSI andexpanded its investigation to include ESSI’s disclosure of a November 2004stop work order relating to ESSI’s Deployable Power Generation and DistributionSystems (“DPGDS”) program for the U.S. Air Force, and relating to trading inESSI stock by certain individuals associated with ESSI.

In connection with the foregoing SEC investigation,ESSI and certain of its directors and officers have provided information and/ortestimony to the SEC. On November 14, 2005, ESSI was informed by theEnforcement Division of the SEC that one of ESSI’s former directors andofficers, and subsequently a consultant to ESSI, had been issued a so-calledWells notice informing him that the staff of the SEC was consideringrecommending that the SEC bring a civil injunctive action against him inconnection with the SEC’s investigation into trading in ESSI common stock in2003. A Wells notice provides prospective defendants with an opportunity torespond to the SEC staff members before the staff makes a formal recommendationon whether the SEC should pursue disciplinary action against them. ESSI,itself, has not received a Wells notice and continues to cooperate with theinvestigation.

In January 2006, ESSI was informed that theOffice of the U.S. Attorney for the Eastern District of Missouri was initiatingan investigation into ESSI’s disclosure of the DPGDS stop-work order and intotrading in ESSI stock by ESSI insiders which preceded such disclosure. The U.S.Attorney’s office advised ESSI that although it considered ESSI to be a subjectof its investigation, ESSI was not a target. In connection with thisinvestigation, the U.S. Attorney’s office issued ESSI a subpoena requestingspecified information, which ESSI continues to furnish.

In May 2006, the Company was advised that theEnforcement Division of the SEC and the U.S. Attorney’s office had eachexpanded its investigation to include possible “backdating” of the timing ofoption grants at ESSI prior to the time ESSI was acquired by DRS. As a part ofits investigation, the SEC has issued subpoenas to certain officers and employeesof ESSI to provide testimony and produce certain documents. Although ESSIcontinues to be a subject of the U.S. Attorney’s office’s investigation, theU.S. Attorney’s office has advised the Company that ESSI is not a target.Because the events being investigated occurred prior to the time of the Company’sacquisition of ESSI, the U.S. Attorney’s office has further advised the Companythat it considers DRS to be a witness, not a subject or target of itsinvestigation.

The Company is committed to full cooperation withregard to the foregoing investigations. The Company is unable to determine atthis time either the timing of the SEC or U.S. Attorney’s office investigationsor the impact, if any, which the investigations could have on the Company.

In September 2006, ESSI was advised that theInternal Revenue Service was commencing an audit of its Federal tax return forthe fiscal year ended October 31, 2004. In connection therewith, ESSIreceived an information document request (“IDR”) asking for specific informationrelating to stock option deductions provided therein. The Company iscooperating with this process.

21

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

The Company has recorded an accrual against goodwillto reflect the likely disallowance of certain compensation deductions taken onseveral of ESSI’s previous State and Federal income tax returns. Principally,this adjustment was made to account for Internal Revenue Code Section 162(m) andits limitations on the deductibility of certain non-performance basedcompensation.

In July 2006, DRS and one of our subsidiaries,DRS Training and Control Systems, Inc. (“TCS”) were each issued a subpoenaby the United States District Court for the Northern District of Florida (“FloridaDistrict Court”).

The subpoenas were issued in connection with aninquiry being conducted by the Antitrust Division of the U.S. Department ofJustice (“DOJ”) and require TCS to produce certain documents related to aninvestigation we believe involves allegations of anticompetitive activity incertain international markets.

In addition, certain employees and officers of TCSwere served with subpoenas to testify before the grand jury of the FloridaDistrict Court with regard to this matter. The DOJ is continuing itsinvestigation, but we have no information as to when the DOJ will conclude thisprocess. We have cooperated with the DOJ in producing documents in response tothe subpoenas. We have commenced an internal investigation regarding thismatter, which we expect to continue through the conclusion of the DOJ’sinvestigatory process.

**RelatedParty Transactions****  **TheCompany currently leases a building in Oakland, New Jersey, owned by LDR RealtyCo., a partnership that was wholly owned in equal amounts by David E. Gross,DRS’s cofounder and the former President and Chief Technical Officer, and thelate Leonard Newman, DRS’s cofounder, the former Chairman of the Board, ChiefExecutive Officer, and Secretary and the father of Mark S. Newman, the Company’scurrent Chairman of the Board, President and Chief Executive Officer. The leaseagreement with a monthly rental of $21,200 expires on April 30, 2007.Following Leonard Newman’s death in November 1998, Mrs. Ruth Newman,the wife of Leonard Newman and the mother of Mark S. Newman, succeeded toLeonard Newman’s interest in LDR Realty Co.

Skadden, Arps, Slate, Meagher & Flom LLP, alaw firm to which a member of our Board is of counsel, provided legal servicesto the Company during the six months ended September 30, 2006 and 2005. Feespaid to Skadden, Arps, Slate, Meagher & Flom LLP for the six monthsended September 30, 2006 and 2005 were $2.8 million and $0.8 million,respectively.

Kronish Lieb Weiner &Hellman LLP, a law firm of which Alison Newman, sister of Mark S. Newman, is apartner, provided legal services to the Company during the six months ended September 30,2005. The Company paid fees to Kronish Lieb Weiner & Hellman LLP of$0.2 million for the six months ended September 30, 2005.

**16. Guarantor andNon-Guarantor Financial Statements**

As presented in Note 8, “Debt”, the Company has $350.0million 65¤8% Senior Notes, $550.0million 67¤8% Senior SubordinatedNotes, $250.0 million 75¤8% Senior Subordinated Notesand $345.0 million 2% Convertible Senior Notes outstanding (collectively, theNotes). The Notes are fully and unconditionally guaranteed, jointly andseverally, by the Company’s wholly-owned domestic subsidiaries (the GuarantorSubsidiaries). The foreign subsidiaries and certain domestic subsidiaries ofDRS (the Non-Guarantor Subsidiaries) do not guarantee the Notes.

22

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

The following condensed consolidating financialinformation in the Condensed Consolidating Balance Sheets as of September 30,2006 and March 31, 2006, the Condensed Consolidating Statements ofEarnings for the three- and six-month periods ended September 30, 2006 and2005, and the Condensed Consolidating Statements of Cash Flows for the sixmonths ended September 30, 2006 and 2005 presents:

a) DRS Technologies, Inc. (the Parent),

b) the Guarantor Subsidiaries,

c) the Non-Guarantor Subsidiaries, and

d) DRS Technologies, Inc. on a consolidated basis

The information includes elimination entries necessaryto consolidate the Parent with the Guarantor and Non-Guarantor Subsidiaries.

The Guarantor and Non-Guarantor subsidiaries arepresented on a combined basis. The principal elimination entries eliminateinvestments in subsidiaries and intercompany balances and transactions. Separatefinancial information for each of the Guarantor and Non-Guarantor Subsidiariesare not presented because management believes such financial statements wouldnot be meaningful to investors.

23

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

**CondensedConsolidating Balance Sheet**

**As of September 30, 2006**

**(inthousands)**

| ** **                                           | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                           | ** ** | ** **          | ** ** | ** **                  | ** ** |                              | ** ** | ** **       |       | ** **       | ** ** |   | ** ** | ** ** |   |
| **Current assets**                                   | ** ** | ** **          | ** ** | ** **                  | ** ** |                              | ** ** | ** **       |       | ** **       | ** ** |   | ** ** | ** ** |   |
| Cash and cash equivalents                            |       | $                   | 39,208     |                        | $          | (14,486                           | )          |             | $          | 10,140           |       |   | $ | — |   |   | $ | 34,862 | ** ** |   |
| Accounts receivable, net                             |       | 4                   |       | 473,334                     |       |                              | 32,527     |             |       | —           |       |   | 505,865 | ** ** |   |
| Inventories, net                                     |       | (4,238              | )          | 288,922                     |       |                              | 42,421     |             |       | —           |       |   | 327,105 | ** ** |   |
| Prepaid expenses and  other current assets      |       | 6,837               |       | 104,172                     |       |                              | 12,771     |             |       | (7,266           | )          |   | 116,514 | ** ** |   |
| Intercompany receivables                             |       | 2,038,511           |       | —                      |       |                              | 24,115     |             |       | (2,062,626       | )          |   | — | ** ** |   |
| **Total  current assets**                            |       | 2,080,322           |       | 851,942                     |       |                              | 121,974    |             |       | (2,069,892       | )          |   | 984,346 | ** ** |   |
| Property, plant and  equipment, net                  |       | 14,017              |       | 201,411                     |       |                              | 8,051      |             |       | —           |       |   | 223,479 | ** ** |   |
| Acquired intangibles,  net                           |       | —              |       | 214,995                     |       |                              | 703        |             |       | —           |       |   | 215,698 | ** ** |   |
| Goodwill                                             |       | 24,115              |       | 2,560,073                   |       |                              | 40,326     |             |       | —           |       |   | 2,624,514 | ** ** |   |
| Deferred income taxes  and other noncurrent assets   |       | 53,017              |       | 8,114                       |       |                              | 10,277     |             |       | (12,054          | )          |   | 59,354 | ** ** |   |
| Investment in  subsidiaries                          |       | 1,147,206           |       | 46,642                      |       |                              | —     |             |       | (1,193,848       | )          |   | — | ** ** |   |
| **Total  assets**                                    |       | $                   | 3,318,677  |                        | $          | 3,883,177                         |       |             | $          | 181,331          |       |   | $ | (3,275,794 | ) |   | $ | 4,107,391 | ** ** |   |
| **Liabilities  and Stockholders’ Equity**       | ** ** | ** **          | ** ** | ** **                  | ** ** |                              | ** ** | ** **       |       | ** **       | ** ** |   | ** ** | ** ** |   |
| **Current liabilities**                              | ** ** | ** **          | ** ** | ** **                  | ** ** |                              | ** ** | ** **       |       | ** **       | ** ** |   | ** ** | ** ** |   |
| Current installments of  long-term debt              |       | $                   | 2,750      |                        | $          | 224                               |       |             | $          | 2,304            |       |   | $ | — |   |   | $ | 5,278 | ** ** |   |
| Accounts payable                                     |       | 5,404               |       | 203,204                     |       |                              | 13,690     |             |       | —           |       |   | 222,298 | ** ** |   |
| Accrued expenses and  other current liabilities      |       | 48,560              |       | 390,187                     |       |                              | 31,950     |             |       | (7,224           | )          |   | 463,473 | ** ** |   |
| Intercompany payables                                |       | —              |       | 1,620,001                   |       |                              | 25,482     |             |       | (1,645,483       | )          |   | — | ** ** |   |
| Total current  liabilities                           |       | 56,714              |       | 2,213,616                   |       |                              | 73,426     |             |       | (1,652,707       | )          |   | 691,049 | ** ** |   |
| Long-term debt,  excluding current installments      |       | 1,853,894           |       | 3,329                       |       |                              | 9,215      |             |       | —           |       |   | 1,866,438 | ** ** |   |
| Other liabilities                                    |       | 2,947               |       | 130,175                     |       |                              | 23,715     |             |       | (12,055          | )          |   | 144,782 | ** ** |   |
| **Total  liabilities**                               |       | 1,913,555           |       | 2,347,120                   |       |                              | 106,356    |             |       | (1,664,762       | )          |   | 2,702,269 | ** ** |   |
| **Total  stockholders’ equity**                 |       | 1,405,122           |       | 1,536,057                   |       |                              | 74,975     |             |       | (1,611,032       | )          |   | 1,405,122 | ** ** |   |
| **Total  liabilities and stockholders’ equity** |       | $                   | 3,318,677  |                        | $          | 3,883,177                         |       |             | $          | 181,331          |       |   | $ | (3,275,794 | ) |   | $ | 4,107,391 | ** ** |   |

 

24

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

**CondensedConsolidating Balance Sheet**

**As of March 31, 2006**

**(inthousands)**

| ** **                                           | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                           | ** ** | ** **          | ** ** | ** **                  | ** ** |                              | ** ** | ** **       |       | ** **       | ** ** |   | ** ** | ** ** |   |
| **Current assets**                                   | ** ** | ** **          | ** ** | ** **                  | ** ** |                              | ** ** | ** **       |       | ** **       | ** ** |   | ** ** | ** ** |   |
| Cash and cash equivalents                            |       | $                   | 15,905     |                        | $          | (19,520                           | )          |             | $          | 4,908            | ** ** |   | $ | — |   |   | $ | 1,293 | ** ** |   |
| Accounts receivable, net                             |       | 5                   |       | 401,958                     |       |                              | 30,715     | ** **       |       | —           |       |   | 432,678 | ** ** |   |
| Inventories, net                                     |       | —              |       | 282,109                     |       |                              | 49,109     | ** **       |       | (12              | )          |   | 331,206 | ** ** |   |
| Prepaid expenses and other current assets       |       | 10,525              |       | 123,684                     |       |                              | 9,962      | ** **       |       | (8,558           | )          |   | 135,613 | ** ** |   |
| Intercompany receivables                             |       | 1,976,809           |       | —                      |       |                              | 24,115     | ** **       |       | (2,000,924       | )          |   | — | ** ** |   |
| **Total current assets**                             |       | 2,003,244           |       | 788,231                     |       |                              | 118,809    | ** **       |       | (2,009,494       | )          |   | 900,790 | ** ** |   |
| Property, plant and equipment, net                   |       | 13,937              |       | 198,656                     |       |                              | 7,913      | ** **       |       | —           |       |   | 220,506 | ** ** |   |
| Acquired  intangibles, net                           |       | —              |       | 231,139                     |       |                              | —     | ** **       |       | —           |       |   | 231,139 | ** ** |   |
| Goodwill                                             |       | 24,115              |       | 2,547,436                   |       |                              | 36,517     | ** **       |       | —           |       |   | 2,608,068 | ** ** |   |
| Deferred income  taxes and other noncurrent assets   |       | 54,234              |       | 7,443                       |       |                              | 10,420     | ** **       |       | (13,481          | )          |   | 58,616 | ** ** |   |
| Investment in  subsidiaries                          |       | 1,140,066           |       | 46,635                      |       |                              | —     | ** **       |       | (1,186,701       | )          |   | — | ** ** |   |
| **Total assets**                                     |       | $                   | 3,235,596  |                        | $          | 3,819,540                         |       |             | $          | 173,659          | ** ** |   | $ | (3,209,676 | ) |   | $ | 4,019,119 | ** ** |   |
| **Liabilities and Stockholders’  Equity**       | ** ** | ** **          | ** ** | ** **                  | ** ** |                              | ** ** | ** **       |       | ** **       | ** ** |   | ** ** | ** ** |   |
| **Current  liabilities**                             | ** ** | ** **          | ** ** | ** **                  | ** ** |                              | ** ** | ** **       |       | ** **       | ** ** |   | ** ** | ** ** |   |
| Current installments of long-term debt               |       | $                   | 2,750      |                        | $          | 194                               |       |             | $          | 1,678            | ** ** |   | $ | — |   |   | $ | 4,622 | ** ** |   |
| Accounts payable                                     |       | 9,701               |       | 186,530                     |       |                              | 28,442     | ** **       |       | —           |       |   | 224,673 | ** ** |   |
| Accrued expenses and other current liabilities  |       | 53,401              |       | 404,080                     |       |                              | 22,151     | ** **       |       | (8,564           | )          |   | 471,068 | ** ** |   |
| Intercompany payables                                |       | —              |       | 1,670,055                   |       |                              | 22,098     | ** **       |       | (1,692,153       | )          |   | — | ** ** |   |
| Total current liabilities                            |       | 65,852              |       | 2,260,859                   |       |                              | 74,369     | ** **       |       | (1,700,717       | )          |   | 700,363 | ** ** |   |
| Long-term debt, excluding current installments       |       | 1,815,835           |       | 3,432                       |       |                              | 9,504      | ** **       |       | —           |       |   | 1,828,771 | ** ** |   |
| Other liabilities                                    |       | 2,329               |       | 127,026                     |       |                              | 22,532     | ** **       |       | (13,482          | )          |   | 138,405 | ** ** |   |
| **Total liabilities**                                |       | 1,884,016           |       | 2,391,317                   |       |                              | 106,405    | ** **       |       | (1,714,199       | )          |   | 2,667,539 | ** ** |   |
| **Total stockholders’ equity**                  |       | 1,351,580           |       | 1,428,223                   |       |                              | 67,254     | ** **       |       | (1,495,477       | )          |   | 1,351,580 | ** ** |   |
| **Total  liabilities and stockholders’ equity** |       | $                   | 3,235,596  |                        | $          | 3,819,540                         |       |             | $          | 173,659          | ** ** |   | $ | (3,209,676 | ) |   | $ | 4,019,119 | ** ** |   |

 

25

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

**CondensedConsolidating Statements of Earnings**

**Three Months Ended September 30, 2006**

**(inthousands)**

| ** **                                                      | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Revenues**                                                    |       |                | $          | —                      |       |                              |       | $                | 654,138    |             |       |   | $ | 61,175 |   |   |   | $ | (3,775 | ) |   |   | $ | 711,538 |   |   |
| Cost and expenses                                               |       |                | (1,303     | )                           |       |                              | 589,017    |             |       |             | 55,709     |   |   |   | (3,773 | ) |   |   | 639,650 |   |   |
| Operating income                                                |       |                | 1,303      |                        |       |                              | 65,121     |             |       |             | 5,466      |   |   |   | (2 | ) |   |   | 71,888 |   |   |
| Interest income                                                 |       |                | 266        |                        |       |                              | 31         |             |       |             | 25         |   |   |   | — |   |   |   | 322 |   |   |
| Interest and  related expense                                   |       |                | 30,367     |                        |       |                              | 92         |             |       |             | 160        |   |   |   | — |   |   |   | 30,619 |   |   |
| Other income  (expense), net                                    |       |                | 28         |                        |       |                              | (24        | )                |       |             | (61        | ) |   |   | 3 |   |   |   | (54 | ) |   |
| Management fees                                                 |       |                | 730        |                        |       |                              | (685       | )                |       |             | (45        | ) |   |   | — |   |   |   | — |   |   |
| Royalties                                                       |       |                | 623        |                        |       |                              | —     |             |       |             | (623       | ) |   |   | — |   |   |   | — |   |   |
| Intercompany  interest                                          |       |                | 24,931     |                        |       |                              | (24,823    | )                |       |             | (108       | ) |   |   | — |   |   |   | — |   |   |
| Earnings before non-controlling interest and income  taxes |       |                | (2,486     | )                           |       |                              | 39,528     |             |       |             | 4,494      |   |   |   | 1 |   |   |   | 41,537 |   |   |
| Non-controlling  interest                                       |       |                | —     |                        |       |                              | —     |             |       |             | 485        |   |   |   | — |   |   |   | 485 |   |   |
| Earnings before income taxes                                    |       |                | (2,486     | )                           |       |                              | 39,528     |             |       |             | 4,009      |   |   |   | 1 |   |   |   | 41,052 |   |   |
| Income taxes                                                    |       |                | (958       | )                           |       |                              | 15,230     |             |       |             | 1,548      |   |   |   | 1 |   |   |   | 15,821 |   |   |
| Earnings from  subsidiary entities                              |       |                | 26,759     |                        |       |                              | —     |             |       |             | —     |   |   |   | (26,759 | ) |   |   | — |   |   |
| **Net  earnings**                                               |       |                | $          | 25,231                      |       |                              |       | $                | 24,298     |             |       |   | $ | 2,461 |   |   |   | $ | (26,759 | ) |   |   | $ | 25,231 |   |   |

 

26

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

**CondensedConsolidating Statements of EarningsThree Months Ended September 30, 2005(in thousands)**

| ** **                         | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Revenues**                       |       |                | $          | —                      |       |                              |       | $                | 314,654    |             |       |   | $ | 52,482 |   |   |   | $ | (5,206 | ) |   |   | $ | 361,930 |   |   |
| Cost and expenses                  |       |                | 2,218      |                        |       |                              | 278,548    |             |       |             | 47,779     |   |   |   | (5,192 | ) |   |   | 323,353 |   |   |
| Operating income                   |       |                | (2,218     | )                           |       |                              | 36,106     |             |       |             | 4,703      |   |   |   | (14 | ) |   |   | 38,577 |   |   |
| Interest income                    |       |                | 1,970      |                        |       |                              | 19         |             |       |             | 79         |   |   |   | — |   |   |   | 2,068 |   |   |
| Interest and  related expense      |       |                | 12,248     |                        |       |                              | 45         |             |       |             | (3         | ) |   |   | — |   |   |   | 12,290 |   |   |
| Other income  (expense), net       |       |                | 23         |                        |       |                              | 57         |             |       |             | (426       | ) |   |   | 9 |   |   |   | (337 | ) |   |
| Management fees                    |       |                | 533        |                        |       |                              | (492       | )                |       |             | (41        | ) |   |   | — |   |   |   | — |   |   |
| Royalties                          |       |                | 507        |                        |       |                              | —     |             |       |             | (507       | ) |   |   | — |   |   |   | — |   |   |
| Intercompany  interest             |       |                | 7,070      |                        |       |                              | (7,306     | )                |       |             | 236        |   |   |   | — |   |   |   | — |   |   |
| Earnings before non-controlling    |       |                | (4,363     | )                           |       |                              | 28,339     |             |       |             | 4,047      |   |   |   | (5 | ) |   |   | 28,018 |   |   |
| interest and income taxes          |       |                |       |                        |       |                              |       |             |       |             |       |   |   |   |   |   |   |   | — |   |   |
| Non-controlling  interest          |       |                | —     |                        |       |                              | —     |             |       |             | 502        |   |   |   | — |   |   |   | 502 |   |   |
| Earnings before income taxes       |       |                | (4,363     | )                           |       |                              | 28,339     |             |       |             | 3,545      |   |   |   | (5 | ) |   |   | 27,516 |   |   |
| Income taxes                       |       |                | (1,386     | )                           |       |                              | 8,788      |             |       |             | 1,165      |   |   |   | (5 | ) |   |   | 8,562 |   |   |
| Earnings from  subsidiary entities |       |                | 21,931     |                        |       |                              | —     |             |       |             | —     |   |   |   | (21,931 | ) |   |   | — |   |   |
| **Net  earnings**                  |       |                | $          | 18,954                      |       |                              |       | $                | 19,551     |             |       |   | $ | 2,380 |   |   |   | $ | (21,931 | ) |   |   | $ | 18,954 |   |   |

 

27

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

**CondensedConsolidating Statements of EarningsSix Months Ended September 30, 2006(in thousands)**

| ** **                                                 | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Revenues**                                               |       |                | $          | —                      |       |                              | $          | 1,228,644        |       |             | $          | 121,964 |   |   |   | $ | (8,805 | ) |   |   | $ | 1,341,803 |   |   |
| Cost and expenses                                          |       |                | (917       | )                           |       | 1,102,386                         |       |             | 112,276    |             |       |   | (8,815 | ) |   |   | 1,204,930 |   |   |
| Operating income                                           |       |                | 917        |                        |       | 126,258                           |       |             | 9,688      |             |       |   | 10 |   |   |   | 136,873 |   |   |
| Interest income                                            |       |                | 391        |                        |       | 48                                |       |             | 59         |             |       |   | — |   |   |   | 498 |   |   |
| Interest and  related expense                              |       |                | 60,045     |                        |       | 157                               |       |             | 319        |             |       |   | — |   |   |   | 60,521 |   |   |
| Other income  (expense), net                               |       |                | 61         |                        |       | 38                                |       |             | (171       | )                |       |   | — |   |   |   | (72 | ) |   |
| Management fees                                            |       |                | 1,450      |                        |       | (1,369                            | )          |             | (81        | )                |       |   | — |   |   |   | — |   |   |
| Royalties                                                  |       |                | 1,140      |                        |       | —                            |       |             | (1,140     | )                |       |   | — |   |   |   | — |   |   |
| Intercompany  interest                                     |       |                | 49,880     |                        |       | (49,690                           | )          |             | (190       | )                |       |   | — |   |   |   | — |   |   |
| Earnings before non-controlling interest and income  taxes |       |                | (6,206     | )                           |       | 75,128                            |       |             | 7,846      |             |       |   | 10 |   |   |   | 76,778 |   |   |
| Non-controlling  interest                                  |       |                | —     |                        |       | —                            |       |             | 958        |             |       |   | — |   |   |   | 958 |   |   |
| Earnings before income taxes                               |       |                | (6,206     | )                           |       | 75,128                            |       |             | 6,888      |             |       |   | 10 |   |   |   | 75,820 |   |   |
| Income taxes                                               |       |                | (2,410     | )                           |       | 29,064                            |       |             | 2,667      |             |       |   | 10 |   |   |   | 29,331 |   |   |
| Earnings from  subsidiary entities                         |       |                | 50,285     |                        |       | —                            |       |             | —     |             |       |   | (50,285 | ) |   |   | — |   |   |
| **Net  earnings**                                          |       |                | $          | 46,489                      |       |                              | $          | 46,064           |       |             | $          | 4,221 |   |   |   | $ | (50,285 | ) |   |   | $ | 46,489 |   |   |

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

28

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

**CondensedConsolidating Statements of EarningsSix Months Ended September 30, 2005(in thousands)**

| ** **                         | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------|------------|---------------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **Revenues**                       |       |                | $          | —                      |       |                            |       | $                | 602,116    |             |       |   | $ | 108,086 |   |   |   | $ | (9,813 | ) |   |   | $ | 700,389 |   |   |
| Cost and expenses                  |       |                | 2,436      |                        |       |                            | 533,775    |             |       |             | 100,342    |   |   |   | (9,799 | ) |   |   | 626,754 |   |   |
| Operating income                   |       |                | (2,436     | )                           |       |                            | 68,341     |             |       |             | 7,744      |   |   |   | (14 | ) |   |   | 73,635 |   |   |
| Interest income                    |       |                | 3,744      |                        |       |                            | 57         |             |       |             | 144        |   |   |   | — |   |   |   | 3,945 |   |   |
| Interest and  related expense      |       |                | 24,417     |                        |       |                            | 83         |             |       |             | 1          |   |   |   | — |   |   |   | 24,501 |   |   |
| Other income  (expense), net       |       |                | 59         |                        |       |                            | 64         |             |       |             | (444       | ) |   |   | 9 |   |   |   | (312 | ) |   |
| Management fees                    |       |                | 1,053      |                        |       |                            | (972       | )                |       |             | (81        | ) |   |   | — |   |   |   | — |   |   |
| Royalties                          |       |                | 1,030      |                        |       |                            | —     |             |       |             | (1,030     | ) |   |   | — |   |   |   | — |   |   |
| Intercompany  interest             |       |                | 13,324     |                        |       |                            | (13,655    | )                |       |             | 331        |   |   |   | — |   |   |   | — |   |   |
| Earnings before  non-controlling   |       |                |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
|  interest and  income taxes   |       |                | (7,643     | )                           |       |                            | 53,752     |             |       |             | 6,663      |   |   |   | (5 | ) |   |   | 52,767 |   |   |
| Non-controlling  interest          |       |                | —     |                        |       |                            | —     |             |       |             | 1,082      |   |   |   | — |   |   |   | 1,082 |   |   |
| Earnings before income taxes       |       |                | (7,643     | )                           |       |                            | 53,752     |             |       |             | 5,581      |   |   |   | (5 | ) |   |   | 51,685 |   |   |
| Income taxes                       |       |                | (2,764     | )                           |       |                            | 19,462     |             |       |             | 2,020      |   |   |   | (5 | ) |   |   | 18,713 |   |   |
| Earnings from  subsidiary entities |       |                | 37,851     |                        |       |                            | —     |             |       |             | —     |   |   |   | (37,851 | ) |   |   | — |   |   |
| **Net  earnings**                  |       |                | $          | 32,972                      |       |                            |       | $                | 34,290     |             |       |   | $ | 3,561 |   |   |   | $ | (37,851 | ) |   |   | $ | 32,972 |   |   |

 

 

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

**CondensedConsolidating Statements of Cash FlowsSix Months Ended September 30, 2006(in thousands)**

| ** **                                                         | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Net  cash provided by operating activities**                     |       | $                   | 12,042     |                        |       | $                                 | 18,068     |             |       |             | $          | 2,219 |   |   |   |   |   |   |   | $ | 32,329 |   |   |
| **Cash Flows from Investing  Activities**                          | ** ** | ** **          | ** ** |                        |       |                              |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Capital expenditures                                               |       | (2,623              | )          |                        | (23,459    | )                                 |       |             | (1,136     | )                |       |   | — |   |   |   | (27,218 | ) |   |
| Payments pursuant to business combinations, net of  cash  acquired |       | (7,705              | )          |                        | (1,550     | )                                 |       |             | —     |             |       |   | — |   |   |   | (9,255 | ) |   |
| Dispositions of property, plant & equipment               |       | —              |       |                        | 335        |                              |       |             | —     |             |       |   | — |   |   |   | 335 |   |   |
| Other                                                              |       | 60                  |       |                        | —     |                              |       |             | —     |             |       |   | — |   |   |   | 60 |   |   |
| **Net cash used in investing  activities**                         |       | (10,268             | )          |                        | (24,674    | )                                 |       |             | (1,136     | )                |       |   | — |   |   |   | (36,078 | ) |   |
| **Cash  Flows from Financing Activities**                          | ** ** | ** **          | ** ** |                        |       |                              |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Borrowings of long-term debt                                       |       | 40,000              |       |                        | —     |                              |       |             | 467        |             |       |   | — |   |   |   | 40,467 |   |   |
| Repayments of long-term debt                                       |       | (1,375              | )          |                        | (115       | )                                 |       |             | (683       | )                |       |   | — |   |   |   | (2,173 | ) |   |
| Proceeds from exercise of stock options                            |       | 1,305               |       |                        | (1         | )                                 |       |             | —     |             |       |   | — |   |   |   | 1,304 |   |   |
| Tax benefit realized from share options exercised                  |       | 97                  |       |                        | —     |                              |       |             | —     |             |       |   | — |   |   |   | 97 |   |   |
| Dividends paid                                                     |       | (2,397              | )          |                        | (8         | )                                 |       |             | —     |             |       |   | — |   |   |   | (2,405 | ) |   |
| Other                                                              |       | —              |       |                        | 245        |                              |       |             | —     |             |       |   | — |   |   |   | 245 |   |   |
| Parent company                                                     |       | (16,101             | )          |                        | 11,617     |                              |       |             | 4,484      |             |       |   | — |   |   |   | — |   |   |
| **Net cash used in financing activities**                          |       | 21,529              |       |                        | 11,738     |                              |       |             | 4,268      |             |       |   | — |   |   |   | 37,535 |   |   |
| **Effects  of exchange rates on cash and cash equivalents**        |       | —              |       |                        | (98        | )                                 |       |             | (119       | )                |       |   | — |   |   |   | (217 | ) |   |
| **Net increase  in cash and cash equivalents**                     |       | 23,303              |       |                        | 5,034      |                              |       |             | 5,232      |             |       |   | — |   |   |   | 33,569 |   |   |
| **Cash  and cash equivalents, beginning of period**           |       | 15,905              |       |                        | (19,520    | )                                 |       |             | 4,908      |             |       |   | — |   |   |   | 1,293 |   |   |
| **Cash and cash equivalents, end  of period**                      |       | $                   | 39,208     |                        |       | $                                 | (14,486    | )                |       |             | $          | 10,140 |   |   |   | $ | — |   |   |   | $ | 34,862 |   |   |
|                                                                    |            |                     |            |                             |            |                                   |            |                  |            |                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

**CondensedConsolidating Statements of Cash FlowsSix Months Ended September 30, 2005(in thousands)**

| ** **                                                         | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Net  cash (used in) provided by operating activities**           |       | $                   | 14,269     |                        |       | $                                 | 4,182      |             |       |             | $          | 16,538 |   |   |   | $ | — | ** ** |   |   | $ | 34,989 |   |   |
| **Cash Flows from Investing Activities**                           | ** ** | ** **          | ** ** |                        | ** ** | ** **                        |       |             | ** ** | ** **       |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Capital expenditures                                               |       | (2,271              | )          |                        | (12,773    | )                                 |       |             | (1,210     | )                |       |   | — | ** ** |   |   | (16,254 | ) |   |
| Payments pursuant to business combinations, net of  cash  acquired |       | (52,549             | )          |                        | —     |                              |       |             | —     |             |       |   | — | ** ** |   |   | (52,549 | ) |   |
| Dispositions of property, plant & equipment               |       | —              |       |                        | —     |                              |       |             | 909        |             |       |   | — | ** ** |   |   | 909 |   |   |
| Other                                                              |       | (308                | )          |                        | 494        |                              |       |             | (255       | )                |       |   | — | ** ** |   |   | (69 | ) |   |
| **Net cash used in investing  activities**                         |       | (55,128             | )          |                        | (12,279    | )                                 |       |             | (556       | )                |       |   | — | ** ** |   |   | (67,963 | ) |   |
| **Cash Flows from Financing Activities**                           | ** ** | ** **          | ** ** |                        | ** ** | ** **                        |       |             | ** ** | ** **       |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Return of advanced interest on senior subordinated  notes     |       | (1,986              | )          |                        | —     |                              |       |             | —     |             |       |   | — | ** ** |   |   | (1,986 | ) |   |
| Debt issuance costs                                                |       | (191                | )          |                        | —     |                              |       |             | —     |             |       |   | — | ** ** |   |   | (191 | ) |   |
| Repayments of long-term debt                                       |       | (21,181             | )          |                        | (174       | )                                 |       |             | —     |             |       |   | — | ** ** |   |   | (21,355 | ) |   |
| Proceeds from exercise of stock options                            |       | 7,737               |       |                        | —     |                              |       |             | —     |             |       |   | — | ** ** |   |   | 7,737 |   |   |
| Dividends paid                                                     |       | (1,664              | )          |                        | —     |                              |       |             | —     |             |       |   | — | ** ** |   |   | (1,664 | ) |   |
| Parent company                                                     |       | (8,113              | )          |                        | 15,701     |                              |       |             | (7,588     | )                |       |   | — | ** ** |   |   | — |   |   |
| **Net cash provided by (used in) financing activities**            |       | (25,398             | )          |                        | 15,527     |                              |       |             | (7,588     | )                |       |   | — | ** ** |   |   | (17,459 | ) |   |
| **Effects  of exchange rates on cash and cash equivalents**        |       | —              |       |                        | —     |                              |       |             | 835        |             |       |   | — | ** ** |   |   | 835 |   |   |
| **Net (decrease) increase in cash and cash equivalents**           |       | (66,257             | )          |                        | 7,430      |                              |       |             | 9,229      |             |       |   | — | ** ** |   |   | (49,598 | ) |   |
| **Cash  and cash equivalents, beginning of period**           |       | 300,788             |       |                        | (8,272     | )                                 |       |             | 14,336     |             |       |   | — | ** ** |   |   | 306,852 |   |   |
| **Cash and cash equivalents, end  of period**                      |       | $                   | 234,531    |                        |       | $                                 | (842       | )                |       |             | $          | 23,565 |   |   |   | $ | — | ** ** |   |   | $ | 257,254 |   |   |

 

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

**17. Recently IssuedAccounting Pronouncements**

In February 2006, the FASB issued SFAS No. 155,“Accounting for Certain Hybrid Financial Instruments—an amendment of FASBStatements No. 133 and 140” (SFAS No. 155). SFAS No. 155 permitsa fair value remeasurement for any hybrid financial instrument that contains anembedded derivative that would otherwise require bifurcation. This accountingstandard will be effective for the Company beginning April 1, 2007. SFAS No. 155is not expected to have an impact on the Company’s financial position, resultsof operations or cash flows.

In July of 2006, the FASB issued FASBInterpretation (FIN) No. 48, “Accounting for Uncertainty in Income Taxes—aninterpretation of FASB Statement No. 109.” FIN 48 prescribes a comprehensivemodel for how a company should recognize, measure, present, and disclose in itsfinancial statements uncertain tax positions that the company has taken orexpects to take on a tax return. FIN 48 states that a tax benefit from anuncertain position may be recognized only if it is “more likely than not” thatthe position is sustainable, based on its technical merits. The tax benefit ofa qualifying position is the largest amount of tax benefit that is greater than50 percent likely of being realized upon ultimate settlement with a taxingauthority having full knowledge of all relevant information. The Companycurrently recognizes a tax position if it is probable of being sustained. FIN48 is effective beginning April 1, 2007 for DRS. The Company is currentlyevaluating the impact that adopting FIN 48 will have on its operations andfinancial condition.

In September of 2006, the FASB issued SFAS No. 157,“Fair Value Measurement.”  SFAS No. 157defines fair value, establishes a framework for measuring fair value ingenerally accepted accounting principles (GAAP), and expands disclosures aboutfair value measurements. This Statement applies under other accountingpronouncements that require or permit fair value measurements, the Board havingpreviously concluded in those accounting pronouncements that fair value is therelevant measurement attribute. Accordingly, this Statement does not requireany new fair value measurements. However, for some entities, the application ofthis Statement will change current practice. This statement is effectivebeginning April 1, 2007 for DRS. The Company is currently evaluating theimpact that adopting SFAS No. 157 will have on its results of operationsand financial condition.

In September of 2006, the FASB issued SFAS No. 158,“Employers Accounting for Defined Benefit Pension and Other PostretirementPlans.”  SFAS No. 158 requiresrecognition of the over or underfunded status of postretirement plans, measuredas the difference between the fair value of the plan assets and the benefitobligation. For pension plans, the benefit obligation is the projected benefitobligation and, for other postretirement plans, the benefit obligation is theaccumulated postretirement obligation. Upon adoption, SFAS No. 158requires the recognition of previously unrecognized actuarial gains and lossesand prior service costs within accumulated other comprehensive income, net oftax (a component of stockholders’ equity). The requirement to recognize thefunded status of a benefit plan and the disclosure requirements are effectivefor the Company’s fiscal year ending March 31, 2007. The requirement tomeasure plan assets and benefit obligations as of the employer’s fiscalyear-end is effective for DRS’s fiscal year ending March 31, 2009. Based on our unfunded obligations as ofMarch 31, 2006, had the adoption of SFAS 158 been effective on that date, theresult would have been to increase the Company’s total liabilities byapproximately $36.9 million, increase deferred tax assets by $14.5 millionand to reduce total stockholders’ equity by approximately $22.4 million. Theadoption of SFAS No. 158 is not expected to have an impact on theCompany’s debt covenants.

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the Consolidated Financial Statements (Continued) (Unaudited)**

In September 2006, the Securities and ExchangeCommission issued Staff Accounting Bulletin No. 108 (“SAB 108”),which provides guidance on the consideration of the effects of prior periodmisstatements in quantifying current year misstatements for the purpose of amateriality assessment. SAB 108 provides for the quantification of theimpact of correcting all misstatements, including both the carryover andreversing effects of prior year misstatements, on the current year financialstatements. If a misstatement is material to the current year financialstatements, the prior year financial statements should also be corrected, eventhough such revision was, and continues to be, immaterial to the prior yearfinancial statements. Correcting prior year financial statements for immaterialerrors would not require previously filed reports to be amended. Suchcorrection should be made in the current period filings. The Company will applythe provision of SAB 108 in the fourth quarter of its fiscal year endingMarch 31, 2007 and is currently evaluating the impact of such adoption.

**18. SubsequentEvent**

On October 2, 2006, the Company implemented a neworganizational operating structure, that realigned its three operating groups(C4I Group, SR Group and S3 Group) into four operating segments. The fouroperating segments are the Command, Control, Communications, Computers andIntelligence Segment, the Reconnaissance, Surveillance and Target AcquisitionSegment, the Sustainment Systems Segment and the Technical Services Segment.

During the three months ended September 30, 2006,the Company recorded a $3.7 million severance-related charge in anticipation ofwith the organizational realignment.

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**Item 2.   Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

We begin the Management’sDiscussion and Analysis of Financial Condition and Results of Operations(MD&A) of DRS Technologies, Inc. and subsidiaries, and a partnershipof which DRS owns an 80% controlling interest (hereinafter, we, us, our, theCompany or DRS) with a discussion of acquisition activity and a companyoverview, followed by summaries of defense industry considerations and otherbusiness considerations to provide context for understanding our business. Thisis followed by a discussion of the critical accounting estimates that webelieve are important to understanding the assumptions and judgmentsincorporated in our reported financial results, which we discuss under “Resultsof Operations.” We then provide an analysis of cash flows and discuss ourfinancial commitments under “Liquidity and Capital Resources” and “ContractualObligations,” respectively. This MD&A should be read in conjunction withthe consolidated financial statements and related notes contained herein and inour March 31, 2006 Annual Report on Form 10-K.

**Forward-Looking Statements**

The following discussionand analysis contains forward-looking statements, within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended, that are based on management’sbeliefs and assumptions, current expectations, estimates and projections. Suchstatements, including statements relating to the Company’s expectations forfuture financial performance, are not considered historical facts and areconsidered forward-looking statements under the federal securities laws. Thesestatements may contain words such as “believes,” “anticipates,” “plans,” “expects,”“intends,” “estimates” or similar expressions. These statements are notguarantees of our future performance and are subject to risks, uncertaintiesand other important factors that could cause our actual performance orachievements to differ materially from those expressed or implied by theseforward-looking statements and include, without limitation: the effect of ouracquisition strategy on future operating results, including our ability toeffectively integrate acquired companies into our existing operations; theuncertainty of acceptance of new products and successful bidding for newcontracts; the effect of technological changes or obsolescence relating to ourproducts and services; and the effects of government regulation or shifts ingovernment priorities (including changes in priorities in response to the waron terrorism and to homeland security), as they may relate to our products andservices; and other risks or uncertainties detailed in the Company’s Securitiesand Exchange Commission filings. Given these uncertainties, you should not relyon forward-looking statements. The Company undertakes no obligations to updateany forward-looking statements, whether as a result of new information, futureevents or otherwise.

**Business Combinations**

On January 31, 2006we completed our acquisition of Engineered Support Systems, Inc. (ESSI)for $1.93 billion in cash and DRS common stock. In the transaction, awholly-owned subsidiary of DRS was merged with ESSI, forming our thirdoperating segment—the Sustainment Systems & Services (S3) Group. ESSI,formerly headquartered in St. Louis, Missouri, is a supplier of integratedmilitary electronics, support equipment and technical services focused onadvanced sustainment and logistics support solutions for all branches of theU.S. armed services, major prime defense contractors, certain internationalmilitaries, homeland security forces and selected government and intelligenceagencies. ESSI also produces specialized equipment and systems for commercialand industrial applications. The addition of ESSI has contributed a significantbase of systems, products and services focused on military force sustainment,technical and logistics support, integrated military electronics and fieldsupport equipment.

On June 27, 2005, weacquired WalkAbout Computer Systems, Inc. (WalkAbout) in a stock purchasetransaction for approximately $13.8 million in cash, with additionalconsideration payable of up to $5.0 million upon achievement of certainrevenue targets for a period of two and a half years. WalkAbout, 

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formerlylocated in West Palm Beach, Florida, is a manufacturer of several lines ofrugged, mobile tablet PCs, serving industrial, municipal, military andgovernment markets. We believe that the acquisition of WalkAbout has enhancedour position in the tactical computer systems business by broadening ourproduct offerings. WalkAbout is being managed as part of our Command, Control,Communications, Computers and Intelligence (C4I) Group.

On April 15, 2005, weacquired Codem Systems, Inc. (Codem) in a stock purchase transaction forapproximately $31.6 million in cash, with additional consideration payable ofup to $5.0 million upon achievement of certain annual bookings targets for aperiod of three years. Codem, located in Merrimack, New Hampshire, is aprovider of signals intelligence (SIGINT) systems, network interface modulesand high-performance antenna control systems. Management believes that theaddition of Codem has enhanced our existing intelligence product base. Codem isbeing managed as part of our C4I Group.

**Company Overview**

DRS is a supplier ofdefense electronic products, systems and military support services. We providehigh technology products, services and support to all branches of the U.S.military, major aerospace and defense prime contractors, governmentintelligence agencies, international military forces and industrial markets.

At September 30, 2006we operated in three principal operating segments, on the basis of products andservices offered. Each operating segment is comprised of separate and distinctbusinesses. Our operating segments are: the Command, Control, Communications,Computers and Intelligence (C4I) Group, the Surveillance and Reconnaissance(SR) Group, and the Sustainment Systems & Services Group (S3). Allother operations, primarily our Corporate Headquarters, are grouped in Other.

As more fully described inNote 18 to our unaudited Consolidated Financial Statements, onOctober 2, 2006, we implemented a new organizational structure, whichrealigned our three operating segments into four operating segments.Information contained throughout this MD&A is presented in the operatingstructure that was in effect on September 30, 2006. The new organization,implemented to meet current and future defense challenges and homeland securitygrowth opportunities, consists of the Command, Control, Communications,Computers and Intelligence Segment, the Reconnaissance, Surveillance &Target Acquisition (RSTA) Segment, the Sustainment Systems Segment and theTechnical Services Segment.

The C4I Group is comprisedof the following business areas: Command, Control and Communications (C3),which includes naval display systems, ship communications systems, radar systems,technical support, electronic manufacturing and system integration services andsecure voice and data communications; Power Systems, which includes naval andindustrial power generation, conversion, propulsion, distribution and controlsystems; Intelligence Technologies, which includes signals intelligence,communications intelligence, data collection, processing and disseminationequipment; and Tactical Systems, which includes battle management tacticalcomputer systems and peripherals product lines.

The SR Group is comprisedof the following business areas: Reconnaissance, Surveillance & TargetAcquisition (RSTA), which develops and produces electro-optical sighting,targeting and weapon sensor systems, aircraft weapons alignment systems and imageintensification (I2) night vision, combat identification and laseraimers/illuminator products, and provides electronic manufacturing services;Training & Control Systems, which develops and produces air combattraining, electronic warfare and network systems, high-speed digital data andimaging systems, unmanned vehicles and mission and flight recorders; and Test &Energy Management, which develops and produces electronic test, diagnostics andvehicle electronics.

The S3 Group is comprisedof the following business areas: Sustainment Systems, which designs, engineersand manufactures integrated military electronics and other military supportequipment, 

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primarilyfor the U.S. Department of Defense (DoD) as well as related heat transfer andair handling equipment and power generation and distribution equipment fordomestic commercial and industrial users; and Support Services, which providesengineering services, logistics and training services, advanced technologyservices, asset protection systems and services, telecommunication systemsintegration and information technology services, and vehicle armor kits formilitary, humanitarian, disaster recovery and emergency responder applications.

On April 1, 2006, DRSTechnical Services, Inc. (TSI), an operating unit of the C4I Group, wasconsolidated into an operating unit of the S3 Group to achieve certainoperating synergies. For the three- and six-month periods ended September 30,2005 the operating unit recorded $5.1 million and $10.4 million in revenues,respectively, and $0.1 million and $0.4 million in operating income,respectively, and had $10.7 million of assets at September 30, 2005,which was considered immaterial for purposes of restating prior year goodwillbalances and segment information for both the C4I Group and the S3 Group.

**Defense Industry Considerations and Business Strategy**

The substantial majorityof our revenue is generated pursuant to written contractual arrangements todesign, develop, manufacture and/or modify complex products and to provide relatedengineering, technical and other services according to the specifications ofthe buyers (customers). Our primary “end-use” customer is the DoD. Our othercustomers include certain U.S. government intelligence agencies, foreigngovernments, commercial customers and other U.S. federal, state and localgovernment agencies.

We believe markets fordefense and related advanced technology systems and services for fiscal 2007and beyond will continue to be affected by the global war on terrorism, throughthe continued need for military missions and efforts in Iraq and Afghanistan.The war on terrorism has focused greater attention on homeland security andbetter communication and interplay among local, state and federal governmentagencies and U.S. military services. We believe the United States’ overalldefense posture continues to move toward a more joint-capabilities-basedstructure, which creates the ability for a more flexible response with greaterforce mobility, stronger space capabilities, enhanced missile defense, andimproved information systems capability and security.

We believe DoD budgetscontinue to experience increased focus on command, control, communications,computers, intelligence, surveillance and reconnaissance (C4ISR), precisionguided weapons, unmanned aerial vehicles (UAVs), network-centriccommunications, Special Operations Forces (SOF) and missile defense. Inaddition, we believe the DoD philosophy has focused on a transformationstrategy that balances modernization and recapitalization (or upgradingexisting platforms), while enhancing readiness and joint operations. As aresult, we believe defense budget program allocations continue to favoradvanced information technologies related to command, control, communications,and computers, (C4) and Intelligence, Surveillance and Reconnaissance (ISR).Furthermore, the DoD’s emphasis on system interoperability, force multipliersand providing battlefield commanders with real-time data is increasing theelectronic content of nearly all major military procurement and researchprograms.

Our strategy is designedto capitalize on the breadth of our technology and extensive expertise in orderto meet the evolving needs of our customers. We intend to expand our share ofexisting programs and participate in new programs by leveraging the strongrelationships that we have developed with the DoD, several other U.S.government agencies and all of the major U.S. defense prime contractors. Weplan to continue to align our research and development, manufacturing and newbusiness efforts to complement our customers’ requirements and to providestate-of-the-art products and services. We plan to maintain a diversified andbroad business mix with limited reliance on any single program. We also intendto expand our technical services and support offerings to the DoD, thusdiversifying our business beyond the historical investment accounts and intoOperations and Maintenance funded activities.

A significant component ofour strategy has been to enhance our existing product base through selectiveacquisitions that add new products and technologies in areas that complementour present 

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businessbase. We intend to continue acquiring select publicly and privately heldcompanies, as well as defense businesses of larger companies that (i) exhibitsignificant market position(s) in their business areas, (ii) offerproducts that complement and/or expand our product offerings, and (iii) displaygrowing revenues and positive operating income and cash flow prospects.

**Other Business Considerations**

As a governmentcontractor, we are subject to U.S. government oversight. The government may askabout and investigate our business practices and audit our compliance withapplicable rules and regulations. Depending on the results of those auditsand investigations, the government could make claims against us. Undergovernment procurement regulations and practices, an indictment of a governmentcontractor could result in that contractor being fined and/or suspended frombeing able to bid on, or be awarded, new government contracts for a period oftime. A conviction could result in debarment for a specific period of time.Similar government oversight exists in most other countries where we conductbusiness.

We are party to variouslegal actions and claims arising in the ordinary course of our business. Webelieve we have adequate legal defenses for each of the actions and claims, andwe believe that their ultimate disposition will not have a material adverseeffect on our consolidated financial position, results of operations orliquidity (see Part II. Other Information, Item 1. Legal Proceedings).

Our sales to internationalcustomers involve additional risks, such as exposure to currency fluctuationsand changes in foreign economic and political environments. Internationaltransactions frequently involve increased financial and legal risks arisingfrom stringent contractual terms and conditions, and widely differing legalsystems, customs and practices in foreign countries. We expect that internationalsales, as a percentage of our overall sales, may increase in future years as aresult of, among other factors, our growth strategy and continuing changes inthe defense industry.

Our future operatingresults depend on our ability to successfully compete in a highly competitiveindustry that is characterized by rapid technological change and to find andeffectively integrate acquired companies into our existing operations.Continuation of our recent revenue growth rate depends primarily on our abilityto identify and acquire suitable acquisition targets. We continue toparticipate successfully in the defense industry consolidation throughstrategic business acquisitions and by streamlining our existing operations;however, we cannot guarantee that we will have sufficient funds available to usto continue investing in business acquisitions.

**Critical Accounting Policies**

Our consolidated financialstatements and accompanying notes are prepared in accordance with accountingprinciples generally accepted in the United States of America. Preparingconsolidated financial statements requires us to make estimates and assumptionsthat affect the reported amounts of assets, liabilities, revenues and expenses,and disclosures of contingent assets and liabilities. These estimates andassumptions are affected by the application of our accounting policies. Oursignificant accounting policies are described in Note 1 to the ConsolidatedFinancial Statements included in our March 31, 2006 Annual Report on Form 10-K.Except for the change in our accounting for share-based payments describedbelow, there were no significant changes in the Company’s critical accountingpolicies during the six months ended September 30, 2006. Criticalaccounting policies are those that require application of management’s mostdifficult, subjective or complex judgments, often as a result of the need tomake estimates about the effects of matters that are inherently uncertain andmay change in subsequent periods. Critical accounting policies for us includerevenue recognition on contracts and contract estimates, valuation of goodwilland acquired intangible assets, pension plan and postretirement benefit planobligations, accounting for income taxes, share-based payments and othermanagement estimates.

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*Share-Based Compensation**—As*of April 1,2006 we adopted the provisions of Statement of Financial Accounting Standards No. 123(revised 2004), “Share-Based Payment” (SFAS 123R), as interpreted by SEC StaffAccounting Bulletin No. 107, which requires that the cost resulting fromall share-based payment transactions be recognized in the financial statementsat their fair values. We adopted SFAS 123R using the modified prospectiveapplication method under which the provisions of SFAS 123R apply to new awardsand to awards modified, repurchased, or cancelled after the adoption date.Under the fair value recognition provisions of this statement, share-basedcompensation cost is measured at the grant date based on the value of the awardand is recognized as expense over the vesting period. Determining the fairvalue of share-based awards at the grant date requires judgment, includingestimating our stock price volatility and employee stock option exercisebehaviors. Our expected volatility is based upon the historical volatility ofour stock. The expected life of share-based awards is based on observedhistorical exercise patterns for different groups of employees and directors.As share-based compensation expense recognized in the consolidated statement ofearnings is based on awards ultimately expected to vest, the amount of expensehas been reduced for estimated forfeitures. SFAS 123R requires forfeitures tobe estimated at the time of grant and revised, if necessary, in subsequentperiods if actual forfeitures differ from those estimates. Forfeitures are estimatedbased on historical experience.

**Results of Operations**

Ouroperating cycle is long-term and involves various types of production andservice contracts and varying production delivery schedules. Accordingly,operating results of a particular period, or year-to-year comparisons ofrecorded revenues and earnings, may not be indicative of future operatingresults. Members of our senior management team regularly review key performancemetrics and the status of operating initiatives within our business. These keyperformance indicators are primarily revenues, operating income and bookings.We review this information on a monthly basis through extensive operatingsegment reviews which include, among other operating issues, detaileddiscussions related to significant programs, proposed investments in newbusiness opportunities or property, plant, and equipment and integration andcost reduction efforts. The following table presents a summary comparison ofthe key performance metrics, other significant financial metrics andsignificant liquidity metrics monitored by senior management of the Company.

| ** **                              | ** ** | **Three Months Ended  September 30,**  | ** ** | **Percent** | ** ** | **Six Months Ended  September 30,** | ** ** | **Percent** | ** ** |
|-----------------------------------------|------------|-------------------------------------------------------|------------|-------------|------------|----------------------------------------------------|------------|-------------|------------|
| ** **                              | ** ** | **2006**                                              | ** ** | **2005**    | ** ** | **Change**                                         | ** ** | **2006**    | ** ** | **2005** | ** ** | **Change** | ** ** |
| ** **                              | ** ** | **(in thousands, except percentages)** | ** ** |
| **Key performance metrics**             | ** ** | ** **                                            | ** ** | ** **  | ** ** |                                               | ** ** | ** **  |       | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |
| Revenues                                |       | $                                                     | 711,538    |        | $          | 361,930                                            |       |        | 96.6       | % |   | $ | 1,341,803 |   | $ | 700,389 |   |   | 91.6 | % |   |
| Operating income                        |       | $                                                     | 71,888     |        | $          | 38,577                                             |       |        | 86.3       | % |   | $ | 136,873 |   | $ | 73,635 |   |   | 85.9 | % |   |
| Bookings                                |       | $                                                     | 915,241    |        | $          | 597,965                                            |       |        | 53.1       | % |   | $ | 1,697,371 |   | $ | 1,118,469 |   |   | 51.8 | % |   |
| **Other significant financial metrics** | ** ** | ** **                                            | ** ** | ** **  | ** ** |                                               | ** ** | ** **  |       | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |
| Interest and related  expenses          |       | $                                                     | 30,619     |        | $          | 12,290                                             |       |        | 149.1      | % |   | $ | 60,521 |   | $ | 24,501 |   |   | 147.0 | % |   |
| Income taxes                            |       | $                                                     | 15,821     |        | $          | 8,562                                              |       |        | 84.8       | % |   | $ | 29,331 |   | $ | 18,713 |   |   | 56.7 | % |   |
| **Significant liquidity metrics (A)**   | ** ** | ** **                                            | ** ** | ** **  | ** ** |                                               | ** ** | ** **  |       | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |
| Free cash flow                          |       | $                                                     | 44,133     |        | $          | 39,617                                             |       |        | 11.4       | % |   | $ | 5,111 |   | $ | 18,735 |   |   | (72.7 | )% |   |
| EBITDA                                  |       | $                                                     | 90,587     |        | $          | 48,262                                             |       |        | 87.7       | % |   | $ | 174,206 |   | $ | 93,182 |   |   | 87.0 | % |   |

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(A)       SeeLiquidity and Capital Resources and Use of Non-GAAP Financial Measures foradditional discussion and information.

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*Three- and Six-Month Periods Ended September 30,2006, Compared with the Three- and Six-Month Periods Ended September 30,2005*

**Revenuesand operating income****  **Consolidatedrevenues and operating income for the three-month period ended September 30,2006 increased $349.6 million and $33.3 million, respectively, to $711.5million and $71.9 million, respectively, as compared with the corresponding periodin the prior year. The primary driver of increased revenues was our acquisitionof ESSI which contributed incremental (current quarter  over corresponding prior year quarter)revenues of $287.8 million. Also contributing to the increase in revenues wereincreased shipments of ground-based target acquisition and missile controlsubsystems, uncooled thermal weapons sights, chassis modernization kits,thermal imaging systems, and higher engineering and development revenue from anaval infrared search and track program.**Partiallyoffsetting the overall increase in revenues were lower volume from airborneelectro-optical sighting systems products and services, decreased shipments of certainrugged computer systems, and the cancellation of a test range support program.

The growth in operating income in the second quarterof fiscal 2006, as compared with the corresponding prior year period, wasprimarily due to our acquisition of ESSI which contributed incrementaloperating income of $24.9 million, the overall increase in revenues, as well asstrong margins from our power systems business. Partially offsetting theoverall increase in operating income for the three months ended September 30,2006, were lower margins on certain rugged computer systems and $3.7 million ofseverance-related costs in anticipation of the new organizational operatingstructure.

Consolidated revenues and operating income for thesix-month period ended September 30, 2006 increased $641.4 million and$63.2 million, respectively, to $1.34 billion and $136.9 million, respectively,as compared with the corresponding period in the prior year. The primary driverto the overall increase in revenues was our acquisition of ESSI and ourJune 27, 2005 acquisition of WalkAbout which contributed incremental(current year to date over corresponding prior year to date) revenues of $525.5million*.* Also contributing to the increase in revenues were increasedshipments of target acquisition and missile control subsystems, chassismodernization kits, uncooled thermal weapons sights, higher engineering and developmentrevenue from a naval infrared search and track program and higher shipment ofthermal imaging systems.**Partiallyoffsetting the overall increase in revenues were decreased shipments of securevoice systems, airborne electro-optical sighting systems products and services,combat display workstations, certain rugged computer systems, and thecancellation of a test range support program.

The growth in operating income for the six monthsended September 30, 2006, as compared with the corresponding prior yearperiod, was due primarily to the overall increase in revenues from ouracquisition of ESSI which contributed incremental operating income of $49.1million and strong margins from our power systems business. Partiallyoffsetting the overall increase in operating income for the six months ended September 30,2006 were lower margins on certain rugged computer systems and $3.7 million ofseverance-related costs in anticipation of the new organizational operatingstructure.

As described in Note 4 to our unaudited ConsolidatedFinancial Statements, we adopted SFAS 123R effective April 1, 2006 usingthe modified prospective method. As a result of the application of SFAS 123R inthe three-and six-month periods ended September 30, 2006, we recorded totalshare-based costs related to stock options and nonvested stock of $3.4 millionand $6.1 million, respectively, $2.8 million and $5.6 million,respectively, which was charged to operating income. At  September 30, 2006, there was $12.0million of unrecognized compensation costs related to stock options, which isexpected to be recognized over a weighted average remaining period of 2.4years. As of September 30, 2006, total unrecognized compensation costsrelated to non-vested stock awards was $16.1 million which is expected to berecognized over a weighted average remaining period of 2.4 years.

As a result of applying SFAS 123R, our earnings beforeincome taxes for the three-and-six month periods ended September 30, 2006were $2.0 million and $3.8 million lower, respectively, and net earnings 

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during the same periodswere $1.2 million lower and $2.3 million lower, respectively, than if we hadcontinued to account for share-based compensation under Accounting PrinciplesBulletin (APB) No. 25.

Basic earnings per share for the three- and six monthperiods ended September 30, 2006 would have been $0.67 per share and $1.23per share, respectively, and diluted earnings per share would have been $0.65and $1.20, respectively, if we had not adopted SFAS 123R. For the three-andsix-month periods ended September 30, 2006 we reported basic earnings pershare of $0.64 and $1.17, respectively, and diluted earnings per share of $0.62and $1.14, respectively.

**Bookings****  **We define bookings as the value ofcontract awards received from the U.S. government, for which the U.S.government has appropriated funds, plus the value of contract awards and ordersreceived from customers other than the U.S. government. Bookings for thethree-month period ended September 30, 2006 increased $317.3 million,versus the same period in the prior year, to $915.2 million. The primary driverof the increase was our acquisition of ESSI which contributed incrementalbookings of $391.3 million partially offset by lower bookings at theSR Group.

Bookings for the six-month period ended September 30,2006 increased $578.9 million, versus the same period in the prior year, to$1.7 billion. The primary drivers of the increase were our ESSI and WalkAboutacquisitions which contributed combined incremental bookings of $670.2 million partiallyoffset by lower bookings at the SR Group.

**Interestand related expenses****  **Interestand related expenses increased $18.3 million and $36.0 million for the three-and six-month periods ended September 30, 2006, respectively, as comparedwith the same period in the prior year, to $30.6 million and $60.5 million,respectively. The increase in interest and related expenses is primarily theresult of an increase in our average borrowings outstanding for the three- andsix-month periods ended September 30, 2006, as compared with thecorresponding period in the prior year. In connection with our acquisition ofESSI our average borrowings increased due to our January 31, 2006 issuanceof $350 million of 65¤8%senior notes, $250 million issuance of 75¤8% seniorsubordinated notes, $300 million 2% senior convertible notes and the February 8,2006 exercise of an over-allotment option for an additional $45 million 2%senior convertible notes. In addition there was approximately $80.0 millionoutstanding against our revolving line of credit at September 30, 2006(see Liquidity and Capital Resources below). We had no borrowings outstandingunder our revolving credit facility at September 30, 2005.

**Income taxes****  **The provision for income taxes forthe three- and six-month periods ended September 30, 2006, reflected aneffective income tax rate of approximately 38.5% and 38.7%, respectively, ascompared with 31.1% and 36.2%, respectively, in the same periods last year. Oureffective tax rate was lower in the prior periods primarily due to thefavorable resolution of the Internal Revenue Service’s audit of our federalincome tax returns for fiscal years 1999 through 2001. As a result of theoutcome of the audit, we recorded a tax adjustment of approximately $3.0million in the three- and six- month periods ended September 30, 2005. Weanticipate our effective income tax rate for the year ending March 31,2007, will approximate 39.6%.

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**Operating Segments**

Thefollowing table sets forth, by operating segment, revenues, operating incomeand operating margin, and the percentage increase or decrease of those items,as compared with the corresponding prior year:

| ** **              | ** ** | **Three Months Ended  September 30,**           | ** ** | **Three Months  Ended Percent  Changes** | ** ** | **Six Months Ended  September 30,** | ** ** | **Six Months  Ended Percent  Changes** | ** ** |
|-------------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **              | ** ** | **2006**                                                       | ** ** | **2005**                                           | ** ** | **2006 vs. 2005**                        | ** ** | **2006**                                         | ** ** | **2005** | ** ** | **2006 vs. 2005** | ** ** |
| ** **              | ** ** | **(in thousands, except for percentages)** | ** ** |
| **C4I Group**           | ** ** | ** **                                                     | ** ** | ** **                                         | ** ** |                                               | ** ** | ** **                                       |       | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |
| Revenues                |       | $                                                              | 194,958    |                                               | $          | 194,420                                            |       |                                             | 0.3        | % |   | $ | 388,950 |   | $ | 384,910 |   |   | 1.0 | % |   |
| Operating income        |       | $                                                              | 22,551     |                                               | $          | 19,719                                             |       |                                             | 14.4       | % |   | $ | 42,488 |   | $ | 39,207 |   |   | 8.4 | % |   |
| Operating margin        |       | 11.6                                                           | %          | 10.1                                               | %          |                                               | 14.0       | %                                                |       | 10.9 | % | 10.2 | % |   | 7.2 | % |   |
| **SR  Group**           | ** ** | ** **                                                     | ** ** | ** **                                         | ** ** |                                               | ** ** | ** **                                       |       | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |
| Revenues                |       | $                                                              | 225,147    |                                               | $          | 167,510                                            |       |                                             | 34.4       | % |   | $ | 418,105 |   | $ | 315,479 |   |   | 32.5 | % |   |
| Operating income        |       | $                                                              | 22,990     |                                               | $          | 21,077                                             |       |                                             | 9.1        | % |   | $ | 43,739 |   | $ | 36,865 |   |   | 18.6 | % |   |
| Operating margin        |       | 10.2                                                           | %          | 12.6                                               | %          |                                               | (19.0      | )%                                               |       | 10.5 | % | 11.7 | % |   | (10.3 | )% |   |
| **S3  Group**           | ** ** | ** **                                                     | ** ** | ** **                                         | ** ** |                                               | ** ** | ** **                                       |       | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |
| Revenues                |       | $                                                              | 291,433    |                                               | N/A        |                                               |       | N/A                                              |       |   | $ | 534,748 |   | N/A |   |   | N/A |   |   |
| Operating income        |       | $                                                              | 25,045     |                                               | N/A        |                                               |       | N/A                                              |       |   | $ | 49,731 |   | N/A |   |   | N/A |   |   |
| Operating margin        |       | 8.6                                                            | %          | N/A                                                |       |                                               | N/A        |                                             |       | 9.3 | % | N/A |   |   | N/A |   |   |
| **Other**               | ** ** | ** **                                                     | ** ** | ** **                                         | ** ** |                                               | ** ** | ** **                                       |       | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |
| Operating income (loss) |       | $                                                              | 1,302      |                                               | $          | (2,219                                             | )          |                                             | 158.7      | % |   | $ | 915 |   | $ | (2,437 | ) |   | 137.5 | % |   |

 

***Three-Month PeriodEnded September 30, 2006, Compared with the Three-Month Period Ended September 30,2005***

**C4IGroup**   Revenues increased $0.5 million, or 0.3%,to $195.0 million for the three-month period ended September 30, 2006, ascompared with the corresponding prior-year period. Operating income increased$2.8 million, or 14.4%, to $22.6 million. The increase in revenue wasprincipally attributable to higher engineering and development revenue from anaval infrared search and track program, increased engineering for anelectronic throttle control program, increased shipments of reactor monitoringequipment and broadcast receivers and greater power conversion engineeringrevenue. Largely offsetting our increases in revenues were decreased shipmentsof rugged computers, combat display workstations and lower revenues from anaval-based terrorism protection program.

The increase in operating income for the three-monthsended September 30, 2006, as compared to the corresponding period in theprior year, was driven primarily by improved margins on our power systemsbusiness. Partially offsetting our overall higher operating income were lowermargins on certain rugged computer systems under a new contract.

**SRGroup****  **Revenuesincreased $57.6 million, or 34.4%, to $225.1 million for the three-month periodended September 30, 2006, as compared with the corresponding prior-yearperiod. Operating income increased $1.9 million, or 9.1%, to $23.0 million. Theincrease in revenues was primarily attributable to increased shipments ofground-based target acquisition and missile control subsystems, uncooledthermal weapons sights, chassis modernization kits, thermal imaging systems,and subsystems for a long range surveillance system. Partially offsetting theoverall increase in revenues were lower volume from airborne electro-opticalsighting systems products and services, the cancellation of a test rangesupport systems, and lower shipments of formation flying avionics and datarecorders.

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The increase in operating income for the three-monthperiod ended September 30, 2006, as compared with the corresponding periodin the prior year was largely due to higher overall revenues, offset in part by$2.0 million in severance-related costs in anticipation of the neworganizational operating structure.

**S3Group****  **TheS3 Group, which consists substantially of operating units acquired from ouracquisition of ESSI on January 31, 2006, recorded revenues of $291.4million and operating income of $25.0 million. The primary revenue andoperating income drivers in the group were demand for equipment and servicesprovided under the Rapid Response (R2) program, add-on commercial vehicle armorkits, defense communication and transmission systems, heavy equipment transportrefurbishment for the U.S. Army and defense satellite transmission services. Operatingincome for the three months ended September 30, 2006, were unfavorablyimpacted by $1.7 million in severance-related costs in anticipation of the neworganizational structure.

**Other****  **During the three months ended September 30,2006, we realized a $1.3 million gain on the expected collection of a notereceivable that had previously been partially reserved. The $2.2 millionoperating loss in other in the three-month period ended September 30, 2005was driven primarily by a $2.0 million accrual recorded in the period inconnection with a litigation reserve.

***Six-Month Period Ended September 30, 2006,Compared with the Six-Month Period Ended September 30, 2005***

**C4IGroup****  **Revenuesincreased $4.0 million, or 1.0%, to $389.0 million for the six-month periodended September 30, 2006, as compared with the corresponding prior-yearperiod. Operating income increased $3.3 million, or 8.4%, to $42.5 million. Theincrease in revenue was largely attributable to higher engineering anddevelopment revenue from a naval infrared search and track program, increasedshipments on an electronic throttle control program, reactor monitoringequipment, and surface search radar equipment and higher revenues from a cablecleaning and refurbishment program and power conversion engineering revenue.Our June 27, 2005 acquisition of WalkAbout contributed incrementalrevenues of $5.3 million to the six-month period ended September 30, 2006.Partially offsetting the overall increase in revenues were decreased shipmentsof secure voice systems, rugged computers, combat display workstations andsurveillance tuners.

The increase in operating income for the six-monthperiod ended September 30, 2006, as compared to the corresponding periodin the prior year, was driven primarily by improved margins in our PowerSystems businesses, offset, in part, by lower margins on certain ruggedcomputer systems under a new contract.

**SRGroup****  **Revenuesincreased $102.6 million, or 32.5%, to $418.1 million for the six-month periodended September 30, 2006, as compared with the corresponding prior-yearperiod. Operating income increased $6.9 million, or 18.6%, to $43.7 million. Theincrease in revenues was primarily attributable to increased shipments ofground-based target acquisition and missile control subsystems, chassismodernization kits, uncooled thermal weapons sights, thermal imaging systems, andfocal plane arrays. Partially offsetting the overall increase in revenues werelower volume from airborne electro-optical sighting systems products andservices, the cancellation of a test range support program, and lower shipmentsof data recorders and formation flying avionics.

The increase in operating income for the six-monthperiod ended September 30, 2006, as compared with the corresponding periodin the prior year was largely due to higher overall revenues, offset in part by$2.0 million in severance-related costs in anticipation of the neworganizational operating structure.

**S3Group****  **TheS3 Group, recorded revenues of $534.7 million and operating income of $49.7million. The primary revenue and operating income drivers in the group weredemand for equipment and services provided under the Rapid Response (R2)program, add-on commercial vehicle armor kits, heavy equipment transportrefurbishment for the U.S. Army, defense satellite transmission services andmobile 

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power generation and distributionequipment for the U.S. Air Force. Operating income for the six months ended September 30,2006, were unfavorably impacted by $1.7 million in severance-related costs inanticipation of the new organizational structure.

**Other****  **During the six months ended September 30,2006, we realized a $1.3 million gain on the expected collection of a notereceivable that had previously been partially reserved. The $2.4 millionoperating loss in other in the six-month period ended September 30, 2005was driven primarily by a $2.0 million accrual recorded in the period in connectionwith a litigation reserve.

**Liquidity and Capital Resources**

| ** **                                           | ** ** | **Six Months Ended September 30,**                                                               | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **         2006         ** | ** ** | **         2005         ** | ** ** |
| ** **                                           | ** ** | **(in thousands)**                                                                                              | ** ** |
| Net cash provided  by operating activities           |       |                                                                                                                 | $          | 32,329 |   |   |   | $ | 34,989 |   |   |
| Net cash used in  investing activities               |       |                                                                                                                 | $          | (36,078 | ) |   |   | $ | (67,963 | ) |   |
| Net cash provided by  (used in) financing activities |       |                                                                                                                 | $          | 37,535 |   |   |   | $ | (17,459 | ) |   |

 

**Operating****  **During the six months ended September 30,2006, we generated $32.3 million of operating cash flow, $2.7 million less thanthe $35.0 million of operating cash flow generated in the same period in theprior year. Net earnings increased $13.5 million to $46.5 million. Non-cashadjustments to reconcile net earnings to cash flows from operating activitiesincreased $27.6 million over the corresponding prior fiscal period, drivenprimarily by increased depreciation of fixed assets and amortization of theintangible assets related to our acquisition of ESSI, increased share-basedcompensation due to the adoption of SFAS 123R and a decrease in net deferredtax assets.

Changes in assets and liabilities, net of effects frombusiness combinations, used $65.9 million in cash for the six months endedSeptember 30, 2006. Accounts payable used $2.7 million of cash during theperiod. Accounts receivable used $71.8 million of cash as net billings exceededcollections. Inventories used $12.2 million of cash as inventories increased incertain of our electro-optical infrared sighting and targeting businesses,offset, in part, by decreased inventories within certain tactical computingbusinesses. Accrued expenses and other current liabilities used $24.3 millionof cash, primarily driven by income tax payments of $29.0 million.Customer advances increased and net prepaid expenses and other current assetsdecreased generating $23.6 million and $21.5 million in cash, respectively. The $21.5 million in cashgenerated by the decrease in net prepaid expenses and other current assets resultedprimarily from the collection of $30.6 million in ESSI tax refunds.

**Investingactivities****  **Wepaid $27.2 million for capital improvements during the six months endedSeptember 30, 2006, as compared with $16.3 million in the correspondingprior-year period. We expect our capital expenditures to be in the range of$50.0 million to $60.0 million in fiscal 2007, as we continue to upgrade ourfacilities and integrate recent acquisitions into our existing businesses.Payments pursuant to business combinations totaled $9.3 million driven by $7.1million and $1.2 million of additional consideration paid to satisfy earn-outobligations related to our acquisitions of DKD, Inc. (now operating as acomponent of DRS Sensors & Targeting Systems, Inc.) and CodemSystem, Inc. (now operating as DRS Codem Systems, Inc.), respectively,and $1.0 million in ESSI acquisition-related payments.

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**Financingactivities****  **Forthe six months ended September 30, 2006, financing activities generated$37.5 million in cash. Net borrowings on our revolving line of credit were$40.0 million. We also received $1.3 million from the exercise of stock optionsand paid $2.4 million in cash dividends. Simultaneously with the closing of ouracquisition of ESSI, on January 31, 2006 we entered into an amended andrestated credit facility for up to an aggregate amount of $675.0 million with asyndicate of lenders (the Credit Facility), replacing our previously existingcredit facility. The Credit Facility consists of a $400.0 million seniorsecured revolving line of credit and a $275.0 million senior secured term loan.We are permitted, on no more than two occasions, to increase the aggregateamount of the Credit Facility by up to $250.0 million, subject to certainrestrictions. Any increase in the aggregate amount of the Credit Facility maybe borrowed in the form of either additional term loans or available amountsunder the revolving line of credit. The Credit Facility is guaranteed bysubstantially all of DRS’s domestic subsidiaries. In addition, it iscollateralized by liens on substantially all of the assets of our subsidiaryguarantors’ and certain of DRS’s other subsidiaries’ assets and by a pledge ofa portion of certain of our non-guarantor subsidiaries’ capital stock.

From time to time, we enter into standbyletters-of-credit and bank guarantee agreements with financial institutions andcustomers, primarily relating to the guarantee of our future performance oncertain contracts to provide products and services and to secure advancepayments we have received from our customers. As of September 30, 2006,$44.9 million was contingently payable under letters of credit and bankguarantees. Of this amount, approximately $0.9 million and $0.4 million inletters of credit and bank guarantees, respectively, as of September 30,2006, were issued under a previous credit agreement and by a bank agreement forour U.K. subsidiary, respectively, and are not considered when determining theavailability under our revolving line of credit. At September 30, 2006approximately $39.5 million and $0.4 million in letters of credit and bankguarantees, respectively, are due within one year. At September 30, 2006,we had $276.4 million of availability under our revolving line of credit.

On March 29, 2006, DRS Technologies CanadaCompany (DRS Canada) established a five-year senior secured term loan forapproximately $9.9 million (C$11.5 million), maturing on April 1, 2011.The proceeds of the loan were utilized to permit repatriation of certainamounts from Canada to the U.S. which were subject to more favorable taxtreatment under the Jobs Act. The debt is collateralized by the assets of DRSCanada and guaranteed by DRS Technologies, Inc. We are subject to the samefinancial covenants under the DRS Canada loan, as we are under the CreditFacility, and DRS Canada is subject to other non-financial covenants that aresimilar to those described for the Credit Facility.

On October 30, 2003, we issued $350.0 millionaggregate principal amount of 67¤8% senior subordinated notes, due November 1,2013 (the October 2003 Notes). The net proceeds of the October 2003Notes, together with a portion of our available cash and initial borrowingsunder the then existing credit facility, were used to fund the acquisition ofIntegrated Defense Technologies, Inc. (IDT), repay certain of DRS’s andIDT’s outstanding indebtedness, and pay related fees and expenses. The October 2003Notes were issued under an indenture with The Bank of New York. Subject to anumber of exceptions, the indenture restricts our ability and the ability ofour subsidiaries to incur more debt, pay dividends and make distributions, makecertain investments, repurchase stock, create liens, enter into transactionswith affiliates, enter into sale lease-back transactions, merge or consolidate,and transfer or sell assets. The October 2003 Notes are unconditionallyguaranteed, jointly and severally, by DRS’s current and future wholly-owneddomestic subsidiaries. The foreign subsidiaries and certain domesticsubsidiaries of DRS do not guarantee the October 2003 Notes.

On December 23, 2004, we issued an additional$200.0 million aggregate principal amount of 67¤8% seniorsubordinated notes, due November 2013 (December 2004 Notes). The December 2004Notes were offered as additional debt securities under the Company’s indenturewith the Bank of New York with identical terms and the same guarantors as theOctober 2003 Notes.

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On January 31, 2006, in connection with theacquisition of ESSI, we issued $900.0 million of new debt securities,including $350.0 million aggregate principal amount of 65¤8%senior notes due 2016, $250.0 million aggregate principal amount of 75¤8%senior subordinated notes due 2018 (collectively called the January 2006 Notes)and $300.0 million aggregate principal amount of 2.0% convertible seniornotes due 2026 (Convertible Notes). On February 8, 2006, we sold anadditional $45.0 million of Convertible Notes pursuant to an overallotmentoption exercised by the initial purchasers of the Convertible Notes. The netproceeds of the January 2006 Notes and the Convertible Notes, together with aportion of the Company’s available cash and initial borrowings under the CreditFacility, were used to fund the ESSI acquisition, repay certain of ESSI’soutstanding indebtedness, and pay related fees and expenses. 

The January 2006 Notes are unsecured. The 75¤8%senior subordinated notes rank behind the Credit Facility, the 65¤8% senior notes,the Convertible Notes and trade payables and is pari passu with the 67¤8%senior subordinated notes. The January 2006 Notes were issued under indentureswith The Bank of New York. Subject to a number of exceptions, the indenturesrestrict our ability and the ability of our subsidiaries to incur more debt,pay dividends and make distributions, make certain investments, repurchasestock, create liens, enter into transactions with affiliates, enter into salelease-back transactions, merge or consolidate, and transfer or sell assets. TheJanuary 2006 Notes are unconditionally guaranteed, jointly and severally, bycertain of our existing and future domestic subsidiaries.

Accrued interest expense at September 30, 2006and March 31, 2006 was approximately $25.9 million and $27.3 million,respectively.

Based upon our anticipated level of future operations,we believe that our existing cash and cash equivalents balances and our cashgenerated from operating activities, together with available borrowings underour amended and restated senior secured credit facility, will be adequate tomeet our anticipated requirements for working capital, capital expenditures,commitments, research and development expenditures, contingent purchase prices,program and other discretionary investments, and interest and principalpayments for the foreseeable future. There can be no assurance, however, thatour business will continue to generate cash flow at current levels. If we areunable to generate sufficient cash flow from operations to service our debt, wemay be required to sell assets, reduce capital expenditures, refinance all or aportion of our existing debt or obtain additional financing. Our ability to makescheduled principal payments or to pay interest on or to refinance ourindebtedness depends on our future performance and financial results, which, toa certain extent, are subject to general conditions in or affecting the defenseindustry and to general economic, political, financial, competitive,legislative and regulatory factors beyond our control. There can be noassurance that sufficient funds will be available to enable us to service ourindebtedness, make necessary capital expenditures or to make discretionaryinvestments.

**Equity****  **On August 3, 2006, the Board ofDirectors declared a $0.03 per common share cash dividend, which was paid onSeptember 29, 2006 to stockholders of record as of September 15,2006.  On November 2, 2006, theBoard of Directors declared a $0.03 per common share cash dividend, which ispayable on December 29, 2006 to stockholders of record as of December 15,2006.

**FreeCash Flow****  **Freecash flow represents net cash provided by operating activities less capitalexpenditures. Free cash flow for the three-month period ended September 30,2006 was $44.1 million or $4.5 million more than $39.6 million in thecorresponding period in the prior year. Free cash flow for the six-month periodended September 30, 2006 was $5.1 million or $13.6 million less than $18.7million in the corresponding period in the prior year. See ‘‘Use of Non-GAAPFinancial Measures’’ below for additional discussion and information.

**EBITDA****  **Net earnings before net interest andrelated expenses (primarily the amortization of debt issuance costs), incometaxes, depreciation and amortization (EBITDA) for the three- month period endedSeptember 30, 2006 was $90.6 million, or $42.3 million greater than the$48.3 million in the corresponding period in the prior year. EBITDA for thesix- month period ended September 30, 2006 was 

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$174.2 million, or $81.0million greater than the $93.2 million in the corresponding period in the prioryear. See ‘‘Use of Non-GAAP Financial Measures’’ below for additionaldiscussion and information.

**Off-BalanceSheet Financing Arrangements**   We have not enteredinto any off-balance sheet financing arrangements.

**ContractualObligations**   Our contractual obligations andcommitments principally include obligations associated with our outstandingindebtedness, future minimum operating lease obligations, acquisition earn-outsand purchase obligations. The disclosures relating to our contractualobligations in our Annual Report on Form 10-K for the year ended March 31,2006 have not materially changed since we filed that report.

**Backlog****  **Funded backlog represents productsor services that our customers have committed by contract to purchase from us.Due to the general nature of defense procurement and contracting, the operatingcycle for our military business typically has been long term. Military backlogcurrently consists of various production and engineering development contractswith varying delivery schedules and project timetables. Our backlog alsoincludes a significant amount of commercial off-the-shelf (COTS)-based systemsfor the military, which have shorter delivery times. Accordingly, revenues fora particular period, or year-to-year comparisons of reported revenues andrelated backlog positions may not be indicative of future results. Backlog at September 30,2006 was $2.73 billion, as compared with $2.40 billion at March 31, 2006. Webooked $915.2 million and $1.70 billion in new orders for the three- andsix-month periods ended September 30, 2006.

**InternalResearch and Development****  **In addition to customer-sponsored research anddevelopment, we also engage in internal research and development. Theseexpenditures reflect our continued investment in new technology anddiversification of our products. Expenditures for internal research anddevelopment for the three-month periods ended September 30, 2006 and 2005were $14.3 million and $11.5 million, respectively, and $25.3 million and $20.7million for the six-month periods ended September 30, 2006 and 2005,respectively.

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**Use of Non-GAAP FinancialMeasures****  **Certaindisclosures in this document include “non-GAAP (Generally Accepted AccountingPrinciples) financial measures.” A non-GAAP financial measure is defined as anumerical measure of a company’s financial performance that excludes orincludes amounts so as to be different than the most directly comparablemeasure calculated and presented in accordance with GAAP in the ConsolidatedBalance Sheets, Statements of Earnings, or Statements of Cash Flows of theCompany. The components of EBITDA and a reconciliation of EBITDA and “free cashflow” with the most directly comparable GAAP measure follows:

| ** **                                                                                     | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                                     | ** ** | **September 30,**           | ** ** | **September 30,**         | ** ** |
| ** **                                                                                     | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                                     | ** ** | **(in thousands)**          | ** ** |
| Net Earnings                                                                                   |       | $                                | 25,231     |                           | $          | 18,954 |   | $ | 46,489 |   | $ | 32,972 |   |
| Income taxes                                                                                   |       | 15,821                           |       | 8,562                          |       | 29,331 |   | 18,713 |   |
| Interest income                                                                                |       | (322                             | )          | (2,068                         | )          | (498 | ) | (3,945 | ) |
| Interest and  related expenses                                                                 |       | 30,619                           |       | 12,290                         |       | 60,521 |   | 24,501 |   |
| Depreciation and  amortization                                                                 |       | 19,238                           |       | 10,524                         |       | 38,363 |   | 20,941 |   |
| EBITDA(A)                                                                                      |       | 90,587                           |       | 48,262                         |       | 174,206 |   | 93,182 |   |
| Income taxes                                                                                   |       | (15,821                          | )          | (8,562                         | )          | (29,331 | ) | (18,713 | ) |
| Interest income                                                                                |       | 322                              |       | 2,068                          |       | 498 |   | 3,945 |   |
| Interest and  related expenses                                                                 |       | (30,619                          | )          | (12,290                        | )          | (60,521 | ) | (24,501 | ) |
| Deferred income  taxes                                                                         |       | 3,623                            |       | 24                             |       | 4,083 |   | (498 | ) |
| Changes in assets  and liabilities, net of effects from business combinations and divestitures |       | 5,881                            |       | 18,459                         |       | (65,917 | ) | (22,140 | ) |
| Other, net                                                                                     |       | 4,298                            |       | 1,574                          |       | 9,311 |   | 3,714 |   |
| Net cash provided by operating activities                                                      |       | 58,271                           |       | 49,535                         |       | 32,329 |   | 34,989 |   |
| Capital  expenditures                                                                          |       | (14,138                          | )          | (9,918                         | )          | (27,218 | ) | (16,254 | ) |
| Free cash flow(B)                                                                              |       | $                                | 44,133     |                           | $          | 39,617 |   | $ | 5,111 |   | $ | 18,735 |   |

 

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(A)       We define EBITDA as netearnings before net interest and related expenses (principally amortization andwrite-off of debt premium and issuance costs), income taxes, depreciation andamortization. The table above presents the components of EBITDA and areconciliation of EBITDA to net cash provided by operating activities. EBITDAis presented as additional information because we believe it to be a usefulindicator of our debt capacity and our ability to service our debt. EBITDA isnot a substitute for operating income, net earnings or net cash flows fromoperating activities, as determined in accordance with GAAP. EBITDA is not acomplete net cash flow measure because EBITDA is a measure of liquidity thatdoes not reflect cash flows from discontinued operations, and does not includereductions for cash payments for an entity’s obligation to service its debt,fund its working capital, business acquisitions, and capital expenditures andpay its income taxes. Rather, EBITDA is one potential indicator of an entity’sability to fund these cash requirements. EBITDA also is not a complete measureof an entity’s profitability because it does not include costs and expenses fordepreciation and amortization, interest and related expenses and income taxes,and it also does not include the results of operations of discontinued operations.EBITDA, as we define it, may differ from similarly named measures used by otherentities and, consequently, could be misleading unless all entities calculateand define EBITDA in the same manner.

(B)        Freecash flow is defined as net cash provided by operating activities less capitalexpenditures. We disclose free cash flow because we believe that it is usefulin evaluating our financial performance and measuring cash flows generated thatare available for investing and financing activities. We believe that the mostdirectly comparable GAAP financial measure to free cash flow is net cashprovided by operating activities. Free cash flow represents cash generatedafter paying for interest on borrowings, 

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income taxes,capital expenditures and changes in working capital, but before repayingoutstanding debt, investing cash to acquire businesses and making otherstrategic investments, and it does not reflect cash flows of discontinuedoperations. Thus, key assumptions underlying free cash flow are that we will beable to refinance our existing debt when it matures with new debt and that wewill be able to finance any new acquisitions we make by raising new debt orequity capital. We also use free cash flow as a performance measure as acomponent of our management incentive compensation program. Free cash flow, aswe define it, may differ from similarly named measures used by other entitiesand, consequently, could be misleading unless all entities calculate and definefree cash flow in the same manner.

**Item 3.   Quantitativeand Qualitative Disclosures About Market Risk**

**Market Risk**

See Part II, Item 7A,“Qualitative and Quantitative Disclosures About Market Risk,” of the Company’sAnnual Report on Form 10-K for the fiscal year ended March 31,2006 for a discussion of the Company’s exposure to market risks.

**Item 4.   Controlsand Procedures**

**(a) DisclosureControls and Procedures.****  **The Company’s management, with the participation of theCompany’s Chief Executive Officer and Chief Financial Officer, has evaluatedthe effectiveness of the Company’s disclosure controls and procedures (as suchterm is defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of theend of the period covered by this report. Based on such evaluation, the Company’sChief Executive Officer and Chief Financial Officer have concluded that, as ofthe end of such period, the Company’s disclosure controls and procedures areeffective in recording, processing, summarizing and reporting, on a timelybasis, information required to be disclosed by the Company in the reports thatit files or submits under the Exchange Act.

**(b) Internal ControlOver Financial Reporting.****  **The addition of the business units added through theacquisition of ESSI on January 31, 2006, resulted in a material change ininternal control over financial reporting. The acquired ESSI business unitsutilize separate information and accounting systems and processes. With theexception of the change in internal control over financial reporting as weintegrate the acquired ESSI business units, there have not been any changes inthe Company’s internal control over financial reporting (as such term isdefined in Rules 13a-15(f) and 15d-15(f) under theExchange Act) during the three months ended September 30, 2006 that havematerially affected, or are reasonably likely to materially affect, the Company’sinternal control over financial reporting.

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**PART II. OTHERINFORMATION**

**Item 1.   LegalProceedings**

Various legal actions, claims, assessments and othercontingencies arising in the normal course of our business, including certainmatters described below, are pending against us and certain of oursubsidiaries. These matters are subject to many uncertainties, and it ispossible that some of these matters could be ultimately decided, resolved orsettled adversely. We have recorded accruals totaling $4.4 million and$4.3 million at September 30, 2006 and March 31, 2006, respectively,for losses related to those matters that we consider to be probable and thatcan be reasonably estimated (certain legal and environmental matters arediscussed in detail below). Based on our ongoing analysis of various factual,legal and equitable considerations we have recorded an accrual of $11.8 millionagainst goodwill reflecting the probable income tax impact of informationuncovered in our internal investigation of historical ESSI stock optionpractices. Although the ultimate amount of liability at September 30, 2006that may result from those matters for which we have recorded accruals is notascertainable, we believe that any amounts exceeding our recorded accrualsshould not materially affect our financial condition or liquidity. It ispossible, however, that the ultimate resolution of those matters could resultin a material adverse effect on our results of operations and/or cash flowsfrom operating activities for a particular reporting period.

Some environmental laws, such as the ComprehensiveEnvironmental Response, Compensation and Liability Act of 1980 (also known asCERCLA or the Superfund law) and similar state statutes, can impose liabilityfor the entire cost of the clean up of contaminated sites upon any of thecurrent or former site owners or operators (or upon parties who send waste tothese sites), regardless of the lawfulness of the original activities that ledto the contamination. In July 2000, prior to its acquisition by IDT, andprior to DRS’s acquisition of IDT, Tech-Sym Corporation received a Section 104(e) Requestfor Information from the National Park Service (NPS), pursuant to CERCLA,regarding a site known as the Orphan Mine site in the Grand Canyon NationalPark, Arizona, which is the subject of an NPS investigation regarding the presenceof residual radioactive materials and contamination. A corporation of whichTech-Sym is an alleged successor operated this uranium mine from 1956 to 1967.In 1962, the land was sold to the U.S. government and the alleged predecessorof Tech-Sym was given a 25-year mining lease. In 1967, the mining rightswere transferred to a third party by a trustee in bankruptcy, and we believethat the mine was operated by such third party until approximately 1969. Weunderstand that there are other companies in the chain of title to the miningrights subsequent to Tech-Sym’s alleged predecessor, and, accordingly, thatthere are other potentially responsible parties (PRPs) for the environmentalconditions at the site, including the U.S. government as owner, operator andarranger at the site. During its period of ownership, IDT retained a technicalconsultant in connection with this matter, who conducted a limited, preliminaryreview of site conditions and communicated with the NPS regarding actions thatmay be required at the site by all of the PRPs. On February 6, 2005, theNPS sent us an Engineering Evaluation/Cost Analysis Work Plan (the “NPS EE/CA”)under CERCLA (the ‘‘CERCLA Letter’’) with regards to Operable Unit 1 of theOrphan Mine site. In our view, the NPS EE/CA included additional clean up notcovered by CERCLA. The CERCLA Letter also requested (a) payment of $0.5million for costs incurred by the NPS related to the Orphan Mine, and (b) a‘‘good faith offer’’ to conduct the response activity outlined by the NPS andto reimburse the NPS for future costs. The NPS advised that a similar letterhas been sent to another PRP. We initiated discussions with the other PRP andwith NPS, and engaged a technical consultant to evaluate the existingdocumentation and the site in depth. As a result, on September 29, 2005,the technical consultant submitted to the NPS, on behalf of us and the otherPRP, an alternative Engineering Evaluation/Cost Analysis Work Plan (the “alternativeEE/CA”) with regards to Operating Units 1 and 2 of the Orphan Mine site.

In December 2005 and August 2006, the PRPsand NPS met to discuss the technical merits of the alternative EE/CA and waysto resolve certain differences between the alternative EE/CA and the NPS EE/CAprovided with the CERCLA Letter. Since late 2005, the parties have alsodiscussed certain legal 

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issues relating to theprocess for implementing an alternative EE/CA and entering into a settlementagreement that would memorialize the parties’ intent. The potential liabilityassociated with implementation of the EE/CA can change substantially due tosuch factors as additional information on the nature or extent ofcontamination, methods of remediation that might be recommended or required,changes in the apportionment of costs among the responsible parties and otheractions by governmental agencies or private parties.

In connection with the ESSI acquisition, we have beenmade aware of certain legal actions, claims, assessments and othercontingencies, certain of which are described below.

In December 2004, ESSI was notified by theEnforcement Division of the SEC of the issuance of a formal order directing aprivate investigation captioned *In the Matter ofEngineered Support Systems, Inc.* and was notified that the SEChad issued subpoenas to various individuals associated with ESSI to producecertain documents. The SEC staff also requested that ESSI produce certaindocuments in connection with the investigation. The subpoenas related totrading in ESSI stock around ESSI’s earnings releases in 2003 and to theadequacy of certain disclosures made by ESSI regarding related-partytransactions in 2002 and 2003 involving insurance policies placed by ESSIthrough an insurance brokerage firm in which an ESSI director was a principalat the time of the transactions.

On or about September 23, 2005, the SEC staffadvised ESSI’s counsel that it had issued a subpoena directed to ESSI andexpanded its investigation to include ESSI’s disclosure of a November 2004stop work order relating to ESSI’s Deployable Power Generation and DistributionSystems (“DPGDS”) program for the U.S. Air Force, and relating to trading inESSI stock by certain individuals associated with ESSI.

In connection with the foregoing SEC investigation,ESSI and certain of its directors and officers have provided information and/ortestimony to the SEC. On November 14, 2005, ESSI was informed by theEnforcement Division of the SEC that one of ESSI’s former directors andofficers, and subsequently a consultant to ESSI, had been issued a so-calledWells notice informing him that the staff of the SEC was consideringrecommending that the SEC bring a civil injunctive action against him inconnection with the SEC’s investigation into trading in ESSI common stock in2003. A Wells notice provides prospective defendants with an opportunity torespond to the SEC staff members before the staff makes a formal recommendationon whether the SEC should pursue disciplinary action against them. ESSI,itself, has not received a Wells notice and continues to cooperate with theinvestigation.

In January 2006, ESSI was informed that theOffice of the U.S. Attorney for the Eastern District of Missouri was initiatingan investigation into ESSI’s disclosure of the DPGDS stop-work order and intotrading in ESSI stock by ESSI insiders which preceded such disclosure. The U.S.Attorney’s office advised ESSI that although it considered ESSI to be a subjectof its investigation, ESSI was not a target. In connection with thisinvestigation, the U.S. Attorney’s office issued ESSI a subpoena requestingspecified information, which ESSI continues to furnish.

In May 2006, we were advised that the EnforcementDivision of the SEC and the U.S. Attorney’s office had each expanded itsinvestigation to include possible “backdating” of the timing of option grantsat ESSI prior to the time ESSI was acquired by DRS. As a part of itsinvestigation, the SEC has issued subpoenas to certain officers and employeesof ESSI to provide testimony and produce certain documents. Although ESSI continuesto be a subject of the U.S. Attorney’s office’s investigation, the U.S.Attorney’s office has advised us that ESSI is not a target. Because the eventsbeing investigated occurred prior to the time of our acquisition of ESSI, theU.S. Attorney’s office has further advised us that it considers DRS to be awitness, not a subject or target of its investigation.

We are committed to full cooperation with regard tothe foregoing investigations. We are unable to determine at this time eitherthe timing of the SEC or U.S. Attorney’s office investigations or the impact,if any, which the investigations could have on us.

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In September 2006, ESSI was advised that theInternal Revenue Service was commencing an audit of its Federal tax return forthe fiscal year ended October 31, 2004. In connection therewith, ESSIreceived an information document request (“IDR”) asking for specificinformation relating to stock option deductions provided therein. We arecooperating with this process.

We have recorded an accrual against goodwill toreflect the likely disallowance of certain compensation deductions taken onseveral of ESSI’s previous State and Federal income tax returns. Principally, thisadjustment was made to account for Internal Revenue Code Section 162(m) andits limitations on the deductibility of certain non-performance basedcompensation.

In July 2006, DRS and one of our subsidiaries,DRS Training and Control Systems, Inc. (“TCS”) were each issued a subpoenaby the United States District Court for the Northern District of Florida (“FloridaDistrict Court”).

The subpoenas were issued in connection with aninquiry being conducted by the Antitrust Division of the U.S. Department ofJustice (“DOJ”) and require TCS to produce certain documents related to aninvestigation we believe involves allegations of anticompetitive activity incertain international markets.

In addition, certainemployees and officers of TCS were served with subpoenas to testify before thegrand jury of the Florida District Court with regard to this matter. The DOJ iscontinuing its investigation, but we have no information as to when the DOJwill conclude this process. We have cooperated with the DOJ in producingdocuments in response to the subpoenas. We have commenced an internalinvestigation regarding this matter, which we expect to continue through theconclusion of the DOJ’s investigatory process.

**Item 1.A.**             RiskFactors

In addition to theinformation set forth in this report, you should carefully consider the factorsdiscussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-Kfor the year ended March 31, 2006, which could materially affect ourbusiness, financial condition or future results. The risks described in ourAnnual Report on Form 10-K are not the only risks facing our Company.Additional risks and uncertainties not currently known to us or that wecurrently deem to be immaterial also may materially adversely affect ourbusiness, financial condition and/or operating results.

**Item 4.   Submissionsof Matters to a Vote of Security Holders**

On August 3,2006, the Company held its Annual Meeting of Shareholders at the offices ofBear, Stearns & Co. Inc., 383 Madison Avenue, New York, New York,10179. The following matters were submitted to a vote of stockholders:

i.                   To elect four Class IIdirectors, each to hold office for a term of three years;

ii.               To ratify theappointment of KPMG LLP as DRS’s independent registered public accounting firm;

iii.           Toratify the adoption of the 2006 DRS Omnibus Plan

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Thestockholders approved each proposal. The results of the stockholders votes oneach of the proposals are as follows:

| ** **       | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|------------------|------------|------------|------------|--------------|------------|
| Proposal(i):     |       |       |       |         |       |
| Ira Albom        |       | 35,945,264 |       | 258,360      |       |
| Mark N. Kaplan   |       | 31,025,340 |       | 5,178,284    |       |
| Dennis J. Reimer |       | 35,953,785 |       | 249,839      |       |
| Charles G. Boyd  |       | 36,015,436 |       | 188,186      |       |

 

| ** **    | ** ** | **For**    | ** ** | **Abstain** | ** ** | **Against** | ** ** |
|---------------|------------|------------|------------|-------------|------------|-------------|------------|
| Proposal(ii): |       | 36,096,134 |       | 19,554      |       | 87,936      |       |

 

| ** **     | ** ** | **For**    | ** ** | **Abstain** | ** ** | **Against** | ** ** |
|----------------|------------|------------|------------|-------------|------------|-------------|------------|
| Proposal(iii): |       | 24,555,898 |       | 42,965      |       | 7,631,936   |       |

 

**Items 2, 3 and 5are not applicable and have been omitted**

**Item 6.   Exhibits**

(a)          Exhibits
| Exhibit No. | ** ** | **Description**                                                                                           |
|------------------|------------|-----------------------------------------------------------------------------------------------------------|
| 31.1*            |       | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002  |
| 31.2*            |       | Certification of Chief  Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002 |
| 32.1*            |       | Certification of Chief  Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of  2002 |
| 32.2*            |       | Certification of Chief  Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of  2002 |

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*                    Filed herewith

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|                              | DRS TECHNOLOGIES, INC.    |
|------------------------------|---------------------------|
| Date: November 9,  2006 | /s/ RICHARD A. SCHNEIDER  |
|                         | Richard A. Schneider      |
| * *                     | *Chief Financial Officer* |

 

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