**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

**Forthe quarterly period ended September 30, 2005**

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

**Forthe transition period from                        to                        **

**Commissionfile 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 principalexecutive offices)

**(973) 898-1500**

(Registrant’s telephonenumber, including area code)

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Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities and Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes x  No o

Indicate by check markwhether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes x  No o

Indicateby check mark whether the Registrant is a shell company (as defined in ExchangeAct Rule 12b-2). Yes o  No x

Asof November 4, 2005, 28,021,772 shares of DRS Technologies, Inc.$0.01 par value common stock were outstanding.

 

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**DRS TECHNOLOGIES,INC. AND SUBSIDIARIESIndex to Quarterly Report on Form 10-QFor the Quarter Ended September 30, 2005**
|                                            | ** ** |                                                                                                            | ** ** | **Page** |
|--------------------------------------------|------------|------------------------------------------------------------------------------------------------------------|------------|----------|
| **PART I—FINANCIAL INFORMATION** |       |                                                                                                       |       |     |
| Item 1.                                    |       | Financial Statements (unaudited)                                                                           |       |     |   |   |
|                                       |       | Consolidated  Balance Sheets—September 30, 2005 and March 31, 2005                          |       |     | 1 |   |
|                                       |       | Consolidated  Statements of Earnings—Three and Six Months Ended September 30, 2005 and 2004 |       |     | 2 |   |
|                                       |       | Consolidated  Statements of Cash Flows—Six Months Ended September 30, 2005 and 2004         |       |     | 3 |   |
|                                       |       | Notes to  the Consolidated Financial Statements                                                            |       |     | 4 |   |
| Item  2.                                   |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                |       |     | 29 |   |
| Item  3.                                   |       | Quantitative  and Qualitative Disclosure about Market Risk                                                 |       |     | 42 |   |
| Item  4.                                   |       | Controls  and Procedures                                                                                   |       |     | 42 |   |
| **PART II—OTHER  INFORMATION**   |       |                                                                                                       |       |     |
| Item 1.                                    |       | Legal Proceedings                                                                                          |       |     | 43 |   |
| Item  4                                    |       | Submissions  of Matters to a Vote of Security Holders                                                      |       |     | 44 |   |
| Item 5.                                    |       | Other  Information                                                                                         |       |     | 44 |   |
| Item 6.                                    |       | Exhibits                                                                                                   |       |     | 45 |   |
| Signatures                                 |       |                                                                                                       | 46         |     |

 

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**PART I—FINANCIAL INFORMATION**

**Item 1.**                        FinancialStatements

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

| ** **                                                                                                                                                                       | ** ** | **September 30,** | ** ** | **March 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|--------------------|------------|
| ** **                                                                                                                                                                       | ** ** | **2005**               | ** ** | **2005**           | ** ** |
| **Assets**                                                                                                                                                                       | ** ** |                   | ** ** | ** **         |       | ** ** |   |
| Current assets                                                                                                                                                                   |       |                   | ** ** | ** **         |       |   |   |
| Cash and cash equivalents                                                                                                                                                        |       |                   | $          | 257,254            |       |   | $ | 306,852 |   |
| Accounts receivable, net  of allowance for doubtful accounts of $1,591 and $2,659 as of September 30,  2005 and March 31, 2005, respectively                      |       |                   | 238,474    |               |       | 237,912 |   |
| Inventories, net                                                                                                                                                                 |       |                   | 228,811    |               |       | 208,141 |   |
| Prepaid expenses,  deferred income taxes and other current assets                                                                                                                |       |                   | 50,360     |               |       | 42,134 |   |
| Total current assets                                                                                                                                                             |       |                   | 774,899    |               |       | 795,039 |   |
| Property, plant and  equipment, less accumulated depreciation of $118,064 and $101,335 at  September 30, 2005 and March 31, 2005, respectively                    |       |                   | 144,062    |               |       | 143,264 |   |
| Acquired  intangible assets, net                                                                                                                                                 |       |                   | 101,953    |               |       | 100,030 |   |
| Goodwill                                                                                                                                                                         |       |                   | 819,565    |               |       | 815,407 |   |
| Other noncurrent  assets                                                                                                                                                         |       |                   | 31,489     |               |       | 32,901 |   |
| **Total assets**                                                                                                                                                                 | ** ** |                   | $          | 1,871,968          |       |   | $ | 1,886,641 |   |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                   | ** ** |                   |       |               |       |   |   |
| Current liabilities                                                                                                                                                              |       |                   |       |               |       |   |   |
| Current installments of  long-term debt                                                                                                                                          |       |                   | $          | 2,600              |       |   | $ | 2,652 |   |
| Accounts payable                                                                                                                                                                 |       |                   | 121,781    |               |       | 111,222 |   |
| Accrued expenses and  other current liabilities                                                                                                                                  |       |                   | 260,188    |               |       | 301,361 |   |
| Total current liabilities                                                                                                                                                        |       |                   | 384,569    |               |       | 415,235 |   |
| Long-term debt,  excluding current installments                                                                                                                                  |       |                   | 705,775    |               |       | 727,611 |   |
| Other liabilities                                                                                                                                                                |       |                   | 65,167     |               |       | 72,367 |   |
| **Total liabilities**                                                                                                                                                            | ** ** |                   | 1,155,511  |               |       | 1,215,213 |   |
| Commitments and contingencies (Notes 2, 7 and 14)                                                                                                                                |       |                   |       |               |       |   |   |
| Stockholders’ equity                                                                                                                                                        |       |                   |       |               |       |   |   |
| Preferred stock, no par  value. Authorized 2,000,000 shares; none issued at September 30,  2005 and March 31, 2005                                                |       |                   | —     |               |       | — |   |
| Common Stock, $.01 par  value per share. Authorized 50,000,000 shares; issued 28,019,156 and  27,472,495 shares at September 30, 2005 and March 31, 2005, respectively |       |                   | 280        |               |       | 275 |   |
| Additional paid-in  capital                                                                                                                                                      |       |                   | 486,862    |               |       | 467,027 |   |
| Retained earnings                                                                                                                                                                |       |                   | 231,223    |               |       | 199,924 |   |
| Accumulated other  comprehensive earnings                                                                                                                                        |       |                   | 6,952      |               |       | 6,198 |   |
| Unamortized stock  compensation                                                                                                                                                  |       |                   | (8,860     | )                  |       | (1,996 | ) |
| **Total stockholders’ equity**                                                                                                                                              | ** ** |                   | 716,457    |               |       | 671,428 |   |
| **Total liabilities and stockholders’ equity**                                                                                                                              | ** ** |                   | $          | 1,871,968          |       |   | $ | 1,886,641 |   |

 

See accompanying Notes to the Consolidated Financial Statements.

1

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

| ** **                                                                     | ** ** | **Three Months Ended  September 30,** | ** ** | **Six Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                     | ** ** | **2005**                                             | ** ** | **2004**                                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues                                                                       |       | $                                                    | 361,930    |                                               | $          | 318,053 |   | $ | 700,389 |   | $ | 609,204 |   |
| Costs and  expenses                                                            |       | 323,353                                              |       | 284,247                                            |       | 626,754 |   | 546,898 |   |
| Operating income                                                               |       | 38,577                                               |       | 33,806                                             |       | 73,635 |   | 62,306 |   |
| Interest income                                                                |       | 2,068                                                |       | 169                                                |       | 3,945 |   | 298 |   |
| Interest and  related expenses                                                 |       | 12,290                                               |       | 9,006                                              |       | 24,501 |   | 18,000 |   |
| Other expense, net                                                             |       | (337                                                 | )          | (91                                                | )          | (312 | ) | (151 | ) |
| Earnings from continuing operations before minority  interest and income taxes |       | 28,018                                               |       | 24,878                                             |       | 52,767 |   | 44,453 |   |
| Minority interest                                                              |       | 502                                                  |       | 528                                                |       | 1,082 |   | 925 |   |
| Earnings from continuing operations before income  taxes                       |       | 27,516                                               |       | 24,350                                             |       | 51,685 |   | 43,528 |   |
| Income taxes                                                                   |       | 8,562                                                |       | 10,347                                             |       | 18,713 |   | 18,554 |   |
| Earnings from continuing operations                                            |       | 18,954                                               |       | 14,003                                             |       | 32,972 |   | 24,974 |   |
| Earnings from discontinued operations, net of income  taxes                    |       | —                                               |       | 398                                                |       | — |   | 1,198 |   |
| Net earnings                                                                   |       | $                                                    | 18,954     |                                               | $          | 14,401 |   | $ | 32,972 |   | $ | 26,172 |   |
| **Net  earnings per share of common stock:**                                   |       |                                                 |       |                                               |       |   |   |   |   |
| Basic earnings  per share:                                                     |       |                                                 |       |                                               |       |   |   |   |   |
| Earnings from continuing operations                                            |       | $                                                    | 0.68       |                                               | $          | 0.52 |   | $ | 1.20 |   | $ | 0.92 |   |
| Earnings from discontinued operations, net of income  taxes                    |       | $                                                    | —     |                                               | $          | 0.01 |   | $ | — |   | $ | 0.04 |   |
| Net earnings                                                                   |       | $                                                    | 0.68       |                                               | $          | 0.53 |   | $ | 1.20 |   | $ | 0.97 |   |
| Diluted earnings  per share:                                                   |       |                                                 |       |                                               |       |   |   |   |   |
| Earnings from continuing operations                                            |       | $                                                    | 0.66       |                                               | $          | 0.50 |   | $ | 1.15 |   | $ | 0.90 |   |
| Earnings from discontinued operations, net of income  taxes                    |       | $                                                    | —     |                                               | $          | 0.01 |   | $ | — |   | $ | 0.04 |   |
| Net earnings                                                                   |       | $                                                    | 0.66       |                                               | $          | 0.52 |   | $ | 1.15 |   | $ | 0.95 |   |
| **Dividends  per common share**                                                |       | $                                                    | 0.03       |                                               | $          | — |   | $ | 0.06 |   | $ | — |   |

 

See accompanying Notes to the Consolidated Financial Statements.

2

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Consolidated Statementsof Cash Flows(in thousands) (Unaudited)**

| ** **                                                                                                                      | ** ** | **Six Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                                                      | ** ** | **2005**                                           | ** ** | **2004** | ** ** |
| **Cash Flows from Operating Activities**                                                                                        | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| Earnings from  continuing operations                                                                                            |       | $                                                  | 32,972     | ** ** | $ | 24,974 | ** ** |
| Adjustments to reconcile earnings from continuing  operations to cash flows from operating activities of continuing operations: |       |                                               |       |   |   |
| Depreciation and  amortization                                                                                                  |       | 20,941                                             |       | 20,647 |   |
| Stock-based compensation                                                                                                        |       | 1,104                                              |       | 632 |   |
| Deferred income taxes                                                                                                           |       | (498                                               | )          | (382 | ) |
| Inventory reserve and  provision for doubtful accounts                                                                          |       | 1,455                                              |       | 891 |   |
| Amortization and  write-off of deferred financing fees                                                                          |       | 1,904                                              |       | 1,813 |   |
| Other, net                                                                                                                      |       | (749                                               | )          | 770 |   |
| Changes in assets and liabilities, net of effects  from business combinations:                                                  |       |                                               |       |   |   |
| Decrease in accounts  receivable                                                                                                |       | 4,523                                              |       | 31,104 |   |
| (Increase) decrease in  inventories                                                                                             |       | (15,720                                            | )          | 3,412 |   |
| Increase in prepaid  expenses and other current assets                                                                          |       | (480                                               | )          | (501 | ) |
| Increase (decrease) in  accounts payable                                                                                        |       | 8,653                                              |       | (1,459 | ) |
| Decrease in accrued  expenses and other current liabilities                                                                     |       | (23,553                                            | )          | (14,066 | ) |
| Increase (decrease) in  customer advances                                                                                       |       | 4,054                                              |       | (16,950 | ) |
| Decrease in pension and  postretirement benefit liabilities                                                                     |       | (228                                               | )          | (3,050 | ) |
| Other, net                                                                                                                      |       | 611                                                |       | 740 |   |
| **Net cash  provided by operating activities of continuing operations**                                                         |       | 34,989                                             |       | 48,575 |   |
| **Net cash  provided by operating activities of discontinued operations**                                                       |       | —                                             |       | 1,975 |   |
| **Net cash  provided by operating activities**                                                                                  |       | 34,989                                             |       | 50,550 |   |
| **Cash Flows from Investing Activities**                                                                                        | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| Capital expenditures                                                                                                            |       | (16,254                                            | )          | (13,580 | ) |
| Payments pursuant to  business combinations, net of cash acquired                                                               |       | (52,549                                            | )          | (3,118 | ) |
| Disposition of property,  plant and equipment                                                                                   |       | 909                                                |       | 825 |   |
| Other, net                                                                                                                      |       | (69                                                | )          | 220 |   |
| **Net cash  used in investing activities of continuing operations**                                                             |       | (67,963                                            | )          | (15,653 | ) |
| **Net cash  used in investing activities of discontinued operations**                                                           |       | —                                             |       | (358 | ) |
| **Net cash  used in investing activities**                                                                                      |       | (67,963                                            | )          | (16,011 | ) |
| **Cash Flows from Financing Activities**                                                                                        | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| Net borrowings of  short-term debt                                                                                              |       | —                                             |       | (82 | ) |
| Return of advanced  interest on senior subordinated notes                                                                       |       | (1,986                                             | )          | — |   |
| Debt issuance costs                                                                                                             |       | (191                                               | )          | — |   |
| Repayment of long-term  debt                                                                                                    |       | (21,355                                            | )          | (21,508 | ) |
| Proceeds from stock  option exercises                                                                                           |       | 7,737                                              |       | 1,674 |   |
| Dividends paid                                                                                                                  |       | (1,664                                             | )          | — |   |
| Other, net                                                                                                                      |       | —                                             |       | 150 |   |
| **Net cash  used in financing activities of continuing operations**                                                             |       | (17,459                                            | )          | (19,766 | ) |
| **Net cash  used in financing activities of discontinued operations**                                                           |       | —                                             |       | (14 | ) |
| **Net cash  used in financing activities**                                                                                      |       | (17,459                                            | )          | (19,780 | ) |
| **Effect  of exchange rates on cash and cash equivalents**                                                                      |       | 835                                                |       | 359 |   |
| **Net  (decrease) increase in cash and cash equivalents**                                                                       |       | (49,598                                            | )          | 15,118 |   |
| **Cash and  cash equivalents, beginning of period**                                                                             |       | 306,852                                            |       | 56,790 |   |
| **Cash and cash equivalents, end of period**                                                                                    |       | $                                                  | 257,254    |   | $ | 71,908 |   |

 

See accompanying Notes to the Consolidated Financial Statements

3

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

**1.   Basis of Presentation**

The accompanying unauditedConsolidated Financial Statements of DRS Technologies, Inc., its wholly-ownedsubsidiaries and a partnership of which DRS owns an 80% controlling interest(hereinafter, DRS or the Company) have been prepared in accordance withaccounting principles generally accepted in the United States of America andwith the instructions to Form 10-Q and Article 10 of RegulationS-X. In the opinion of the Company, the interim consolidated financialinformation provided herein reflects all adjustments (consisting of normal andrecurring adjustments) necessary for a fair presentation of the Company’sconsolidated financial position as of September 30, 2005, the results ofits operations for the three- and six-month periods ended September 30,2005 and 2004, and its cash flows for the six-month periods ended September 30,2005 and 2004. The results of operations for the three- and six-month periodsended September 30, 2005 are not necessarily indicative of the results tobe expected for the full year. Certain fiscal 2005 amounts have beenreclassified to conform to the fiscal 2006 presentation. These interimConsolidated Financial Statements should be read in conjunction with theConsolidated Financial Statements of the Company for the fiscal year ended March 31,2005, included in the Company’s filing on Form 10-K for the yearended March 31, 2005.

***Proposed Acquisition***

On September 21, 2005, DRS and Engineered SupportSystems, Inc. (ESSI) entered into a merger agreement pursuant to whichESSI will merge with and into a wholly-owned subsidiary of DRS, in atransaction to be accounted for using the purchase method of accounting. Thepurchase price will approximate $1.9 billion, including merger-relatedexpenses. In addition to the purchase price, DRS will refinance approximately $86.0million of ESSI debt at closing of the merger.

The purchase price will be $43.00 per share of ESSIcommon stock, which will be comprised of $30.10 in cash and a fraction of ashare of DRS common stock valued at $12.90, provided that the average closingsale price per share of DRS common stock for a certain period prior to thecompletion of the merger is less than $57.20 per share but greater than $46.80per share. A collar provides that the exchange ratio will not exceed 0.2756 ofa share nor be less than 0.2255 of a share of DRS common stock. The equityconsideration in the merger will not be less than 9.9 million shares and notgreater than 12.1 million shares of DRS common stock, or an aggregate ofapproximately $566.4 million based upon the assumption that the average priceof DRS common stock during the measurement period is not less than $46.80 pershare and not greater than $57.20 per share. The number of shares of DRS commonstock and the value of such shares will not be determined until the secondcomplete trading day before the closing; therefore, the final purchase pricemay be greater than or less than $1.9 billion. The merger agreement providesthat at the time of the completion of the merger, all unexercised options toacquire ESSI common stock will be cancelled in exchange for the sameconsideration paid to ESSI shareholders, reduced by the applicable exerciseprice.

DRS expects to finance the cash portion of theacquisition by utilizing existing excess cash on hand and through a combinationof bank borrowings and the issuance of debt securities.

The transaction is expected to close in the fourthquarter of fiscal 2006 and is subject to customary regulatory approvals andother closing conditions, including approval by DRS’s and ESSI’s stockholdersat respective special stockholder meetings.

4

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

ESSI, headquartered in St.Louis, Missouri, is a supplier of integrated military electronics, supportequipment and technical services focused on advanced sustainment and logisticssupport solutions for all branches of the U.S. armed services, major primedefense contractors, certain international militaries, homeland security forcesand selected government and intelligence agencies. ESSI also producesspecialized equipment and systems for commercial and industrial applications.

***Discontinued Operations***

On March 10, 2005, the Company completed the saleof two of its operating units—DRS Weather Systems, Inc. (DRS Weather) andDRS Broadcast Technology (DRS Broadcast). The operating units were acquired inconnection with the Company’s fiscal 2004 acquisition of Integrated DefenseTechnologies, Inc. (IDT). As a result of the divestiture, DRS Weather’sand DRS Broadcast’s results of operations for the three- and six-month periodsended September 30, 2004 are included in the Consolidated Statement ofEarnings as “Earnings from discontinued operations.” The cash flows of thediscontinued operations also are presented separately in the ConsolidatedStatements of Cash Flows for the six months ended September 30, 2004. Allcorresponding footnotes reflect the discontinued operations presentation.

A summary of the results of discontinued operationsfor the three- and six-month periods ended September 30, 2004 follows:

| ** **                             | ** ** | **Three Months Ended  September 30, 2004** | ** ** | **Six Months Ended  September 30, 2004** | ** ** |
|----------------------------------------|------------|----------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                             | ** ** | **(in thousands)**                                        | ** ** |
| Revenues                               |       |                                                           | $          | 9,969                                                        |       |   |   | $ | 19,547 |   |   |
| Earnings before  taxes                 |       |                                                           | $          | 697                                                          |       |   |   | $ | 1,990 |   |   |
| Income tax  expense                    |       |                                                           | 299        |                                                         |       |   | 792 |   |   |
| Earnings from  discontinued operations |       |                                                           | $          | 398                                                          |       |   |   | $ | 1,198 |   |   |

 

**2.    Acquisitions**

On April 15, 2005, DRS acquired Codem Systems, Inc.(Codem) in a stock purchase transaction for approximately $31.6 million in cash(subject to a working capital adjustment), with additional considerationpayable of up to $5.0 million upon achievement of certain annual bookingstargets for a period of three years. In addition to the purchase price, theCompany recorded approximately $0.4 million for acquisition-related costs. Theresults of Codem’s operations have been included in the Company’s financialstatements since the date of acquisition.

Codem, located in Merrimack, New Hampshire, is aprovider of signals intelligence (SIGINT) systems, network interface modulesand high-performance antenna control systems. As a supplier of SIGINT products,Codem focuses on solutions for communications and surveillance applicationssupporting the intelligence, military and homeland security markets. Managementbelieves that the addition of Codem has enhanced DRS’s existing intelligenceproduct base. Codem is being managed as a part of the Company’s Command,Control, Communications, Computers and Intelligence (C4I) Group.

The Company is in the process of reviewing athird-party valuation of certain Codem acquired assets (including acquiredintangible assets), as well as performing its own internal assessment ofcertain other acquired assets and liabilities; thus, the preliminary allocationof the purchase price may change. Based on 

5

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

preliminary purchase priceallocations, the Company has estimated goodwill to be $26.4 million, which hasbeen allocated to the C4I Group, and acquired intangible assets to be $6.1million. Acquired intangible assets of $1.9 million and $4.2****million were allocated to technology-basedand customer-related intangibles, respectively, which have a weighted averageuseful life of 9 years. The Company expects to complete its purchase priceallocation in the third quarter of fiscal 2006.

On June 27, 2005, DRS acquired WalkAbout ComputerSystems (WalkAbout) in a stock purchase transaction for approximately $13.8million in cash (subject to a working capital adjustment), with additionalconsideration payable of up to $5.0 million upon achievement of certain revenuetargets for a period of two and a half years. In addition to the purchase price,the Company recorded approximately $0.3 million for acquisition-related costs.The results of WalkAbout have been included in the Company’s financialstatements since the date of acquisition.

WalkAbout, located in West Palm Beach, Florida, is amanufacturer of several lines of rugged, mobile tablet PCs, serving industrial,municipal, military and government markets. Management believes that theacquisition of WalkAbout has enhanced DRS’s position in the tactical computersystems business by broadening its product offerings. WalkAbout is beingmanaged as part of the Company’s C4I Group.

The Company is in the process of obtaining athird-party valuation of certain WalkAbout acquired assets (including acquiredintangible assets), as well as performing its own internal assessment ofcertain other acquired assets and liabilities; thus, the preliminary allocationof the purchase price will change, and such change could be significant. Basedon preliminary purchase price allocations, the Company has estimated goodwillto be $12.1 million and has allocated the goodwill to the C4I Group. No amountshave been allocated to acquired intangible assets pending receipt of thethird-party valuation. The Company expects to complete its purchase priceallocation in the third quarter of fiscal 2006.

Unaudited pro forma financial information for theCodem and WalkAbout transactions discussed above is not presented because theeffects of these acquisitions were not material on either an individual oraggregate basis.

During the six-monthperiod ended September 30, 2005, the Company paid $6.7 million inconsideration to satisfy an earn-out obligation on its acquisition of DKD, Inc.(now operating as a component of Infrared Technologies L.P.). The earn-out wasrecorded as an increase to goodwill during the fourth quarter of fiscal 2005,when it became certain a payment would be made.

**3.   Stock-Based Compensation**

The Company has one stock-based compensation plan, the1996 Omnibus Plan (Omnibus Plan). Under the terms of the Omnibus Plan, stockoptions and restricted stock may be granted to key employees, directors andconsultants of the Company. The Company accounts for stock options granted toemployees and directors under the recognition and measurement principles ofAccounting Principles Board Opinion No. 25, “Accounting for Stock Issuedto Employees” and related interpretations. Compensation expense for stockoptions granted to an employee or director is recognized in earnings based onthe excess, if any, of the quoted market price of DRS common stock at the dateof the 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 equals or exceeds the quoted marketprice of DRS common stock at the date of grant, the Company does not recognizecompensation expense. 

6

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

Compensation cost forrestricted stock is recorded based on the quoted market price of DRS commonstock on the date of grant.

The Company elected not to adopt the fair-value-basedmethod of accounting for stock-based employee compensation, as permitted byStatement of Financial Accounting Standards (SFAS) No. 123, “Accountingfor Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting forStock-Based Compensation—Transition and Disclosure, an amendment of SFAS No. 123.”Had the Company adopted the fair-value-based method provisions of SFAS No. 123,it would have recorded a non-cash expense for the estimated fair value of thestock options that the Company had granted to its employees and directors.

Thetable below compares the “as reported” net earnings and earnings per share tothe “pro forma” net earnings and earnings per share that the Company would havereported if it had elected to recognize compensation expense in accordance withthe fair value-based method of accounting of SFAS No. 123. For purposes ofdetermining the pro forma effects of SFAS No. 123, the estimated fairvalue of options granted was calculated using the Black-Scholes option pricingvaluation model.

| ** **                                                                                                           | ** ** | **Three Months Ended  September 30,**          | ** ** | **Six Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                                           | ** ** | **2005**                                                      | ** ** | **2004**                                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                           | ** ** | **(in thousands, except per-share data)** | ** ** |
| Net earnings, as  reported                                                                                           |       | $                                                             | 18,954     |                                               | $          | 14,401 |   | $ | 32,972 |   | $ | 26,172 |   |
| Add: Stock-based  compensation expense included in reported net earnings, net of  taxes                    |       | 519                                                           |       | 180                                                |       | 667 |   | 376 |   |
| Less: Total  stock-based compensation expense determined under fair-value-based method for  all awards, net of taxes |       | (2,832                                                        | )          | (1,235                                             | )          | (4,259 | ) | (2,471 | ) |
| Pro forma net  earnings                                                                                              |       | $                                                             | 16,641     |                                               | $          | 13,346 |   | $ | 29,380 |   | $ | 24,077 |   |
| Earnings per  share:                                                                                                 |       |                                                          |       |                                               |       |   |   |   |   |
| Basic—as reported                                                                                               |       | $                                                             | 0.68       |                                               | $          | 0.53 |   | $ | 1.20 |   | $ | 0.97 |   |
| Basic—pro forma                                                                                                 |       | $                                                             | 0.60       |                                               | $          | 0.49 |   | $ | 1.07 |   | $ | 0.89 |   |
| Diluted—as reported                                                                                             |       | $                                                             | 0.66       |                                               | $          | 0.52 |   | $ | 1.15 |   | $ | 0.95 |   |
| Diluted—pro forma                                                                                               |       | $                                                             | 0.58       |                                               | $          | 0.49 |   | $ | 1.03 |   | $ | 0.89 |   |

 

In December 2004, the FASB issued SFAS No. 123(revised 2004), “Share-Based Payment” (SFAS No. 123R), which replacesSFAS No. 123 and supercedes APB Opinion No. 25. SFAS No. 123Raddresses the accounting for transactions in which an enterprise receivesemployee services in exchange for (a) equity instruments of the enterpriseor (b) liabilities that are based on the fair value of the enterprise’sequity instruments or that may be settled by the issuance of such equityinstruments. SFAS No. 123R requires all share-based payments to employees,including grants of employee stock options and restrictive stock grants andunits, to be recognized as a compensation cost based on their fair values. Thepro forma disclosures previously permitted under SFAS No. 123 no longerwill be an alternative to financial statement recognition. Under SFAS No. 123R,the Company must determine the appropriate fair-value model to be used forvaluing share-based payments, the amortization method for compensation cost andthe transition method to be used at the date of adoption. The transitionmethods include prospective and retroactive adoption options. Under theretroactive option, prior periods may be restated either as of the 

7

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

beginning of the year ofadoption or for all periods presented. The prospective method requires thatcompensation expense be recorded for all unvested stock options and restrictedstock at the beginning of the first quarter of adoption of SFAS No. 123R,while the retroactive methods would record compensation expense for allunvested stock options and restricted stock beginning with the first periodrestated. The Company is evaluating the requirements of SFAS No. 123R andexpects that the adoption of SFAS No. 123R will have a material impact on theCompany’s consolidated results of operations and earnings per share. TheCompany has not yet determined the method of adoption or the effect of adoptingSFAS No. 123R, and it has not determined whether the adoption will resultin amounts that are similar to the current pro forma disclosures under SFAS No. 123included above.

On April 15, 2005,the SEC issued Release No. 33-8568, Amendment to Rule 4-01aof regulation S-X regarding the compliance date for SFAS No. 123R. The SECRelease amends the effective date for compliance with SFAS No. 123R to thebeginning of the first fiscal year following June 15, 2005, which is thefiscal year beginning on April 1, 2006 for DRS. On March 29, 2005,the SEC issued Staff Accounting Bulletin (SAB) No. 107, “Share-BasedPayment” (SAB 107). SAB 107 provides guidance to assist registrants in theinitial implementation of SFAS No. 123R. SAB 107 includes, but is not limitedto, interpretive guidance related to share-based payment transactions withnonemployees, valuation methods and underlying expected volatility and expectedterm assumptions, the classification of compensation expenses and accountingfor the income tax effects of share-based arrangements upon adopting the SFAS No. 123R.The Company currently is assessing the guidance provided in SAB 107 inconnection with its implementation of SFAS No. 123R.

**4.   Inventories**

Inventoriesare summarized as follows:

| ** **                                             | ** ** | **September 30,**  | ** ** | **March 31,** | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|--------------------|------------|
| ** **                                             | ** ** | **2005**                | ** ** | **2005**           | ** ** |
| ** **                                             | ** ** | **(in thousands)** | ** ** |
| Work-in-process                                        |       |                    | $          | 269,348            |       |   | $ | 211,914 |   |
| General and  administrative costs                      |       |                    | 50,813     |               |       | 47,365 |   |
| Raw material and  finished goods                       |       |                    | 45,244     |               |       | 33,127 |   |
|                                                   |       |                    | 365,405    |               |       | 292,406 |   |
| Less: Progress  payments and certain customer advances |       |                    | 128,830    |               |       | 75,541 |   |
| Inventory reserve                                      |       |                    | 7,764      |               |       | 8,724 |   |
| Total                                                  |       |                    | $          | 228,811            |       |   | $ | 208,141 |   |

 

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.

8

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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 cost data in the tablebelow does not include the G&A, IRAD and B&P costs for the Company’slines of businesses that are not primarily contracted with the U.S. government,which are expensed as incurred.

| ** **                                    | ** ** | **Three Months Ended  September 30,** | ** ** | **Six Months Ended  September 30,** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                    | ** ** | **2005**                                             | ** ** | **2004**                                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                    | ** ** | **(in thousands)**                              | ** ** | **(in thousands)**                            | ** ** |
| Balance beginning of  period                  |       | $                                                    | 47,509     |                                               | $          | 40,081 |   | $ | 47,365 |   | $ | 37,854 |   |
| Add: Incurred costs                           |       | 52,095                                               |       | 45,528                                             |       | 105,273 |   | 99,337 |   |
| Less: Amounts included  in costs and expenses |       | (48,791                                              | )          | (42,304                                            | )          | (101,825 | ) | (93,886 | ) |
| Balance in inventory at  September 30,   |       | $                                                    | 50,813     |                                               | $          | 43,305 |   | $ | 50,813 |   | $ | 43,305 |   |

 

Total expenditures forIRAD amounted to approximately $11.5 million and $8.6 million for thethree-month periods ended September 30, 2005 and 2004, respectively, and$20.7 million and $16.9 million, respectively, for the six-month periods thenended.

**5.   Goodwill and Intangible Assets**

Thefollowing disclosure presents certain information regarding the Company’sacquired intangible assets as of September 30, 2005 and March 31,2005. All acquired intangible assets are being amortized over their estimateduseful lives, as indicated below, with no estimated residual values.

| **Acquired Intangible Assets** | ** ** | ** ** | ** ** | **Weighted  Average  Amortization  Period** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net Balance** | ** ** |
|------------------------------------------|------------|------------|------------|---------------------------------------------|------------|-----------------------------|------------|-------------------------------|------------|----------------------|------------|
| ** **                               | ** ** | ** ** | ** ** | ** **                                  | ** ** | **(in thousands)**     | ** ** | ** **                    | ** ** |
| **As of September 30, 2005**        | ** ** |       | ** ** | ** **                                  |       | ** **                  | ** ** |                          | ** ** | ** **           |       |   | ** ** | ** ** |   |
| Technology-based intangibles             |       |       | 18 years   | ** **                                  |       | $                           | 47,861     |                          |       | $                    | (12,623    | ) |   |   | $ | 35,238 | ** ** |   |
| Customer-related intangibles             |       |       | 17 years   | ** **                                  |       | 79,797                      |       |                          | (13,082    | )                    |       |   | 66,715 | ** ** |   |
| Total                                    |       |       |       | ** **                                  |       | $                           | 127,658    |                          |       | $                    | (25,705    | ) |   |   | $ | 101,953 | ** ** |   |
| **As of  March 31, 2005**           | ** ** |       | ** ** | ** **                                  |       | ** **                  | ** ** |                          | ** ** |                 |       |   | ** ** | ** ** |   |
| Technology-based intangibles             |       |       | 19 years   | ** **                                  |       | $                           | 45,961     |                          |       | $                    | (11,172    | ) |   |   | $ | 34,789 | ** ** |   |
| Customer-related intangibles             |       |       | 17 years   | ** **                                  |       | 75,590                      |       |                          | (10,349    | )                    |       |   | 65,241 | ** ** |   |
| Total                                    |       |       |       | ** **                                  |       | $                           | 121,551    |                          |       | $                    | (21,521    | ) |   |   | $ | 100,030 | ** ** |   |

 

The aggregate acquired intangible asset amortizationexpense for the three-month periods ended September 30, 2005 and 2004 was$2.1 million and $1.7 million, respectively, and for the six-month periodsended September 30, 2005 and 2004 was $4.2 million and $3.3 million,respectively. The estimated acquired intangible amortization expense, based ongross carrying amounts at September 30, 2005, is estimated to be $8.4million for fiscal 2006, $8.5 million per year for fiscal 2007 through fiscal2009, $8.3 million for fiscal 2010 and $7.7 million for fiscal 2011.

9

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

Thetable below reconciles the change in the carrying amount of goodwill byoperating segment for the period from March 31, 2005 to September 30,2005.

| ** **                                                                  | ** ** | **C4I  Group**          | ** ** | **SR  Group** | ** ** | **Total** | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------------|------------|---------------|------------|-----------|------------|
| ** **                                                                  | ** ** | **(in thousands)** | ** ** |
| Balance as of  March 31, 2005                                          |       | $                       | 447,631    |          | $          | 367,776   |       | $ | 815,407 |   |
| Codem acquisition                                                           |       | 26,368                  |       | —        |       | 26,368    |       |
| WalkAbout acquisition                                                       |       | 12,083                  |       | —        |       | 12,083    |       |
| Tax adjustments related  to prior acquisitions(A)                           |       | (9,460                  | )          | (24,219       | )          | (33,679   | )          |
| Expiration of  unexercised contract options relating to the IDT acquisition |       | —                  |       | (566          | )          | (566      | )          |
| Foreign currency  translation adjustment                                    |       | (48                     | )          | —        |       | (48       | )          |
| Balance as of September 30, 2005                                       |       | $                       | 476,574    |          | $          | 342,991   |       | $ | 819,565 |   |

 

----

(A)  The Companyoperates in multiple taxing jurisdictions, both within the United States andoutside the United States, and faces audits from these various tax authoritiesregarding the amount of taxes due. Such audits can involve complex issues andmay require an extended period of time to resolve. In the second quarter offiscal 2006, the Company’s income tax provision was reduced by $3.0 millionpredominately due to the resolution of the IRS’s examination of the 1999-2001tax years. Also in connection with the resolution of the 1999-2001 tax audits,the Company adjusted certain acquired deferred tax assets and liabilities andcertain other pre-acquisition related tax amounts, totaling $33.7 million,with a corresponding net decrease to goodwill.

**6.   ProductWarranties**

Productwarranty costs are accrued when the covered products are delivered to thecustomer. Product warranty expense is recognized based on the terms of theproduct warranty and the related estimated costs, considering historical claimsexpense. Accrued warranty costs are reduced as these costs are incurred and asthe warranty period expires, and may be otherwise modified as specific productperformance issues are identified and resolved. The table below presents thechanges in the Company’s accrual for product warranties for the six monthsended September 30, 2005 and 2004, which are included in accrued expensesand other current liabilities.

| ** **                                                | ** ** | **Six Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                | ** ** | **2005**                                           | ** ** | **2004** | ** ** |
| ** **                                                | ** ** | **(in thousands)**                            | ** ** |
| Balance as of  March 31,                             |       | $                                                  | 21,839     |   | $ | 23,279 |   |
| Acquisitions during the  period                           |       | 2,661                                              |       | — |   |
| Accruals for product  warranties issued during the period |       | 4,593                                              |       | 3,753 |   |
| Settlements made during  the period                       |       | (5,273                                             | )          | (6,344 | ) |
| Other                                                     |       | 46                                                 |       | 1,981 |   |
| Balance as of September 30,                          |       | $                                                  | 23,866     |   | $ | 22,669 |   |

 

10

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

**7.   Debt**

| ** **                                                                                                                                | ** ** | **September 30,  2005** | ** ** | **March 31,  2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|--------------------------|------------|
| ** **                                                                                                                                | ** ** | **(in thousands)**      | ** ** |
| Senior subordinated  notes, including bond premium of $9,151 and $9,716 at September 30, 2005  and March 31, 2005, respectively |       |                         | $          | 559,151                  |       |   | $ | 559,716 |   |
| Term loan                                                                                                                                 |       |                         | 146,280    |                     |       | 167,460 |   |
| Other obligations                                                                                                                         |       |                         | 2,944      |                     |       | 3,087 |   |
|                                                                                                                                      |       |                         | 708,375    |                     |       | 730,263 |   |
| Less:                                                                                                                                     |       |                         |       |                     |       |   |   |
| Current installments of  long-term debt                                                                                                   |       |                         | 2,600      |                     |       | 2,652 |   |
| Total long-term debt                                                                                                                      |       |                         | $          | 705,775                  |       |   | $ | 727,611 |   |

 

October 30, 2003, the Company issued $350.0million aggregate principal amount of 67¤8% Senior SubordinatedNotes, due November 1, 2013 (the Notes). The Notes were issued under anindenture with The Bank of New York (the Indenture). Subject to a number ofexceptions, the Indenture restricts the Company’s ability and the ability ofits subsidiaries to incur more debt, make certain investments, repurchasestock, create liens, enter into transactions with affiliates, enter into salelease-back transactions, merge or consolidate, and transfer or sell assets. TheNotes are unconditionally guaranteed, jointly and severally, by DRS’s currentand future wholly-owned domestic subsidiaries. The foreign subsidiaries andcertain domestic subsidiaries of DRS do not guarantee the Notes. See Note 15, “Guarantorand Non-guarantor Financial Statements” for additional disclosures.

On December 23, 2004, the Company issued anadditional $200.0 million aggregate principal amount of 67¤8% Senior Subordinated Notes due November 1,2013. The notes were offered as additional debt securities under the Indenturewith identical terms and the same guarantors as the existing Notes. The newnotes were priced at 105% of the principal amount, reflecting an effectiveinterest rate of approximately 6.13%. The net proceeds of the offering wereapproximately $208.3 million (including $2.0 million of advanced interest onthe new notes that had accrued from November 1, 2004 to December 23,2004), after deducting $3.7 million in commissions and other costs related tothe debt issuance. On May 1, 2005, the advanced interest of $2.0 millionwas repaid in conjunction with the semi-annual interest payments on the Notes.

The book value and fair value of the seniorsubordinated debt at September 30, 2005 was approximately $559.2 millionand $533.5 million, respectively. 

The Company has a $411.0 million credit facility (theCredit Facility), consisting of a $175.0 million senior secured revolving lineof credit and a $236.0 million senior secured term loan, and has the ability toborrow up to two additional term loans totaling $100.0 million at any timeprior to maturity. As of September 30, 2005 and March 31, 2005, theCompany had $146.3 million and $167.5 million, respectively, of term loansoutstanding against the Credit Facility. 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 the Company’ssubsidiary guarantors and certain of DRS’s other subsidiaries’ assets and by apledge of certain of the Company’s non-guarantor subsidiaries’ capital stock.The term loan and the revolving credit facility will mature in November 2010and November 2008, respectively. The weighted average interest rate 

11

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

on the Company’s termloans was 5.62% as of September 30, 2005 (4.4% as of March 31, 2005),excluding the impact of the amortization of debt issuance costs. As of September 30,2005, the Company had $139.9 million available under its revolving line ofcredit. There were no borrowings under the Company’s revolving line of creditas of September 30, 2005 and March 31, 2005.

During the six months ended September 30, 2005,the Company repaid $20.0 million of its term loan, at its discretion, andrecorded a $0.4 million charge to interest and related expenses in the thirdquarter of fiscal 2006 for the related write-off of a portion of the debtissuance costs. On October 28, 2005, the Company prepaid an additional$10.0 million of its term loan, at its discretion, and will recognize a $0.2million charge to interest and related expenses for the related write-off of aportion of debt issuance costs.

From time to time, theCompany enters into standby letter-of-credit and bank guarantee agreements withfinancial institutions and customers, primarily relating to the guarantee ofits future performance on certain contracts to provide products and servicesand to secure advance payments it has received from its customers. As of September 30,2005, an aggregate of $36.3 million was contingently payable under letters ofcredit and bank guarantees. Approximately $0.9 million and $0.3 million inletters of credit and bank guarantees, respectively, as of September 30,2005 were issued outside of the Credit Facility and by a bank agreement for theCompany’s U.K. subsidiary, respectively, that are not considered whendetermining the availability under the Company’s revolving line of credit.

The Company has a mortgagenote payable that is secured by a lien on its facility located in Palm Bay,Florida, and bears interest at a rate equal to the one-month LIBOR plus 1.65%. Thebalance of the mortgage as of September 30, 2005 and March 31, 2005was $2.9 million and $3.0 million, respectively. Monthly payments of principaland interest totaling approximately $34 thousand will continue through December 1,2016.

Accrued interest expenseat September 30, 2005 and March 31, 2005 was approximately $16.5 million.

12

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

**8.   Earningsper 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,** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                       | ** ** | **2005**                                                      | ** ** | **2004**                                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                       | ** ** | **(in thousands, except per-share data)** | ** ** |
| **Basic EPS computation**                                        |       |                                                          |       |                                               |       |   |   |   |   |
| Earnings from continuing  operations                             |       | $                                                             | 18,954     |                                               | $          | 14,003 |   | $ | 32,972 |   | $ | 24,974 |   |
| Earnings from  discontinued operations, net of income taxes |       | $                                                             | —     |                                               | $          | 398 |   | $ | — |   | $ | 1,198 |   |
| Net earnings                                                     |       | $                                                             | 18,954     |                                               | $          | 14,401 |   | $ | 32,972 |   | $ | 26,172 |   |
| Weighted average common  shares outstanding                      |       | 27,676                                                        |       | 27,071                                             |       | 27,578 |   | 27,004 |   |
| Basic earnings per share                                         |       |                                                          |       |                                               |       |   |   |   |   |
| Earnings from continuing  operations                             |       | $                                                             | 0.68       |                                               | $          | 0.52 |   | $ | 1.20 |   | $ | 0.92 |   |
| Earnings from  discontinued operations, net of income taxes      |       | $                                                             | —     |                                               | $          | 0.01 |   | $ | — |   | $ | 0.04 |   |
| Net earnings                                                     |       | $                                                             | 0.68       |                                               | $          | 0.53 |   | $ | 1.20 |   | $ | 0.97 |   |
| **Diluted EPS computation**                                      |       |                                                          |       |                                               |       |   |   |   |   |
| Earnings from continuing  operations                             |       | $                                                             | 18,954     |                                               | $          | 14,003 |   | $ | 32,972 |   | $ | 24,974 |   |
| Earnings from  discontinued operations, net of income taxes |       | $                                                             | —     |                                               | $          | 398 |   | $ | — |   | $ | 1,198 |   |
| Net earnings                                                     |       | $                                                             | 18,954     |                                               | $          | 14,401 |   | $ | 32,972 |   | $ | 26,172 |   |
| Diluted common shares outstanding:                               |       |                                                          |       |                                               |       |   |   |   |   |
| Weighted average common  shares outstanding                      |       | 27,676                                                        |       | 27,071                                             |       | 27,578 |   | 27,004 |   |
| Stock options and  restricted stock                              |       | 1,041                                                         |       | 710                                                |       | 982 |   | 617 |   |
| Diluted common shares  outstanding                               |       | 28,717                                                        |       | 27,781                                             |       | 28,560 |   | 27,621 |   |
| Diluted earnings per share                                       |       |                                                          |       |                                               |       |   |   |   |   |
| Earnings from continuing  operations                             |       | $                                                             | 0.66       |                                               | $          | 0.50 |   | $ | 1.15 |   | $ | 0.90 |   |
| Earnings from  discontinued operations, net of income taxes |       | $                                                             | —     |                                               | $          | 0.01 |   | $ | — |   | $ | 0.04 |   |
| Net earnings                                                     |       | $                                                             | 0.66       |                                               | $          | 0.52 |   | $ | 1.15 |   | $ | 0.95 |   |

 

13

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

At September 30, 2005and****2004, there were 22,500options and 51,000 options outstanding, respectively, that were excluded fromthe diluted EPS calculation because their inclusion would have had anantidilutive effect on EPS.

**9.   Comprehensive earnings**

Thecomponents of comprehensive earnings for the three- and six-month periods endedSeptember 30, 2005 and 2004 consisted of the following:

| ** **                                                                                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Six Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                         | ** ** | **2005**                                             | ** ** | **2004**                                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                         | ** ** | **(in thousands)**                              | ** ** |
| Net earnings                                                                                       |       | $                                                    | 18,954     |                                               | $          | 14,401 |   | $ | 32,972 |   | $ | 26,172 |   |
| Other comprehensive  earnings:                                                                     |       |                                                 |       |                                               |       |   |   |   |   |
| Foreign currency translation adjustments                                                           |       | 2,157                                                |       | 1,958                                              |       | 845 |   | 862 |   |
| Unrealized net (losses) gains on hedging instruments  arising during the period, net of income tax |       | —                                               |       | (682                                               | )          | — |   | 602 |   |
| Amortization of unrealized gain on terminated  hedging instrument, net of income taxes             |       | (46                                                  | )          | —                                             |       | (92 | ) | — |   |
| Comprehensive earnings                                                                             |       | $                                                    | 21,065     |                                               | $          | 15,677 |   | $ | 33,725 |   | $ | 27,636 |   |

 

**10.   Pensionsand Other Employee 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, 2005 and 2004. These plans are more fullydescribed in Note 12 to the Company’s Consolidated Financial Statements for theyear ended March 31, 2005.

| ** **                                       | ** ** | **Funded  Pension Plans**                           | ** ** | **Postretirement  Benefit Plans** | ** ** | **Unfunded  Supplemental  Retirement  Plans** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                       | ** ** | **Three Months Ended September 30,** | ** ** |
| ** **                                       | ** ** | **2005**                                                 | ** ** | **2004**                               | ** ** | **2005**                                      | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                       | ** ** | **(in thousands)**                                  | ** ** |
| Service cost                                     |       | $                                                        | 988        |                                   | $          | 961                                           |       | $ | 150 |   | $ | 134 |   | $ | 136 |   | $ | 104 |   |
| Interest cost                                    |       | 1,511                                                    |       | 1,455                                  |       | 241                                           |       | 238 |   | 279 |   | 241 |   |
| Expected return  on plan assets                  |       | (1,769                                                   | )          | (1,600                                 | )          | (42                                           | )          | (23 | ) | — |   | — |   |
| Amortization of  unrecognized loss (gain)        |       | 43                                                       |       | 32                                     |       | (2                                            | )          | 23 |   | 42 |   | 1 |   |
| Amortization of  transition obligation           |       | —                                                   |       | —                                 |       | 27                                            |       | 9 |   | — |   | — |   |
| Amortization of  unrecognized prior-service cost |       | 2                                                        |       | 1                                      |       | —                                        |       | — |   | 194 |   | 194 |   |
| Net periodic benefit  cost                       |       | $                                                        | 775        |                                   | $          | 849                                           |       | $ | 374 |   | $ | 381 |   | $ | 651 |   | $ | 540 |   |

 

14

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

 

| ** **                                       | ** ** | **Funded  Pension Plans**          | ** ** | **Postretirement  Benefit Plans** | ** ** | **Unfunded  Supplemental  Retirement  Plans** | ** ** |
|--------------------------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                       | ** ** | **Six Months Ended September 30,** | ** ** |
| ** **                                       | ** ** | **2005**                                | ** ** | **2004**                               | ** ** | **2005**                                      | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                       | ** ** | **(in thousands)**                      | ** ** |
| Service cost                                     |       | $                                       | 1,976      |                                   | $          | 1,922                                         |       | $ | 299 |   | $ | 268 |   | $ | 272 |   | $ | 208 |   |
| Interest cost                                    |       | 3,021                                   |       | 2,910                                  |       | 482                                           |       | 476 |   | 558 |   | 482 |   |
| Expected return  on plan assets                  |       | (3,539                                  | )          | (3,200                                 | )          | (84                                           | )          | (46 | ) | — |   | — |   |
| Amortization of  unrecognized loss (gain)        |       | 86                                      |       | 64                                     |       | (5                                            | )          | 46 |   | 84 |   | 2 |   |
| Amortization of  transition obligation           |       | —                                  |       | —                                 |       | 54                                            |       | 18 |   | — |   | — |   |
| Amortization of  unrecognized prior-service cost |       | 5                                       |       | 2                                      |       | —                                        |       | — |   | 389 |   | 388 |   |
| Net periodic benefit  cost                       |       | $                                       | 1,549      |                                   | $          | 1,698                                         |       | $ | 746 |   | $ | 762 |   | $ | 1,303 |   | $ | 1,080 |   |

 

The Company expects tocontribute $4.1 million and $1.8 million to its pension and postretirementplans, respectively, during the fiscal year ended March 31, 2006, of which$1.7 million and $0.9 million, were contributed during the six-month periodended September 30, 2005.

**11.**   Operating Segments

The Company’s two principal operating segments, on thebasis of products and services offered, are: the Command, Control,Communications, Computers and Intelligence (C4I) Group and the Surveillance andReconnaissance (SR) Group. All other operations are grouped in Other.

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, 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 business areas:Reconnaissance, Surveillance and Target Acquisition (RSTA), which develops andproduces electro-optical sighting, targeting and weapon sensor systems,high-speed digital data and imaging systems, aircraft weapons alignmentsystems, mission and flight recorders, image intensification night vision,combat identification and laser aimer/illuminator products, and provideselectronic manufacturing services; Training and Control Systems, which developsand produces air combat training, electronic warfare and network systems andunmanned vehicles; and Test & Energy Management, which develops andproduces electronic test, diagnostics and vehicle electronics.

15

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

Otherincludes the activities of DRS Corporate Headquarters and certain non-operatingsubsidiaries of the Company. Information about the Company’s operating segmentsfor the three- and six-month periods ended September 30, 2005 and 2004 isas follows:

| ** **                                      | ** ** | **C4I Group**      | ** ** | **SR Group** | ** ** | **Other** | ** ** | **Total** | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|-------------------|------------|-----------|------------|-----------|------------|
| ** **                                      | ** ** | **(in thousands)** | ** ** |
| **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 |   |
| **Three  Months Ended September 30, 2004** |       |                    |       |              |       |      |       |      |       |
| Total revenues                                  |       | $                       | 168,672    |              | $          | 152,264   |       | $         | —     |   | $ | 320,936 |   |
| Intersegment revenues                           |       | (547                    | )          | (2,336            | )          | —    |       | (2,883    | )          |
| External revenues                               |       | $                       | 168,125    |              | $          | 149,928   |       | $         | —     |   | $ | 318,053 |   |
| Operating income (loss)                         |       | $                       | 17,557     |              | $          | 16,289    |       | $         | (40        | ) | $ | 33,806 |   |
| Assets of continuing operations                 |       | $                       | 757,106    |              | $          | 679,843   |       | $         | 87,653     |   | $ | 1,524,602 |   |
| Depreciation and amortization                   |       | $                       | 3,604      |              | $          | 6,461     |       | $         | 662        |   | $ | 10,727 |   |
| Capital expenditures                            |       | $                       | 1,805      |              | $          | 3,812     |       | $         | 552        |   | $ | 6,169 |   |
| **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 |   |
| **Six  Months Ended September 30, 2004**   |       |                    |       |              |       |      |       |      |       |
| Total revenues                                  |       | $                       | 327,618    |              | $          | 286,886   |       | $         | —     |   | $ | 614,504 |   |
| Intersegment revenues                           |       | (910                    | )          | (4,390            | )          | —    |       | (5,300    | )          |
| External revenues                               |       | $                       | 326,708    |              | $          | 282,496   |       | $         | —     |   | $ | 609,204 |   |
| Operating income (loss)                         |       | $                       | 32,677     |              | $          | 29,715    |       | $         | (86        | ) | $ | 62,306 |   |
| Assets of continuing operations                 |       | $                       | 757,106    |              | $          | 679,843   |       | $         | 87,653     |   | $ | 1,524,602 |   |
| Depreciation and amortization                   |       | $                       | 6,446      |              | $          | 12,885    |       | $         | 1,316      |   | $ | 20,647 |   |
| Capital  expenditures                           |       | $                       | 3,960      |              | $          | 8,367     |       | $         | 1,253      |   | $ | 13,580 |   |

 

16

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

Thetable below provides a reconciliation of total consolidated assets to totalassets of continuing operations presented above:

| ** **                         | ** ** | **September 30,  2004** | ** ** |
|------------------------------------|------------|------------------------------|------------|
| ** **                         | ** ** | **(in thousands)**      | ** ** |
| Assets of  continuing operations   |       |                         | $          | 1,524,602 |   |   |
| Assets of  discontinued operations |       |                         | 41,657     |   |   |
| Total assets                       |       |                         | $          | 1,566,259 |   |   |

 

**12.**   SupplementalCash Flow Information

| ** **                                                               | ** ** | **Six Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                               | ** ** | **2005**                                           | ** ** | **2004** | ** ** |
| ** **                                                               | ** ** | **(in thousands)**                            | ** ** |
| Cash paid for:                                                           |       |                                               |       |   |   |
| Income taxes                                                             |       | $                                                  | 20,742     |   | $ | 6,020 |   |
| Interest                                                                 |       | $                                                  | 21,411     | * | $ | 16,024 |   |
| Supplemental disclosure  of non-cash investing and financing activities: |       |                                               |       |   |   |
| Acquisition costs  for business combinations, net                        |       | $                                                  | 202        |   | $ | — |   |

----

*                    Excludesthe advanced interest of $2.0 million that was repaid on May 1, 2005 inconjunction with the semi-annual interest payments on the notes. See Note 7, “Debt.”

**13.**   CashDividends on DRS Common Stock

On August 4, 2005,the Board of Directors declared a $0.03 per common share cash dividend, whichwas paid on September 30, 2005 to stockholders of record as of September 15,2005. Cash dividends paid in the first and second quarter’s of fiscal 2006 were$0.8 million and $0.8 million, respectively. On November 3, 2005, theBoard of Directors declared a $0.03 per common share cash dividend, payable on December 30,2005 to stockholders of record as of December 15, 2005.

**14.**   Contingenciesand Related Party Transactions

**Contingencies  **TheCompany is party to various legal actions and claims arising in the ordinarycourse of its business. In the Company’s opinion, the Company has adequatelegal defenses for each of the actions and claims.

Various legal actions,claims, assessments and other contingencies arising in the normal course of theCompany’s business, including certain matters described below, are pendingagainst the Company and certain of its subsidiaries. These matters are subjectto many uncertainties, and it is possible that some of these matters ultimatelycould be decided, resolved or settled adversely. The Company has recordedaccruals totaling $4.7 million and $10.2 million at September 30, 2005 andMarch 31, 2005, respectively, for losses related to those matters that itconsiders to be probable and that can be reasonably estimated (certain legaland environmental matters are discussed in detail below). Although the ultimateamount of liability at September 30, 2005 that may result from thosematters for which the Company has recorded accruals is not ascertainable, theCompany believes that any amounts exceeding the Company’s recorded 

17

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

accrualsshould not materially affect the Company’s financial condition or liquidity. Itis possible, however, that the ultimate resolution of those matters couldresult in a material adverse effect on the Company’s results of operations fora particular reporting period.

***Legal and Environmental***

On October 3, 2001, a lawsuit was filed byMiltope Corporation and IV Phoenix Group, Inc., against DRS Technologies, Inc.,DRS Electronic Systems, Inc. and a number of individual defendants,several of whom had been employed by DRS Electronic Systems, Inc. Theplaintiffs’ claims against DRS related generally to the activities of certainformer employees of IV Phoenix Group and the hiring of some of those employeesby the Company. On May 4, 2005, DRS entered into a settlement agreement,pursuant to which the Company agreed to pay $7.5 million to the plaintiffs, andlitigation involving the parties was resolved to their satisfaction, with theelimination of all outstanding claims. A charge of $6.5 million was recorded duringfiscal 2005 to increase the Company’s accrual for the matter to $7.5 millionas of March 31, 2005. The settlement payment was made on May 5, 2005.

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 thepresence of residual radioactive materials and contamination. Subsequent to theCompany’s acquisition of IDT, the Orphan Mine site was added to the NationalPriority List of contaminated sites. Some environmental laws, such as theComprehensive Environmental Response, Compensation and Liability Act of 1980(also known as CERCLA or the Superfund law) and similar state statutes, canimpose liability for the entire cost of the clean up of contaminated sites uponany of the current or former site owners or operators (or upon parties who sendwaste to these sites), regardless of the lawfulness of the original activitiesthat led to the contamination.

A corporation of which Tech-Sym is an allegedsuccessor operated this uranium mine from 1956 to 1967. In 1962, the land wassold to the U.S. government, and the alleged predecessor of Tech-Sym was givena 25-year mining lease. In 1967, the mining rights were transferred to athird party by a trustee in bankruptcy, and the Company believes that the minewas operated by such third party until approximately 1969. The Companyunderstands 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 the Company an Engineering Evaluation/Cost Analysis Work Plan underCERCLA (the CERCLA Letter) with regard to Operable Unit 1 (the upper mine area)of the Orphan Mine site. In the Company’s view, this Work Plan includedadditional cleanup not covered by CERCLA. The CERCLA Letter also requested (a) paymentof $0.5 million 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 and toreimburse the NPS for future costs. The NPS advised that a similar letter hasbeen sent to another PRP. The Company initiated discussions with such 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,such 

18

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

technical consultantsubmitted to the NPS, on behalf of the Company and such other PRP, analternative Engineering Evaluation/Cost Analysis Work Plan (the “EE/CA”) withregards to Operating Units 1 and 2 of the Orphan Mine Site. It is anticipatedthat the PRPs and NPS will engage in discussions regarding the merits of thisEE/CA prior to the end of calendar year 2005. The potential liability canchange substantially due to such factors as additional information on thenature or extent of contamination, methods of remediation required, changes inthe apportionment of costs among responsible parties and other actions bygovernmental agencies or private parties.

On November 24, 2004,a lawsuit was filed in the United States District Court for the District ofColorado by ITT Industries, Inc., a corporation of the State of Indiana,against DRS Tactical Systems, Inc. The plaintiff alleged DRS breached asubcontract between DRS and ITT and sought damages in excess of $5.0 million.The claim generally related to the performance by DRS and its predecessors, DRSTactical Systems (West), Inc. and Catalina Research Inc., under asubcontract for a component being supplied to ITT under ITT’s prime contractwith the U.S. Army. On February 14, 2005, DRS Tactical Systems, Inc.filed its answer, affirmative defenses and counterclaims. The counterclaimsalleged breach of contract and breach of duties of good faith and fair dealing,and sought damages of no less than $1.8 million. The Company and ITT agreed toconduct nonbinding mediation, as a result of which the case was settled on August 31,2005 with the execution of mutual releases and no damages due to either party.

**Proposed Mergerwith ESSI**

Under the terms of the acquisition agreement betweenESSI and the Company, the Company is obligated to pay, under certaincircumstances, $20.0 million in liquidated damages to ESSI in the event thatthe acquisition is terminated due to the Company’s failure to obtain financing.

**Related Party 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 $21.2 thousand expires on April 30,2007. Following Leonard Newman’s death in November 1998, Mrs. RuthNewman, the wife of Leonard Newman and the mother of Mark S. Newman, succeededto Leonard 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 DRS during the six months ended September 30, 2005 and 2004. Fees paidto Skadden, Arps, Slate, Meagher & Flom LLP for the six months ended September 30,2005 and 2004 were $0.8 million and $0.3 million, respectively.

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

19

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

**15.**   Guarantorand Non-Guarantor Financial Statements

As further discussed in Note 7, “Debt,” at September 30,2005, the Company has $550.0 million of 67¤8% SeniorSubordinated Notes outstanding. The Notes are fully and unconditionallyguaranteed, jointly and severally, by the Company’s wholly-owned domesticsubsidiaries (the Guarantor Subsidiaries). The foreign subsidiaries and certaindomestic subsidiaries of DRS (the Non-Guarantor Subsidiaries) do not guaranteethe Notes. The following condensed consolidating financial information presentsthe Condensed Consolidating Balance Sheets, as of September 30, 2005 and March 31,2005, the Condensed Consolidating Statements of Earnings for the three- andsix-month periods ended September 30, 2005 and 2004, and the CondensedConsolidating Statements of Cash Flows for the six months ended September 30,2005 and 2004 for:

a)     DRSTechnologies, Inc. (the Parent),

b)     theGuarantor Subsidiaries,

c)     theNon-guarantor Subsidiaries, and

d)     DRSTechnologies, 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 statement information for each of the Guarantor and Non-guarantorSubsidiaries are not presented because management believes such financialstatements would not be meaningful to investors.

20

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

**CondensedConsolidating Balance Sheet As of September 30, 2005 (in thousands)**

| ** **                                           | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                           |       |                |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |
| **Current assets**                                   |       |                |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |
| Cash and cash equivalents                            |       | $                   | 234,531    |                        | $          | (842                            | )          |             | $          | 23,565           |       |   |   | $ | — |   |   |   | $ | 257,254 |   |   |
| Accounts receivable, net                             |       | 4                   |       | 209,713                     |       |                            | 28,757     |             |       |             | —     |   |   |   | 238,474 |   |   |
| Inventories, net                                     |       | —              |       | 189,030                     |       |                            | 39,795     |             |       |             | (14        | ) |   |   | 228,811 |   |   |
| Prepaid expenses and other current assets            |       | 5,284               |       | 45,854                      |       |                            | 1,597      |             |       |             | (2,375     | ) |   |   | 50,360 |   |   |
| Intercompany receivables                             |       | 443,071             |       | —                      |       |                            | 23,926     |             |       |             | (466,997   | ) |   |   | — |   |   |
| **Total current assets**                             |       | 682,890             |       | 443,755                     |       |                            | 117,640    |             |       |             | (469,386   | ) |   |   | 774,899 |   |   |
| Property, plant and equipment,   net                 |       | 12,485              |       | 125,249                     |       |                            | 6,328      |             |       |             | —     |   |   |   | 144,062 |   |   |
| Acquired  intangibles, net                           |       | —              |       | 101,953                     |       |                            | —     |             |       |             | —     |   |   |   | 101,953 |   |   |
| Goodwill                                             |       | 23,926              |       | 772,509                     |       |                            | 23,130     |             |       |             | —     |   |   |   | 819,565 |   |   |
| Deferred income  taxes and other noncurrent assets   |       | 28,953              |       | 4,640                       |       |                            | 2,311      |             |       |             | (4,415     | ) |   |   | 31,489 |   |   |
| Investment in  subsidiaries                          |       | 403,911             |       | 49,635                      |       |                            | —     |             |       |             | (453,546   | ) |   |   | — |   |   |
| **Total assets**                                     |       | $                   | 1,152,165  |                        | $          | 1,497,741                       |       |             | $          | 149,409          |       |   |   | $ | (927,347 | ) |   |   | $ | 1,871,968 |   |   |
| **Liabilities and Stockholders’ Equity**   |       |                |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |
| **Current liabilities**                              |       |                |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |
| Current installments of long-term debt               |       | $                   | 2,360      |                        | $          | 240                             |       |             | $          | —           |       |   |   | $ | — |   |   |   | $ | 2,600 |   |   |
| Accounts payable                                     |       | 3,702               |       | 97,008                      |       |                            | 21,071     |             |       |             | —     |   |   |   | 121,781 |   |   |
| Accrued expenses and other current liabilities       |       | 28,574              |       | 212,927                     |       |                            | 21,073     |             |       |             | (2,386     | ) |   |   | 260,188 |   |   |
| Intercompany payables                                |       | —              |       | 495,757                     |       |                            | 16,987     |             |       |             | (512,744   | ) |   |   | — |   |   |
| Total current liabilities                            |       | 34,636              |       | 805,932                     |       |                            | 59,131     |             |       |             | (515,130   | ) |   |   | 384,569 |   |   |
| Long-term debt, excluding current installments       |       | 703,071             |       | 2,704                       |       |                            | —     |             |       |             | —     |   |   |   | 705,775 |   |   |
| Other liabilities                                    |       | 10,433              |       | 46,789                      |       |                            | 12,361     |             |       |             | (4,416     | ) |   |   | 65,167 |   |   |
| **Total liabilities**                                |       | 748,140             |       | 855,425                     |       |                            | 71,492     |             |       |             | (519,546   | ) |   |   | 1,155,511 |   |   |
| **Total stockholders’ equity**                  |       | 404,025             |       | 642,316                     |       |                            | 77,917     |             |       |             | (407,801   | ) |   |   | 716,457 |   |   |
| **Total  liabilities and stockholders’ equity** |       | $                   | 1,152,165  |                        | $          | 1,497,741                       |       |             | $          | 149,409          |       |   |   | $ | (927,347 | ) |   |   | $ | 1,871,968 |   |   |

 

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

**CondensedConsolidating Balance SheetAs of March 31, 2005(in thousands)**

| ** **                                           | ** ** | **Parent   Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------|------------|---------------------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                           |       |                      |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |
| **Current  assets**                                  |       |                      |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |
| Cash and cash equivalents                            |       | $                         | 300,788    |                        | $          | (8,272                          | )          |             | $          | 14,336           |       |   |   | $ | — |   |   |   | $ | 306,852 |   |   |
| Accounts receivable, net                             |       | 4                         |       | 202,517                     |       |                            | 35,391     |             |       |             | —     |   |   |   | 237,912 |   |   |
| Inventories, net                                     |       | —                    |       | 165,036                     |       |                            | 43,105     |             |       |             | —     |   |   |   | 208,141 |   |   |
| Prepaid expenses and other current assets            |       | 4,645                     |       | 35,180                      |       |                            | 2,309      |             |       |             | —     |   |   |   | 42,134 |   |   |
| Intercompany receivables                             |       | 412,641                   |       | 23,269                      |       |                            | 49,876     |             |       |             | (485,786   | ) |   |   | — |   |   |
| **Total current assets**                             |       | 718,078                   |       | 417,730                     |       |                            | 145,017    |             |       |             | (485,786   | ) |   |   | 795,039 |   |   |
| Property, plant and equipment,   net                 |       | 12,073                    |       | 125,422                     |       |                            | 5,769      |             |       |             | —     |   |   |   | 143,264 |   |   |
| Acquired  intangibles, net                           |       | —                    |       | 100,030                     |       |                            | —     |             |       |             | —     |   |   |   | 100,030 |   |   |
| Goodwill                                             |       | 24,093                    |       | 768,303                     |       |                            | 23,011     |             |       |             | —     |   |   |   | 815,407 |   |   |
| Deferred income  taxes and other noncurrent assets   |       | 30,068                    |       | 3,803                       |       |                            | 1,679      |             |       |             | (2,649     | ) |   |   | 32,901 |   |   |
| Investment in  subsidiaries                          |       | 397,168                   |       | 49,635                      |       |                            | —     |             |       |             | (446,803   | ) |   |   | — |   |   |
| **Total assets**                                     |       | $                         | 1,181,480  |                        | $          | 1,464,923                       |       |             | $          | 175,476          |       |   |   | $ | (935,238 | ) |   |   | $ | 1,886,641 |   |   |
| **Liabilities  and Stockholders’ Equity**  |       |                      |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |
| **Current  liabilities**                             |       |                      |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |
| Current installments of long-term debt               |       | $                         | 2,360      |                        | $          | 292                             |       |             | $          | —           |       |   |   | $ | — |   |   |   | $ | 2,652 |   |   |
| Accounts payable                                     |       | 3,146                     |       | 85,922                      |       |                            | 22,154     |             |       |             | —     |   |   |   | 111,222 |   |   |
| Accrued expenses and other current liabilities       |       | 26,108                    |       | 257,029                     |       |                            | 18,193     |             |       |             | 31         |   |   |   | 301,361 |   |   |
| Intercompany payables                                |       | 18,978                    |       | 465,948                     |       |                            | 46,772     |             |       |             | (531,698   | ) |   |   | — |   |   |
| Total current liabilities                            |       | 50,592                    |       | 809,191                     |       |                            | 87,119     |             |       |             | (531,667   | ) |   |   | 415,235 |   |   |
| Long-term debt, excluding current installments       |       | 724,817                   |       | 2,794                       |       |                            | —     |             |       |             | —     |   |   |   | 727,611 |   |   |
| Other liabilities                                    |       | 8,967                     |       | 51,916                      |       |                            | 14,131     |             |       |             | (2,647     | ) |   |   | 72,367 |   |   |
| **Total liabilities**                                |       | 784,376                   |       | 863,901                     |       |                            | 101,250    |             |       |             | (534,314   | ) |   |   | 1,215,213 |   |   |
| **Total stockholders’ equity**                  |       | 397,104                   |       | 601,022                     |       |                            | 74,226     |             |       |             | (400,924   | ) |   |   | 671,428 |   |   |
| **Total  liabilities and stockholders’ equity** |       | $                         | 1,181,480  |                        | $          | 1,464,923                       |       |             | $          | 175,476          |       |   |   | $ | (935,238 | ) |   |   | $ | 1,886,641 |   |   |

 

22

----

**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                             |       |                | 32         |                        |       |                            | 57         |             |       |             | (426       | ) |   |   | — |   |   |   | (337 | ) |   |
| Management fees                                          |       |                | 533        |                        |       |                            | (492       | )                |       |             | (41        | ) |   |   | — |   |   |   | — |   |   |
| Royalties                                                |       |                | 507        |                        |       |                            | —     |             |       |             | (507       | ) |   |   | — |   |   |   | — |   |   |
| Intercompany interest                                    |       |                | 7,070      |                        |       |                            | (7,306     | )                |       |             | 236        |   |   |   | — |   |   |   | — |   |   |
| Earnings before minority  interest and income taxes |       |                | (4,354     | )                           |       |                            | 28,339     |             |       |             | 4,047      |   |   |   | (14 | ) |   |   | 28,018 |   |   |
| Minority interest                                        |       |                | —     |                        |       |                            | —     |             |       |             | 502        |   |   |   | — |   |   |   | 502 |   |   |
| Earnings before income  taxes                            |       |                | (4,354     | )                           |       |                            | 28,339     |             |       |             | 3,545      |   |   |   | (14 | ) |   |   | 27,516 |   |   |
| Income taxes                                             |       |                | (1,386     | )                           |       |                            | 8,788      |             |       |             | 1,165      |   |   |   | (5 | ) |   |   | 8,562 |   |   |
| **Net earnings**                                         |       |                | $          | (2,968                      | )          |                            |       | $                | 19,551     |             |       |   | $ | 2,380 |   |   |   | $ | (9 | ) |   |   | $ | 18,954 |   |   |

 

**CondensedConsolidating Statements of EarningsThree Months Ended September 30, 2004(in thousands)**

| ** **                                                       | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **Revenues**                                                     |       |                | $          | —                      |       |                            |       | $                | 268,562    |             |       |   | $ | 54,612 |   |   |   | $ | (5,121 | ) |   |   | $ | 318,053 |   |   |
| Cost and expenses                                                |       |                | 38         |                        |       |                            | 236,057    |             |       |             | 53,330     |   |   |   | (5,178 | ) |   |   | 284,247 |   |   |
| Operating income                                                 |       |                | (38        | )                           |       |                            | 32,505     |             |       |             | 1,282      |   |   |   | 57 |   |   |   | 33,806 |   |   |
| Interest income                                                  |       |                | 168        |                        |       |                            | (12        | )                |       |             | 13         |   |   |   | — |   |   |   | 169 |   |   |
| Interest and  related expense                                    |       |                | 8,943      |                        |       |                            | 17         |             |       |             | 46         |   |   |   | — |   |   |   | 9,006 |   |   |
| Other income  (expense), net                                     |       |                | 40         |                        |       |                            | 344        |             |       |             | (475       | ) |   |   | — |   |   |   | (91 | ) |   |
| Management fees                                                  |       |                | 422        |                        |       |                            | (388       | )                |       |             | (34        | ) |   |   | — |   |   |   | — |   |   |
| Royalties                                                        |       |                | 424        |                        |       |                            | —     |             |       |             | (424       | ) |   |   | — |   |   |   | — |   |   |
| Intercompany  interest                                           |       |                | 7,283      |                        |       |                            | (7,235     | )                |       |             | (48        | ) |   |   | — |   |   |   | — |   |   |
| Earnings before minority interest and income taxes               |       |                | (644       | )                           |       |                            | 25,197     |             |       |             | 268        |   |   |   | 57 |   |   |   | 24,878 |   |   |
| Minority interest                                                |       |                | —     |                        |       |                            | —     |             |       |             | 528        |   |   |   | — |   |   |   | 528 |   |   |
| Earnings before income taxes                                     |       |                | (644       | )                           |       |                            | 25,197     |             |       |             | (260       | ) |   |   | 57 |   |   |   | 24,350 |   |   |
| Income taxes                                                     |       |                | (272       | )                           |       |                            | 10,705     |             |       |             | (112       | ) |   |   | 26 |   |   |   | 10,347 |   |   |
| Earnings from  continuing operations                             |       |                | (372       | )                           |       |                            | 14,492     |             |       |             | (148       | ) |   |   | 31 |   |   |   | 14,003 |   |   |
| Earnings from  discontinued operations, net of income taxes |       |                | —     |                        |       |                            | 398        |             |       |             | —     |   |   |   | — |   |   |   | 398 |   |   |
| **Net  earnings**                                                |       |                | $          | (372                        | )          |                            |       | $                | 14,890     |             |       |   | $ | (148 | ) |   |   | $ | 31 |   |   |   | $ | 14,401 |   |   |

 

23

----

**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                       |       |                | 68         |                        |       |                            | 64         |             |       |             | (444       | ) |   |   | — |   |   |   | (312 | ) |   |
| Management fees                                    |       |                | 1,053      |                        |       |                            | (972       | )                |       |             | (81        | ) |   |   | — |   |   |   | — |   |   |
| Royalties                                          |       |                | 1,030      |                        |       |                            | —     |             |       |             | (1,030     | ) |   |   | — |   |   |   | — |   |   |
| Intercompany  interest                             |       |                | 13,324     |                        |       |                            | (13,655    | )                |       |             | 331        |   |   |   | — |   |   |   | — |   |   |
| Earnings before minority interest and income taxes |       |                | (7,634     | )                           |       |                            | 53,752     |             |       |             | 6,663      |   |   |   | (14 | ) |   |   | 52,767 |   |   |
| Minority interest                                  |       |                | —     |                        |       |                            | —     |             |       |             | 1,082      |   |   |   | — |   |   |   | 1,082 |   |   |
| Earnings before income taxes                       |       |                | (7,634     | )                           |       |                            | 53,752     |             |       |             | 5,581      |   |   |   | (14 | ) |   |   | 51,685 |   |   |
| Income taxes                                       |       |                | (2,764     | )                           |       |                            | 19,462     |             |       |             | 2,020      |   |   |   | (5 | ) |   |   | 18,713 |   |   |
| **Net  earnings**                                  |       |                | $          | (4,870                      | )          |                            |       | $                | 34,290     |             |       |   | $ | 3,561 |   |   |   | $ | (9 | ) |   |   | $ | 32,972 |   |   |

 

**CondensedConsolidating Statements of EarningsSix Months Ended September 30, 2004(in thousands)**

| ** **                                                       | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **Revenues**                                                     |       |                | $          | —                      |       |                            |       | $                | 519,727    |             |       |   | $ | 98,119 |   |   |   | $ | (8,642 | ) |   |   | $ | 609,204 |   |   |
| Cost and expenses                                                |       |                | 83         |                        |       |                            | 460,553    |             |       |             | 94,985     |   |   |   | (8,723 | ) |   |   | 546,898 |   |   |
| Operating income                                                 |       |                | (83        | )                           |       |                            | 59,174     |             |       |             | 3,134      |   |   |   | 81 |   |   |   | 62,306 |   |   |
| Interest income                                                  |       |                | 273        |                        |       |                            | —     |             |       |             | 25         |   |   |   | — |   |   |   | 298 |   |   |
| Interest and related  expense                                    |       |                | 17,860     |                        |       |                            | 59         |             |       |             | 81         |   |   |   | — |   |   |   | 18,000 |   |   |
| Other income (expense),  net                                     |       |                | 95         |                        |       |                            | 42         |             |       |             | (288       | ) |   |   | — |   |   |   | (151 | ) |   |
| Management fees                                                  |       |                | 835        |                        |       |                            | (766       | )                |       |             | (69        | ) |   |   | — |   |   |   | — |   |   |
| Royalties                                                        |       |                | 792        |                        |       |                            | —     |             |       |             | (792       | ) |   |   | — |   |   |   | — |   |   |
| Intercompany interest                                            |       |                | 14,358     |                        |       |                            | (13,995    | )                |       |             | (363       | ) |   |   | — |   |   |   | — |   |   |
| Earnings before minority  interest and income taxes              |       |                | (1,590     | )                           |       |                            | 44,396     |             |       |             | 1,566      |   |   |   | 81 |   |   |   | 44,453 |   |   |
| Minority interest                                                |       |                | —     |                        |       |                            | —     |             |       |             | 925        |   |   |   | — |   |   |   | 925 |   |   |
| Earnings before income  taxes                                    |       |                | (1,590     | )                           |       |                            | 44,396     |             |       |             | 641        |   |   |   | 81 |   |   |   | 43,528 |   |   |
| Income taxes                                                     |       |                | (677       | )                           |       |                            | 18,921     |             |       |             | 274        |   |   |   | 36 |   |   |   | 18,554 |   |   |
| Earnings from continuing  operations                             |       |                | (913       | )                           |       |                            | 25,475     |             |       |             | 367        |   |   |   | 45 |   |   |   | 24,974 |   |   |
| Earnings from  discontinued operations, net of income taxes |       |                | —     |                        |       |                            | 1,198      |             |       |             | —     |   |   |   | — |   |   |   | 1,198 |   |   |
| **Net earnings**                                                 |       |                | $          | (913                        | )          |                            |       | $                | 26,673     |             |       |   | $ | 367 |   |   |   | $ | 45 |   |   |   | $ | 26,172 |   |   |

 

24

----

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

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

| ** **                                                              | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **Net  cash (used in) provided by operating activities**                |       | $                   | (22,989    | )                           |       | $                               | 41,440     |             |       |             | $          | 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 investing activities                                              |       | (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                                                          |       | 29,145              |       |                        | (21,557    | )                               |       |             | (7,588     | )                |       |   | — |   |   |   | — |   |   |
| **Net cash provided by (used in) financing activities**                 |       | 11,860              |       |                        | (21,731    | )                               |       |             | (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 |   |   |

 

25

----

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

**CondensedConsolidating Statements of Cash FlowsSix Months Ended September 30, 2004(in thousands)**

| ** **                                                                          | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **Net cash (used in) provided by  operating activities of continuing operations**   |       | $                   | (24,956    | )                           |       | $                               | 69,126     |             |       |             | $          | 4,405 |   |   |   | $ | — |   |   |   | $ | 48,575 |   |   |
| **Net cash (used in) provided by  operating activities of discontinued operations** |       | —              |       |                        | 1,975      |                            |       |             | —     |             |       |   | — |   |   |   | 1,975 |   |   |
| **Net cash (used in) provided by  operating activities**                            |       | (24,956             | )          |                        | 71,101     |                            |       |             | 4,405      |             |       |   | — |   |   |   | 50,550 |   |   |
| **Cash Flows from Investing Activities**                                            |       |                |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Capital expenditures                                                                |       | (1,253              | )          |                        | (11,299    | )                               |       |             | (1,028     | )                |       |   | — |   |   |   | (13,580 | ) |   |
| Payments pursuant to  business combinations, net of cash acquired              |       | (3,118              | )          |                        | —     |                            |       |             | —     |             |       |   | — |   |   |   | (3,118 | ) |   |
| Other investing  activities                                                         |       | 37                  |       |                        | 971        |                            |       |             | 37         |             |       |   | — |   |   |   | 1,045 |   |   |
| **Net cash used in investing  activities of continuing operations**            |       | (4,334              | )          |                        | (10,328    | )                               |       |             | (991       | )                |       |   | — |   |   |   | (15,653 | ) |   |
| **Net cash used in investing  activities of discontinued operations**          |       | —              |       |                        | (358       | )                               |       |             | —     |             |       |   | — |   |   |   | (358 | ) |   |
| **Net cash used in investing  activities**                                          |       | (4,334              | )          |                        | (10,686    | )                               |       |             | (991       | )                |       |   | — |   |   |   | (16,011 | ) |   |
| **Cash Flows from Financing Activities**                                            |       |                |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Net payments of  short-term debt                                                    |       | —              |       |                        | —     |                            |       |             | (82        | )                |       |   | — |   |   |   | (82 | ) |   |
| Repayment of long-term  debt                                                        |       | (21,180             | )          |                        | (328       | )                               |       |             | —     |             |       |   | — |   |   |   | (21,508 | ) |   |
| Proceeds from exercise  of stock options                                            |       | 1,674               |       |                        | —     |                            |       |             | —     |             |       |   | — |   |   |   | 1,674 |   |   |
| Other, net                                                                          |       | 51,615              |       |                        | (52,199    | )                               |       |             | 734        |             |       |   | — |   |   |   | 150 |   |   |
| **Net  cash provided by (used in) financing activities of continuing operations**   |       | 32,109              |       |                        | (52,527    | )                               |       |             | 652        |             |       |   | — |   |   |   | (19,766 | ) |   |
| **Net  cash provided by (used in) financing activities of discontinued operations** |       |                |       |                        | (14        | )                               |       |             | —     |             |       |   | — |   |   |   | (14 | ) |   |
| **Net  cash provided by (used in) financing activities**                            |       | 32,109              |       |                        | (52,541    | )                               |       |             | 652        |             |       |   | — |   |   |   | (19,780 | ) |   |
| **Effects of exchange rates on  cash and cash equivalents**                         |       | —              |       |                        | —     |                            |       |             | 359        |             |       |   | — |   |   |   | 359 |   |   |
| **Net increase  in cash and cash equivalents**                                      |       | 2,819               |       |                        | 7,874      |                            |       |             | 4,425      |             |       |   | — |   |   |   | 15,118 |   |   |
| **Cash and cash equivalents,  beginning of period**                                 |       | 55,342              |       |                        | (5,630     | )                               |       |             | 7,078      |             |       |   |   |   |   |   | 56,790 |   |   |
| **Cash and cash equivalents, end of period**                                        |       | $                   | 58,161     |                        |       | $                               | 2,244      |             |       |             | $          | 11,503 |   |   |   | $ | — |   |   |   | $ | 71,908 |   |   |

 

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

**16.   RecentlyIssued Accounting Pronouncements**

In November 2004, the FASB issued SFAS No. 151,“Inventory Costs, an amendment of ARB No. 43, Chapter 4.” SFAS No. 151clarifies that abnormal inventory costs, such as costs of idle facilities,excess freight and handling costs, and wasted materials (spoilage), arerequired to be recognized as current period charges. Additionally, SFAS No. 151requires that the allocation of fixed production overheads to the costs ofconversion be based on the normal capacity of the production facility. Theprovisions of SFAS No. 151 are effective for the fiscal year beginning April 1,2006. The Company currently is evaluating the provisions of SFAS No. 151and does not expect that the adoption will have a material impact on the Company’sconsolidated financial position or results of operations.

In December 2004, the FASB issued SFAS No. 153,“Exchanges of Nonmonetary Assets—An Amendment of APB Opinion No. 29,Accounting for Nonmonetary Transactions,” SFAS No. 153 eliminates the exceptionfrom fair value measurement for nonmonetary exchanges of similar productiveassets in paragraph 21(b) of APB Opinion No. 29, “Accounting forNonmonetary Transactions,” and replaces it with an exception for exchanges thatdo not have commercial substance. SFAS No. 153 specifies that anonmonetary exchange has commercial substance if the future cash flows of theentity are expected to change significantly as a result of the exchange. SFAS No. 153is effective for nonmonetary exchanges occurring in fiscal periods beginningafter June 15, 2005. The Company adopted SFAS No. 153 beginning onJuly 1, 2005 and its adoption had no impact on its consolidated results ofoperations and financial condition.

The U.S. enacted the American Jobs Creation Act of2004 (the American Jobs Creation Act) in October 2004 which contains manyprovisions affecting corporate taxation. The American Jobs Creation Act phasesout the extraterritorial income (ETI) exclusion benefit for export sales andphases in a new tax deduction for income from qualified domestic productionactivities (QPA) over a transition period beginning in 2005. In December 2004,the FASB issued FASB Staff Position 109-1 (FSP 109-1), whichprovides guidance that the QPA deduction should be treated as a special incometax deduction in the period earned and not as a tax-rate reduction. As such,QPA has no impact on our deferred tax assets or liabilities existing as of theenactment date. The Company will recognize a reduction in its provision forincome taxes for the QPA deduction in the period(s) in which the Companyis eligible for the deduction. The Company has completed its preliminaryevaluation of the net impact of the American Jobs Creation Act, and hasdetermined that the benefit from the phase-in of the QPA deduction willslightly exceed the lost benefit from the phase-out of the ETI exclusion. TheCompany also determined that the other provisions included in the American JobsCreation Act will not have a significant impact on the Company’s financialposition, results of operations or cash flows.

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

In May 2005,the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections—areplacement of APB Opinion No. 20 and FASB Statement No. 3,” ThisStatement replaces APB Opinion No. 20, “Accounting Changes,” and FASBStatement No. 3, “Reporting Accounting Changes in Interim FinancialStatements.” SFAS 154 changes the requirements for the accounting for andreporting of a change in accounting principle. Previously, most voluntarychanges in accounting principles required recognition through a cumulativeadjustment within net income of the period of the change. SFAS 154 requiresretrospective application to prior periods’ financial statements, unless it isimpracticable to determine either the period-specific effects or thecumulative effect of the change. SFAS 154 is effective for accountingchanges made in fiscal years beginning after December 15, 2005; however,the Statement does not change the specific transition provisions of anyexisting or future accounting pronouncements. The Company does not believeadoption of SFAS 154 will have a material effect on its consolidated financialposition and results of operations.

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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 business combination and disposal activityand a Company overview, followed by summaries of defense industryconsiderations and other business considerations to provide context forunderstanding our business. This is followed by a discussion of the criticalaccounting estimates that we believe are important to understanding theassumptions and judgments incorporated in our reported financial results, whichwe discuss under “Results of Continuing Operations.” We then provide ananalysis of cash flows and discuss our financial commitments under “Liquidityand Capital Resources” and “Contractual Obligations,” respectively. ThisMD&A should be read in conjunction with the consolidated financialstatements and related notes contained in our March 31, 2005 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.

**BusinessCombinations and Disposals**

On September 21, 2005, DRS and Engineered SupportSystems, Inc. (ESSI) entered into a merger agreement pursuant to whichESSI will merge with and into a wholly-owned subsidiary of ours, (the merger),in a transaction to be accounted for using the purchase method of accounting.The purchase price will approximate $1.9 billion, including merger-relatedexpenses. In addition to the purchase price, we will refinance approximately $86.0million of ESSI debt at closing of the merger.

The purchase price will be $43.00 per share of ESSIcommon stock, which will be comprised of $30.10 in cash and a fraction of ashare of DRS common stock valued at $12.90, provided that the average closingsale price per share of DRS common stock for a certain period prior to thecompletion of the merger is less than $57.20 per share but greater than $46.80per share. A collar provides that the exchange ratio will not exceed 0.2756 ofa share nor be less than 0.2255 of a share of DRS common stock. The equityconsideration in the merger will not be less than 9.9 million shares and notgreater than 12.1 million shares of DRS common stock, or an aggregate ofapproximately $566.4 million, based upon the assumption that the average priceof DRS common stock during the measurement period is not less than $46.80 pershare 

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and not greater than$57.20 per share. The number of shares of DRS common stock and the value ofsuch shares will not be determined until the second complete trading day beforethe closing; therefore, the final purchase price may be greater than or lessthan $1.9 billion. The merger agreement provides that at the time of thecompletion of the merger, all unexercised options to acquire ESSI common stockwill be cancelled in exchange for the same consideration paid to ESSIshareholders, reduced by the applicable exercise price.

We expect to finance the cash portion of theacquisition by utilizing existing excess cash on hand and through a combinationof bank borrowings and the issuance of debt securities.

The transaction is expected to close in the fourthquarter of fiscal 2006 and is subject to customary regulatory approvals andother closing conditions, including approval by our and ESSI’s stockholders atrespective special stockholder meetings.

ESSI, headquartered in St. Louis, Missouri, is asupplier of integrated military electronics, support equipment and technicalservices focused on advanced sustainment and logistics support solutions forall branches of the U.S. armed services, major prime defense contractors,certain international militaries, homeland security forces and selectedgovernment and intelligence agencies. ESSI also produces specialized equipmentand systems for commercial and industrial applications.

On April 15, 2005, we acquired Codem Systems, Inc.(Codem) in a stock purchase transaction for approximately $31.6 million in cash(subject to a working capital adjustment), with additional consideration payableof up to $5.0 million upon achievement of certain annual bookings targets for aperiod of three years. In addition to the purchase price, we recordedapproximately $0.4 million for acquisition-related costs. The results of Codem’soperations have been included in our financial statements since the date ofacquisition.

Codem located in Merrimack, New Hampshire, is aprovider of signals intelligence (SIGINT) systems, network interface modules,and high-performance antenna control systems. As a supplier of SIGINT products,Codem focuses on solutions for communications and surveillance applicationssupporting the intelligence, military and homeland security markets. We believethat the addition of Codem has enhanced our existing intelligence product base.Codem is being managed as a part of our Command, Control, Communications,Computers and Intelligence (C4I) Group.

On June 27, 2005, we acquired WalkAbout ComputerSystems (WalkAbout) in a stock purchase transaction for approximately $13.8million in cash (subject to a working capital adjustment), with additionalconsideration payable of up to $5.0 million upon achievement of certain revenuetargets for a period of two and a half years. In addition to the purchase price,we recorded approximately $0.3 million for acquisition-related costs. Theresults of WalkAbout have been included in our financial statements since thedate of acquisition.

WalkAbout, located in West Palm Beach, Florida, is amanufacturer of several lines of rugged, mobile tablet PCs, serving industrial,municipal, military and government markets. We believe that the acquisition ofWalkAbout has enhanced our position in the tactical computer systems businessby broadening our product offerings. WalkAbout is being managed as part of ourC4I Group.

On December 14, 2004, we acquired certain assetsand liabilities of Night Vision Equipment Co., Inc. and Excalibur ElectroOptics, Inc. (collectively referred to as NVEC hereinafter), a privately-heldbusiness headquartered in Allentown, Pennsylvania. The purchase price was $47.2million in cash, including a $4.7 million working capital adjustment paid inthe fourth quarter of fiscal 2005, with additional consideration of up to amaximum of $37.5 million payable upon achieving certain annual revenue targetsfor a period of three years. In addition to the purchase price, we recordedapproximately $0.3 million for acquisition-related costs. The results of NVEC’soperations have been included in our financial statements since the date of theacquisition.

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NVEC is a manufacturer and marketer of night visionproducts and combat identification systems. The company focuses on the rapiddevelopment and delivery of lightweight, affordable image intensification nightvision, uncooled thermal imaging, reflective combat identification andlaser-based products for U.S. and international militaries and paramilitaryorganizations. The acquisition of NVEC has enhanced DRS’s position in theuncooled infrared sensor and thermal imaging systems market, and has providedincreased access to and participation in homeland defense efforts at thefederal, state and local levels. NVEC is being managed as part of ourSurveillance and Reconnaissance (SR) Group.

On March 10, 2005, wecompleted the sale of DRS Weather Systems, Inc. and DRS BroadcastTechnology. We have restated our financial statements, related financialstatement data and discussions in this MD&A to present the operatingresults of these operating units as discontinued operations. Both companiesoperated as a part of our C4I Group.

**Company Overview**

DRS is primarily a supplier of defense electronicproducts and systems. We provide high-technology products and services to allbranches of the U.S. military, major aerospace and defense prime contractors,government intelligence agencies, international military forces and industrialmarkets. We are a leading provider of thermal imaging devices, combat displayworkstations, electronic sensor systems, power systems, battlefielddigitization systems, air combat training systems, mission recorders anddeployable flight incident recorders.

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

Our SR Group is comprised of the following businessareas: Reconnaissance, Surveillance and Target Acquisition (RSTA), whichdevelops and produces electro-optical sighting, targeting and weapon sensorsystems, high-speed digital data and imaging systems, aircraft weaponsalignment systems, mission and flight recorders and image intensification, nightvision, combat identification and laser aimer/illuminator products, andprovides electronic manufacturing services; Training and Control Systems, whichdevelops and produces air combat training, electronic warfare and networksystems and unmanned vehicles; and Test & Energy Management, whichdevelops and produces electronic test, diagnostics and vehicle electronics.

The substantial majority of our sales are generatedusing written contractual arrangements. These contracts require us to design,develop, manufacture, modify, test and/or integrate complex defense electronicequipment and systems, and to provide related engineering and technicalservices according to specifications provided to us by our customers. Ourprimary “end-use” customer is the U.S. Department of Defense (DoD).

The markets for defense and related advancedtechnology systems for fiscal 2006 and beyond will continue to be affected bythe global war on terrorism, through the continued need for military missionsand reconstruction efforts in Iraq and Afghanistan. The war on terrorism hasfocused greater attention on homeland security and better communication andinterplay between local, state and federal government agencies and U.S.military services. Our nation’s overall defense posture continues to movetoward a more capabilities-based structure, which creates the ability for amore flexible response with greater force mobility, stronger spacecapabilities, missile defense, and improved information systems capability andsecurity.

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DoD budgets haveexperienced increased focus on command, control, communications, computers,intelligence, surveillance and reconnaissance (C4ISR), precision-guidedweapons, unmanned aerial vehicles (UAVs), network-centric communications,Special Operations Forces (SOF) and missile defense. In addition, the DoDphilosophy has focused on a transformation strategy that balances modernizationand recapitalization (or upgrading existing platforms), while enhancingreadiness and joint operations. As a result, defense budget program allocationscontinue to favor advanced information technologies related to command,control, communications and computers, (C4) and Intelligence, Surveillance andReconnaissance (ISR). Furthermore, the DoD’s emphasis on system interoperability,force multipliers and providing battlefield commanders with real-time data isincreasing the electronic content of nearly all major military procurement andresearch programs.

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. Weexpect to continue to benefit from the outsourcing of subsystems, componentsand products by prime contractors. We plan to continue to align our researchand development, manufacturing and new business efforts to complement ourcustomers’ requirements and to provide state-of-the-art products. We plan tomaintain a diversified and broad business mix with limited reliance on anysingle program, a significant follow-on business and an attractive customerprofile.

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 business base. We intend to continue acquiring select publicly andprivately-held companies, as well as defense businesses of larger companiesthat (i) exhibit significant market position(s) in their businessareas, (ii) offer products that complement and/or expand our productofferings and (iii) display growing revenues, positive operating incomeand cash flow prospects.

**OtherBusiness 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. Under governmentprocurement regulations and practices, an indictment of a government contractorcould result in that contractor being fined and/or suspended from being able tobid on, or be awarded, new government contracts for a period of time. Aconviction could result in debarment for a specific period of time. Similar governmentoversight exists in most other countries where we conduct business.

We are party to variouslegal actions and claims arising in the ordinary course of our business. In ouropinion, 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 future operatingresults depend on our ability to successfully compete in a highly competitiveindustry that is characterized by rapid technological change and to effectivelyintegrate acquired companies into our existing operations. Continuation of ourrecent revenue growth rate depends primarily on our ability to identify andacquire suitable acquisition targets, as well as our ability to increasenonacquisition related revenues. We have participated successfully in thedefense industry consolidation through strategic business acquisitions and bystreamlining our existing operations; however, we cannot guarantee that we willhave sufficient funds available to us to continue investing in businessacquisitions. Our debt arrangements restricts our ability and the ability ofour subsidiaries to incur more debt, make certain investments, repurchasestock, create liens, enter into transactions with affiliates, enter into salelease-back transactions, merge or consolidate, and transfer or sell assets.

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**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, 2005 Form 10-K.There were no significant changes in the Company’s critical accounting policiesduring the six months ended September 30, 2005. Critical accountingpolicies are those that require application of management’s most difficult,subjective or complex judgments, often as a result of the need to makeestimates about the effects of matters that are inherently uncertain and maychange 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 and other management estimates.

**Results of Continuing Operations**

Our operating cycle is long-term and involves varioustypes of production contracts and varying production delivery schedules.Accordingly, operating results of a particular period, or year-to-yearcomparisons of recorded revenues and earnings, may not be indicative of futureoperating results.

Membersof our senior management team regularly review key performance metrics and thestatus of operating initiatives within our business. These key performanceindicators are primarily revenues, operating income and bookings. We reviewthis information on a monthly basis through extensive operating segment reviewswhich include, among other operating issues, detailed discussions related tosignificant programs, proposed investments in new business opportunities orproperty, plant, and equipment and integration and cost reduction efforts. Thefollowing table presents a summary comparison of the key performance metrics,other significant financial metrics and significant liquidity metrics monitoredby senior management of the Company.

| ** **                               | ** ** | **Three Months Ended  September 30,**  | ** ** | **Percent** | ** ** | **Six Months Ended  September 30,** | ** ** | **Percent** | ** ** |
|------------------------------------------|------------|-------------------------------------------------------|------------|-------------|------------|----------------------------------------------------|------------|-------------|------------|
| ** **                               | ** ** | **2005**                                              | ** ** | **2004**    | ** ** | **Change**                                         | ** ** | **2005**    | ** ** | **2004** | ** ** | **Change** | ** ** |
| ** **                               | ** ** | **(in thousands, except percentages)** | ** ** |
| **Key performance metrics**              | ** ** | ** **                                            | ** ** | ** **  |       |                                               |       | ** **  |       | ** ** | ** ** | ** ** |   |   |   |   |   |
| Revenues                                 |       | $                                                     | 361,930    |        | $          | 318,053                                            |       |        | 13.8       | % |   | $ | 700,389 |   | $ | 609,204 |   |   | 15.0 | % |   |
| Operating income                         |       | $                                                     | 38,577     |        | $          | 33,806                                             |       |        | 14.1       | % |   | $ | 73,635 |   | $ | 62,306 |   |   | 18.2 | % |   |
| Bookings                                 |       | $                                                     | 597,965    |        | $          | 335,683                                            |       |        | 78.1       | % |   | $ | 1,118,469 |   | $ | 678,935 |   |   | 64.7 | % |   |
| **Other  significant financial metrics** |       |                                                  |       |        |       |                                               |       |        |       |   |   |   |   |   |   |   |   |
| Interest and related  expenses           |       | $                                                     | 12,290     |        | $          | 9,006                                              |       |        | 36.5       | % |   | $ | 24,501 |   | $ | 18,000 |   |   | 36.1 | % |   |
| Income taxes                             |       | $                                                     | 8,562      |        | $          | 10,347                                             |       |        | (17.3      | )% |   | $ | 18,713 |   | $ | 18,554 |   |   | 0.9 | % |   |
| **Significant  liquidity metrics(A)**    |       |                                                  |       |        |       |                                               |       |        |       |   |   |   |   |   |   |   |   |
| Free cash flow                           |       | $                                                     | 39,617     |        | $          | 21,740                                             |       |        | 82.2       | % |   | $ | 18,735 |   | $ | 34,995 |   |   | (46.5 | )% |   |
| EBITDA                                   |       | $                                                     | 48,262     |        | $          | 43,914                                             |       |        | 9.9        | % |   | $ | 93,182 |   | $ | 81,877 |   |   | 13.8 | % |   |

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

*Three- and Six-Month Periods Ended September 30,2005, Compared with the Three-and Six-Month Periods Ended September 30,2004*

**Revenuesand operating income****  **Consolidatedrevenues and operating income for the three-month period ended September 30,2005 increased $43.9 million and $4.8 million, respectively, to $361.9 million 

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and $38.6 million,respectively, as compared with the corresponding period in the prior year. Theincrease in revenues was largely driven by increased shipments of ruggedcomputer systems,**powerconversion systems and control panel displays, flight range test and evaluationequipment and vision enhancement equipment for ground-based vehicles*.* Also contributing to the overallincrease in revenues was our December 14, 2004 acquisition of NVEC and ourApril 15, 2005 and June 27, 2005 acquisitions of Codem and WalkAbout,respectively, which contributed incremental (current quarter over correspondingprior-year quarter) revenues of $26.0 million*.*Partially offsetting the overall increase in revenues were decreasedship propulsion engineering services and lower shipments of certain turbinegenerators and certain**infraredimaging systems.

The growth in operating income in the second quarterof fiscal 2006, as compared with the corresponding prior year period, was dueprimarily to the overall increase in revenues and strong margins from certainrugged computer systems and infrared assemblies, partially offset by decreased marginsfrom ship propulsion engineering*.*The three recently acquired operating units, NVEC, Codem and WalkAbout,contributed $4.4 million of incremental operating income for the three-monthperiod ended September 30, 2005.

Consolidated revenues and operating income for thesix-month period ended September 30, 2005 increased $91.2 million and$11.3 million, respectively, to $700.4 million and $73.6 million, respectively,as compared with the corresponding period in the prior year. The increase inrevenues was largely driven by increased shipments of rugged computer systems,combat display workstations, vision enhancement equipment for ground-basedvehicles and**power conversionsystems and control panel displays. Also contributing to the overall increasein revenues were our acquisitions of NVEC, Codem and WalkAbout whichcontributed incremental (current year-to-date over corresponding prior-year todate) revenues of $47.0 million. Partially offsetting the overall increase inrevenues were decreased ship propulsion engineering services, a decline inshipments of certain infrared imaging systems and certain turbine generatorprograms, as well as fewer shipments of certain ground-based electro-opticaltargeting and fire control subsystems.

The growth in operating income for the six monthsended September 30, 2005, as compared with the corresponding prior yearperiod, was due primarily to the overall increase in revenues and strongmargins from certain rugged computer systems and certain infrared assemblies,partially offset by decreased margins from ship propulsion engineering. NVEC,Codem and WalkAbout contributed $9.2 million to operating income for thesix-month period ended September 30, 2005.

**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, 2005 increased $262.3 million,versus the same period in the prior year, to $598.0 million. The primarydrivers of the increase were stronger bookings for ground-based electro-opticalsighting and targeting systems, rugged computer systems, certain ground-basedvehicle diagnostic systems and combat display workstations. Our NVEC, Codem andWalkAbout acquisitions contributed combined bookings of $38.1 million.

Bookings for the six-month period ended September 30,2005 increased $439.5 million, versus the same period in the prior year, to$1.1 billion. The primary drivers of the increase were stronger bookings forground-based electro-optical sighting and targeting systems, rugged computersystems, ground-based vehicle diagnostic systems and combat displayworkstations.**Our NVEC, Codem,and WalkAbout acquisitions contributed combined bookings of $62.4 million.

**Interest and relatedexpenses****  **Interestand related expenses increased $3.3 million and $6.5 million for the three- andsix-month periods ended September 30, 2005, respectively, as compared withthe same period in the prior year, to $12.3 million and $24.5 million,respectively. The increase in interest and 

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related expenses isprimarily the result of an increase in our average borrowings outstanding forthe three- and six-month periods ended September 30, 2005, as comparedwith the corresponding period in the prior-year, due to our December 23,2004, issuance of $200 million of 67¤8% seniorsubordinated notes (see Liquidity and Capital Resources below). We had noborrowings outstanding under our revolving credit facility at September 30,2005 and 2004.

**Income taxes****  **The provision for income taxes forthe three- and six-month periods ended September 30, 2005, reflected aneffective income tax rate of approximately 31.1% and 36.2%, respectively, ascompared with 42.5% and 42.6%, respectively, in the same periods last year. Oureffective tax rate declined primarily due to the favorable resolution of theInternal Revenue Service’s audit of our federal income tax returns for fiscalyears 1999 through 2001. As a result of the outcome of the audit, we recorded atax adjustment of approximately $3.0 million in the three month period ended September 30,2005. We anticipate our effective income tax rate for the year endedMarch 31, 2006, will approximate 40%.

**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** | ** ** |
|------------------|------------|----------------------------------------------------------------|------------|------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------|------------|
| ** **       | ** ** | **2005**                                                       | ** ** | **2004**                                       | ** ** | **2005 vs. 2004**                        | ** ** | **2005**                                     | ** ** | **2004** | ** ** | **2005 vs. 2004** | ** ** |
| ** **       | ** ** | **(in thousands, except for percentages)** | ** ** |
| **C4I Group**    |       |                                                           |       |                                           |       |                                               |       |                                         |       |   |   |   |   |   |   |   |   |
| Revenues         |       | $                                                              | 194,420    |                                           | $          | 168,125                                            |       |                                         | 15.6       | % |   | $ | 384,910 |   | $ | 326,708 |   |   | 17.8 | % |   |
| Operating income |       | $                                                              | 19,719     |                                           | $          | 17,557                                             |       |                                         | 12.3       | % |   | $ | 39,207 |   | $ | 32,677 |   |   | 20.0 | % |   |
| Operating margin |       | 10.1                                                           | %          | 10.4                                           | %          |                                               | (2.9       | )%                                           |       | 10.2 | % | 10.0 | % |   | 1.8 | % |   |
| **SR  Group**    | ** ** | ** **                                                     | ** ** | ** **                                     | ** ** |                                               |       |                                         | ** ** | ** ** | ** ** | ** ** | ** ** |   |   |   |   |
| Revenues         |       | $                                                              | 167,510    |                                           | $          | 149,928                                            |       |                                         | 11.7       | % |   | $ | 315,479 |   | $ | 282,496 |   |   | 11.7 | % |   |
| Operating income |       | $                                                              | 21,077     |                                           | $          | 16,289                                             |       |                                         | 29.4       | % |   | $ | 36,865 |   | $ | 29,715 |   |   | 24.1 | % |   |
| Operating margin |       | 12.6                                                           | %          | 10.9                                           | %          |                                               | 15.6       | %                                            |       | 11.7 | % | 10.5 | % |   | 11.4 | % |   |
| **Other**        | ** ** | ** **                                                     | ** ** | ** **                                     | ** ** |                                               |       |                                         | ** ** | ** ** | ** ** | ** ** | ** ** |   |   |   |   |
| Operating loss   |       | $                                                              | (2,219     | )                                              | $          | (40                                                | )          |                                         | (5,447.5   | )% |   | $ | (2,437 | ) | $ | (86 | ) |   | (2,733.7 | )% |   |

 

*Three-Month Period Ended September 30, 2005,Compared with the Three-Month Period Ended September 30, 2004*

**C4I Group****  **Revenues increased $26.3 million, or15.6%, to $194.4 million for the three-month period ended September 30,2005, as compared with the corresponding prior-year period. Operating incomeincreased $2.2 million, or 12.3%, to $19.7 million. The increase in revenue waslargely attributable to increased shipments of rugged computer systems,**power conversion systems and controlpanel displays and surveillance tuners. Our April 15, 2005 acquisition ofCodem and June 27, 2005 acquisition of WalkAbout contributed revenues of$10.2 million to the three-month period ended September 30, 2005.Partially offsetting the overall increase in revenues were decreased shippropulsion engineering services and lower shipments of certain turbinegenerator programs and secure voice systems.

The increase in operatingincome for the three-month period ended September 30, 2005, as compared tothe corresponding period in the prior year, was driven primarily by the overallincrease in revenues, as well as the $2.2 million operating income contributionfrom our acquisition of Codem and WalkAbout, partially offset by decreasedmargins from ship propulsion engineering.

**SR Group****  **Revenues increased $17.6 million, or11.7%, to $167.5 million for the three-month period ended September 30,2005, as compared with the corresponding prior-year period. Operating income 

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increased $4.8million, or 29.4%, to $21.1 million. The increase in revenues was primarilyattributable to our December 14, 2004 acquisition of NVEC whichcontributed incremental revenues of $15.8 million. Revenues were also favorablyimpacted by increased shipments of flight range test and evaluation equipment,vision enhancement equipment for ground-based vehicles and launch controlelectronics. Partially offsetting the overall increase in revenues were lowershipments of a certain infrared imaging system.

The increase in operating income for the three-monthperiod ended September 30, 2005, as compared with the corresponding periodin the prior year, was driven primarily by our acquisition of NVEC, whichcontributed $2.3 million of operating income, as well as strong margins on****certain vision enhancement equipment forground-based vehicles, certain infrared assemblies and formation flying systems.The increase in operating income was partially offset by decreased margins on amobile launch system.

**Other****  **The $2.2 million operating loss inOther in the three-month period ended September 30, 2005 was driven primarilyby a $2.0 million accrual recorded in the period in connection with alitigation reserve. (See Part II, Item 1. Legal Proceedings).

*Six-Month PeriodEnded September 30, 2005, Compared with the Six-Month Period Ended September 30,2004*

**C4I Group****  **Revenues increased $58.2 million, or17.8%, to $384.9 million for the six-month period ended September 30,2005, as compared with the corresponding prior-year period. Operating incomeincreased $6.5 million, or 20.0%, to $39.2 million. The increase in revenue waslargely attributable to increased shipments of rugged computer systems, combatdisplay workstations, power conversion systems and control panel displays**and surveillancetuners. Our April 15, 2005 acquisition of Codem and June 27,2005 acquisition of WalkAbout contributed incremental revenues of $16.2 millionto the six-month period ended September 30, 2005. Partially offsetting theoverall increase in revenues were decreased ship propulsion engineeringservices and decreased shipments of certain turbine generator programs andcertain surveillance receivers.

The increase in operatingincome for the six-month period ended September 30, 2005, as compared tothe corresponding period in the prior year, was driven primarily by the overallincrease in revenues, as well as the $3.6 million of incremental operatingincome contribution from our acquisitions of Codem and WalkAbout, partiallyoffset by decreased margins from ship propulsion engineering.

**SR Group****  **Revenues increased $33.0 million, or11.7%, to $315.5 million for the six-month period ended September 30,2005, as compared with the corresponding prior-year period. Operating incomeincreased $7.2 million, or 24.1%, to $36.9 million. The increase in revenueswas primarily attributable to our acquisition of NVEC, which contributedincremental revenues of $30.8 million. Revenues also were impacted favorably byincreased shipments of vision enhancement equipment for ground-based vehiclesand flight range test and evaluation equipment and launch control electronics.Partially offsetting the overall increase in revenues were lower shipments ofan infrared imaging system and a certain ground-based electro-optical targetacquisition and fire control subsystems.

The increase in operatingincome for the six-month period ended September 30, 2005, as compared withthe corresponding period in the prior year, was driven primarily by ouracquisition of NVEC, which contributed $5.6 million of operating income, as well as strong margins on certain visionenhancement equipment for ground-based vehicles, certain infrared assembliesand formation flying systems. The increase in operating income waspartially offset by decreased margins on a mobile launch system.

**Other****  **The $2.4 million operating loss inOther in the six-month period ended September 30, 2005 was driven primarilyby a $2.0 million accrual recorded in the period in connection with alitigation reserve. (See Part II, Item 1. Legal Proceedings).

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**Results ofDiscontinued Operations**

Aconsolidated summary of the operating results of the discontinued operationsfor the three- and six-month periods ended September 30, 2004 are asfollows:

| ** **                             | ** ** | **Three Months Ended  September 30, 2004** | ** ** | **Six Months Ended  September 30, 2004** | ** ** |
|----------------------------------------|------------|----------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                             | ** ** | **(in thousands)**                                        | ** ** |
| Revenues                               |       |                                                           | $          | 9,969                                                        |       |   |   | $ | 19,547 |   |   |
| Earnings before  taxes                 |       |                                                           | $          | 697                                                          |       |   |   | $ | 1,990 |   |   |
| Income tax  expense                    |       |                                                           | 299        |                                                         |       |   | 792 |   |   |
| Earnings from  discontinued operations |       |                                                           | $          | 398                                                          |       |   |   | $ | 1,198 |   |   |

 

**Liquidity and Capital Resources**

| ** **                                                          | ** ** | **Six Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                          | ** ** | **2005**                                           | ** ** | **2004** | ** ** |
| ** **                                                          | ** ** | **(in thousands)**                            | ** ** |
| Net cash provided  by operating activities of continuing operations |       | $                                                  | 34,989     |   | $ | 48,575 |   |
| Net cash provided  by operating activities                          |       | $                                                  | 34,989     |   | $ | 50,550 |   |
| Net cash used in  investing activities of continuing operations     |       | $                                                  | (67,963    | ) | $ | (15,653 | ) |
| Net cash used in  investing activities                              |       | $                                                  | (67,963    | ) | $ | (16,011 | ) |
| Net cash used in  financing activities of continuing operations     |       | $                                                  | (17,459    | ) | $ | (19,766 | ) |
| Net cash used in  financing activities                              |       | $                                                  | (17,459    | ) | $ | (19,780 | ) |

 

**Operating activities  **Duringthe six months ended September 30, 2005, we generated $35.0 million ofoperating cash flow from continuing operations, $13.6 million less than the$48.6 million of operating cash flow from continuing operations generated inthe same period in the prior year. Earnings from continuing operationsincreased $8.0 million to $33.0 million. Non-cash adjustments toreconcile net earnings to cash flows from operating activities decreased $0.2 millionover the corresponding prior fiscal period.

Changes in assets and liabilities, net of effects frombusiness combinations, used $22.1 million in cash for the six months ended September 30,2005. Inventories used $15.7 million of cash for the six-month periodended September 30, 2005. Increased inventories in certain of ourelectro-optical infrared sighting and targeting businesses, power distributionand control and signals intelligence businesses were offset, in part, bydecreased inventories for our combat display workstations and certain trainingand test systems. Accounts payable increased $8.7 million as purchases requiredto build inventories exceeded related payments. Accrued expenses and othercurrent liabilities used $23.6 million of cash during the quarter. The cashused by these accounts primarily resulted from interest payments on the 67¤8% senior subordinated notes due2013, certain compensation payments and the settlement of the Miltopelitigation. Net liquidations in customer advances generated $4.1 million in cash.

**Investing activities**   Wepaid $16.3 million for capital improvements during the six-month period ended September 30,2005, as compared with $13.6 million in the corresponding prior-year period. Weexpect our capital expenditures to range between $35.0 million to $45.0 millionin fiscal 2006, as we continue to upgrade our facilities and integrate recentacquisitions into our existing businesses. Payments pursuant to businesscombinations, net of cash acquired, totaled $52.6 million driven by ouracquisitions of Codem and Walkabout and $6.7 million of additionalconsideration paid to satisfy an earn-out obligation related to our acquisitionof DKD, Inc. (now operating as a component of DRS Infrared Technologies, L.P.)

Our long-term growth strategy includes a disciplinedprogram of acquiring companies that are both strategic to our business andexpected to be accretive to our earnings. Continuation of our acquisition 

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program (excluding theimpact of the anticipated ESSI merger and its related financing) will depend,in part, on the availability of financial resources at a cost of capital thatis acceptable to us. We would expect to utilize cash generated by operations,as well as cash available under our Credit Facility, which also may include therenegotiation of our credit limit to finance such acquisitions. Other sourcesof capital could include proceeds from a sale of our common stock and theplacement of debt. We continually evaluate the capital markets climate and mayaccess such markets when the circumstances appear favorable to us. We believethat sufficient capital resources will be available to us from one or severalof these sources to finance future acquisitions that we determine to bestrategic and accretive to our net earnings. However, no assurances can be madethat such financing will be available and at a cost that is acceptable to us,that we will identify acceptable acquisition candidates, or that suchacquisitions will be accretive to earnings.

**Financing Activities**   Forthe six-month period ended September 30, 2005, financing activities used$17.5 million in cash. Payments on long-term debt included $21.4 million ofpayments on our term loan, $20.0 million of which was paid at our discretion.Our discretionary term loan payments caused us to record a $0.4 million chargeto interest and related expenses for the write-off of a portion of the relateddebt issuance costs. We repaid $2.0 million in advanced interest that wereceived in connection with the new notes issued on December 23, 2004 (seebelow). For the six months ended September 30, 2005, we paid cashdividends of $1.7 million. These payments were partially offset by cashreceived from the exercise of stock options.

On October 30, 2003, we issued $350.0 millionaggregate principal amount of 67¤8% SeniorSubordinated Notes, due November 1, 2013 (the Notes). The Notes wereissued under an indenture with The Bank of New York (the Indenture). Subject toa number of exceptions, the Indenture restricts our ability and the ability ofour subsidiaries to incur more debt, make certain investments, repurchasestock, create liens, enter into transactions with affiliates, enter into salelease-back transactions, merge or consolidate, and transfer or sell assets. TheNotes are unconditionally guaranteed, jointly and severally, by DRS’s currentand future wholly-owned domestic subsidiaries. The foreign subsidiaries andcertain domestic subsidiaries of DRS do not guarantee the Notes. See Note 15, “Guarantorand Non-guarantor Financial Statements” for additional disclosures.

On December 23, 2004, we issued an additional$200.0 million aggregate principal amount of 67¤8% SeniorSubordinated Notes due November 1, 2013. The notes were offered asadditional debt securities under the Indenture with identical terms and thesame guarantors as the existing Notes. The new notes were priced at 105% of theprincipal amount, reflecting an effective interest rate of approximately 6.13%.The net proceeds of the offering were approximately $208.3 million (including$2.0 million of advanced interest on the new notes that had accrued from November 1,2004 to December 23, 2004), after deducting $3.7 million in commissionsand other costs related to the debt issuance. On May 1, 2005, the advancedinterest of $2.0 million was repaid in conjunction with the semi-annualinterest payments on the Notes.

The book value and fair value of the seniorsubordinated debt at September 30, 2005 were approximately $559.2 millionand $533.5 million, respectively.

We have a $411.0 million credit facility (the CreditFacility), consisting of a $175.0 million senior secured revolving line ofcredit and a $236.0 million senior secured term loan, and have the ability toborrow up to two additional term loans totaling $100.0 million at any timeprior to maturity. As of September 30, 2005 and March 31, 2005, wehad $146.3 million and $167.5 million, respectively, of term loans outstandingagainst the Credit Facility. The Credit Facility is guaranteed by substantiallyall of DRS’s domestic subsidiaries. In addition, it is collateralized by lienson substantially all of the assets of our subsidiary guarantors’ and certain ofDRS’s other subsidiaries’ assets and by a pledge of certain of our non-guarantorsubsidiaries’ capital stock. The term loan and the revolving credit facilitywill mature in November 2010 and November 2008, respectively. Theweighted average interest rate on our term loans was 5.62% as of September 30,2005 (4.4% as of March 31, 2005), excluding the impact of the amortization

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of debt issuance costs. Asof September 30, 2005, we had $139.9 million available under our revolvingline of credit. There were no borrowings under our revolving line of credit asof September 30, 2005 and March 31, 2005.

On October 28, 2005 we prepaid an additional$10.0 million of our term loan at our discretion and will recognize a $0.2million charge to interest and related expenses for the related write-off of aportion of debt issuance costs.

From time to time, we enter into standbyletter-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, 2005,$36.3 million was contingently payable under letters of credit and bankguarantees. Approximately $0.9 million and $0.3 million in letters of creditand bank guarantees as of September 30, 2005 were issued outside of theCredit Facility and by a bank agreement for our U.K. subsidiary, respectively, thatare not considered when determining the availability under our revolving lineof credit.

We have a mortgage note payable that is secured by alien on our facility located in Palm Bay, Florida, and bears interest at a rateequal to the one-month LIBOR plus 1.65%. The balance of the mortgage as of September 30,2005 and March 31, 2005 was $2.9 million and $3.0 million, respectively.Monthly payments of principal and interest totaling approximately $34 thousandwill continue through December 1, 2016.

Accrued interest expense at September 30, 2005and March 31, 2005 was approximately $16.5 million.

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 facility, will be adequate to meet our anticipatedrequirements for working capital, capital expenditures, commitments, researchand development expenditures, contingent purchase prices, program and otherdiscretionary investments, and interest and principal payments for theforeseeable future. There can be no assurance, however, that our business willcontinue to generate cash flow at current levels. If we are unable to generatesufficient cash flow from operations to service our debt, we may be required tosell assets, reduce capital expenditures, refinance all or a portion of ourexisting debt or obtain additional financing. Our ability to make scheduledprincipal payments or to pay interest on or to refinance our indebtednessdepends on our future performance and financial results, which, to a certainextent, are subject to general conditions in or affecting the defense industryand to general economic, political, financial, competitive, legislative andregulatory factors beyond our control. There can be no assurance thatsufficient funds will be available to enable us to service our indebtedness,make necessary capital expenditures or to make discretionary investments.

**Free Cash Flow  **Freecash flow represents net cash provided by operating activities of continuingoperations less capital expenditures. Free cash flow for the three-month periodended September 30, 2005 was $39.6 million, or $17.9 million more than the$21.7 million of free cash flow in the corresponding period in the prior year. Freecash flow for the six-month period ended September 30, 2005 was $18.7million or $16.3 million less than the $35.0 million of free cash flow in thecorresponding period in the prior year. See “Use of Non-GAAP Financial Measures”below for additional discussion and information.

**EBITDA  **Earningsfrom continuing operations before net interest and related expenses (primarilythe amortization and write-off of debt issuance costs), income taxes,depreciation and amortization (EBITDA) for the three-month period ended September 30,2005 was $48.3 million, or $4.4 million greater than the $43.9 million ofEBITDA in the corresponding period in the prior year. EBITDA for the six-monthperiod ended September 30, 2005 was $93.2 million, or $11.3 milliongreater than the $81.9 million of EBITDA in the corresponding period in theprior year. See “Use of Non-GAAP Financial Measures” below for additionaldiscussion and information.

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**ContractualObligations  **Our contractual obligations and commitmentsprincipally include obligations associated with our outstanding indebtedness,future minimum operating lease obligations, acquisition earn-outs and purchaseobligations as set forth in the table below:

| ** **                     | ** ** | **As of September 30, 2005** | ** ** |
|--------------------------------|------------|--------------------------------------------------|------------|
| ** **                     | ** ** | **Payments Due by Period**        | ** ** |
| ** **                     | ** ** | **Total**                                        | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  5 years** | ** ** |
| ** **                     | ** ** | **(in thousands)**                          | ** ** |
| Long-term debt                 |       | $                                                | 699,224    |   |   | $ | 2,600 |   |   | $ | 5,136 |   | $ | 139,685 |   | $ | 551,803 |   |
| Operating lease  commitments   |       | 97,040                                           |       |   | 23,132 |   |   | 32,091 |   | 22,049 |   | 19,768 |   |
| Acquisition earn-outs(A)       |       | 42,551                                           |       |   | 7,807 |   |   | 28,511 |   | 6,233 |   |   |   |
| Purchase obligations(B)        |       | 46,523                                           |       |   | 26,540 |   |   | 19,983 |   | — |   | — |   |
| Total contractual  obligations |       | $                                                | 885,338    |   |   | $ | 60,079 |   |   | $ | 85,721 |   | $ | 167,967 |   | $ | 571,571 |   |

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(A)       Represents contingentpurchase price payments or “earn-outs” for certain of our acquisitions that arecontingent upon the receipt of post-acquisition revenues or orders at thoseacquired businesses. Any amount that we pay for the earn-outs will be reportedas cash paid for acquisition of business within investing activities on theConsolidated Statement of Cash Flows and will be recorded as an increase togoodwill for the acquisition. The last earn-out period expires on December 31,2009.

(B)        Includes amounts underlegally enforceable agreements for goods and services with defined terms as toquantity, price and timing of delivery. Excludes purchase orders for productsand services under firm government contracts for which we have full recourseunder normal contract termination clauses.

Under the terms of the acquisition agreement betweenESSI and the Company, the Company is obligated to pay, under certaincircumstances, $20.0 million in liquidated damages to ESSI in the event thatthe acquisition is terminated due to the Company’s failure to obtain financing.

Weenter into standby letter-of-credit agreements and bank guarantees withfinancial institutions and customers primarily relating to the guarantee of ourfuture performance on certain contracts to provide products and services and tosecure advance payments we have received from certain international customers.At September 30, 2005, we had contingent liabilities on outstandingletters of credit and bank guarantees as follows:

| ** **                 | ** ** | **Contingent Payments Due by Period** | ** ** |
|----------------------------|------------|-----------------------------------------------------------|------------|
| ** **                 | ** ** | **Total**                                                 | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **More than  3 years** | ** ** |
| ** **                 | ** ** | **(in thousands)**                                   | ** ** |
| Standby letters  of credit |       | $                                                         | 35,962     |   |   | $ | 29,289 |   |   |   | $ | 6,673 |   |   |   | $ | — |   |   |
| Bank guarantees            |       | $                                                         | 384        |   |   | $ | 341 |   |   |   | $ | 43 |   |   |   | $ | — |   |   |

 

**Backlog  **Fundedbacklog represents products or services that our customers have committed bycontract to purchase from us. Due to the general nature of defense procurementand contracting, the operating cycle for our military business typically hasbeen long term. Military backlog currently consists of various production andengineering development contracts with varying delivery schedules and projecttimetables. Our backlog also includes a significant amount of commercialoff-the-shelf (COTS)-based systems for the military, which have shorterdelivery times. Accordingly, revenues for a particular period, or year-to-yearcomparisons of reported revenues and related backlog positions, may not beindicative of future results. Backlog at September 30, 2005 was $1.7 billion,as compared with $1.3 billion at March 31, 2005. We booked $598.0 millionand $1.1 billion in new orders for the three- and six-month periods ended September 30,2005.

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**Internal Research and Development  **Inaddition to customer-sponsored research and development, we also engage ininternal research and development. These expenditures reflect our continuedinvestment in new technology and diversification of our products. Expendituresfor internal research and development for the three-month periods ended September 30,2005 and 2004 was $11.5 million and $8.6 million, respectively, and $20.7million and $16.9 million for the six-month periods ended September 30,2005 and 2004, respectively.

**Use of Non-GAAP Financial Measures  **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,**         | ** ** |
| ** **                                                                                     | ** ** | **2005**                         | ** ** | **2004**                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                     | ** ** | **(in thousands)**          | ** ** |
| Earnings from  continuing operations                                                           |       | $                                | 18,954     |                           | $          | 14,003 |   | $ | 32,972 |   | $ | 24,974 |   |
| Income taxes                                                                                   |       | 8,562                            |       | 10,347                         |       | 18,713 |   | 18,554 |   |
| Interest income                                                                                |       | (2,068                           | )          | (169                           | )          | (3,945 | ) | (298 | ) |
| Interest and  related expenses                                                                 |       | 12,290                           |       | 9,006                          |       | 24,501 |   | 18,000 |   |
| Depreciation and  amortization                                                                 |       | 10,524                           |       | 10,727                         |       | 20,941 |   | 20,647 |   |
| EBITDA(A)                                                                                      |       | 48,262                           |       | 43,914                         |       | 93,182 |   | 81,877 |   |
| Income taxes                                                                                   |       | (8,562                           | )          | (10,347                        | )          | (18,713 | ) | (18,554 | ) |
| Interest income                                                                                |       | 2,068                            |       | 169                            |       | 3,945 |   | 298 |   |
| Interest and  related expenses                                                                 |       | (12,290                          | )          | (9,006                         | )          | (24,501 | ) | (18,000 | ) |
| Deferred income  taxes                                                                         |       | 24                               |       | 533                            |       | (498 | ) | (382 | ) |
| Changes in assets  and liabilities, net of effects from business combinations and divestitures |       | 18,539                           |       | 690                            |       | (22,140 | ) | (770 | ) |
| Other, net                                                                                     |       | 1,494                            |       | 1,956                          |       | 3,714 |   | 4,106 |   |
| Net cash provided by operating activities of  continuing operations                            |       | 49,535                           |       | 27,909                         |       | 34,989 |   | 48,575 |   |
| Capital  expenditures                                                                          |       | (9,918                           | )          | (6,169                         | )          | (16,254 | ) | (13,580 | ) |
| Free cash flow(B)                                                                              |       | $                                | 39,617     |                           | $          | 21,740 |   | $ | 18,735 |   | $ | 34,995 |   |

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(A)       We define EBITDA as netearnings from continuing operations before net interest and related expenses(principally amortization and write-off of debt issuance costs), income taxes,depreciation and amortization. The table above presents the components ofEBITDA and a reconciliation of EBITDA to net cash provided by operatingactivities of continuing operations. EBITDA is presented as additionalinformation because we believe it to be a useful indicator of our debt capacityand our ability to service our debt. EBITDA is not a substitute for operatingincome, net earnings or cash flows from operating activities of continuingoperations, as determined in accordance with GAAP. EBITDA is not a complete netcash flow measure because EBITDA is a measure of liquidity that does notreflect 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 

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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 of continuingoperations less capital expenditures. We disclose free cash flow because webelieve that it is useful in evaluating our financial performance and measuringcash flows generated that are available for investing and financing activities.We believe that the most directly comparable GAAP financial measure to freecash flow is net cash provided by operating activities of continuingoperations. Free cash flow represents cash generated after paying for intereston borrowings, income taxes, capital expenditures and changes in workingcapital, but before repaying outstanding debt, investing cash to acquirebusinesses and making other strategic investments, and it does not reflect cashflows of discontinued operations. Thus, key assumptions underlying free cashflow are that the Company will be able to refinance its existing debt when itmatures with new debt and that the Company will be able to finance any newacquisitions it makes by raising new debt or equity capital. We also use freecash flow as a performance measure as a component of our management incentivecompensation program. Free cash flow, as we define it, may differ fromsimilarly named measures used by other entities and, consequently, could bemisleading unless all entities calculate and define free cash flow in the samemanner.

**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 31,2005 for a discussion of the Company’s exposure to market risks. There havebeen no significant changes in those risks since the filing of the above referencedAnnual Report.

**Item 4.**                        Controlsand Procedures

(a)          Disclosure Controls andProcedures. The Company’s management, with the participation of the Company’sChief Executive Officer and Chief Financial Officer, has evaluated theeffectiveness of the Company’s disclosure controls and procedures (as such termis defined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the endof 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 Control OverFinancial Reporting. There have not been any changes in the Company’s internalcontrol over financial reporting (as such term is defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act) during the three months ended September 30,2005 that have materially affected, or are reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

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**PART II. OTHER INFORMATION**

**Item 1.**                        LegalProceedings

We are party to various legal actions and claimsarising in the ordinary course of its business. In our opinion, we haveadequate legal defenses for each of the actions and claims.

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 is possiblethat some of these matters ultimately could be decided, resolved or settledadversely. We have recorded accruals totaling $4.7 million and $10.2 million atSeptember 30, 2005, respectively, for losses related to those matters thatwe consider to be probable and that can be estimated reasonably (certain legaland environmental matters are discussed in detail below). Although the ultimateamount of liability at September 30, 2005 that may result from thosematters for which we have recorded accruals is not ascertainable, we believethat any amounts exceeding our recorded accruals should not materially affectour financial condition or liquidity. It is possible, however, that theultimate resolution of those matters could result in a material adverse effecton our results of operations for a particular reporting period.

On October 3, 2001, a lawsuit was filed byMiltope Corporation and IV Phoenix Group, Inc., against DRS Technologies, Inc.,DRS Electronic Systems, Inc. and a number of individual defendants,several of whom had been employed by DRS Electronic Systems, Inc. Theplaintiffs’ claims against us related generally to the activities of certainformer employees of IV Phoenix Group and the hiring of some of those employeesby us. On May 4, 2005, DRS entered into a settlement agreement, pursuantto which we agreed to pay $7.5 million to the plaintiffs, and litigationinvolving the parties was resolved to their satisfaction, with the eliminationof all outstanding claims. A charge of $6.5 million was recorded during fiscal2005 to increase our accrual for the matter to $7.5 million as of March 31,2005. The settlement payment was made on May 5, 2005.

In July 2000, prior to its acquisition by IDT,and prior to our 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. Subsequent to ouracquisition of IDT, the Orphan Mine site was added to the National PriorityList of contaminated sites. 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.

A corporation of which Tech-Sym is an allegedsuccessor operated this uranium mine from 1956 to 1967. In 1962, the land wassold to the U.S. government and the alleged predecessor of Tech-Sym was given a25-year mining lease. In 1967, the mining rights were transferred to athird party by a trustee in bankruptcy, and we believe that the mine wasoperated by such third party until approximately 1969. We understand that thereare other companies in the chain of title to the mining rights subsequent toTech-Sym’s alleged predecessor, and, accordingly, that there are other potentiallyresponsible parties (PRPs) for the environmental conditions at the site,including the U.S. government as owner, operator and arranger at the site.During its period of ownership, IDT retained a technical consultant inconnection with this matter, who conducted a limited, preliminary review ofsite conditions and communicated with the NPS regarding actions that may berequired at the site by all of the PRPs. On February 6, 2005, the NPS sentus an Engineering Evaluation/Cost Analysis Work Plan under CERCLA (the “CERCLALetter”) with regards to Operable Unit 1 (the upper mine area) of the OrphanMine site. In our view, this Work Plan included additional cleanup not coveredby CERCLA. The CERCLA Letter also requested 

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(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 and toreimburse the NPS for future costs. The NPS advised that a similar letter hasbeen sent to another PRP. We initiated discussions with such other PRP and withNPS, and engaged a technical consultant to evaluate the existing documentationand the site in depth. As a result, on September 29, 2005, such technicalconsultant submitted to the NPS, on behalf of us and such other PRP, analternative Engineering Evaluation/Cost Analysis Work Plan (EE/CA) with regardsto Operating Units 1 and 2 of the Orphan Mine site. It is anticipated that thePRPs and NPS will engage in discussions regarding the merits of this EE/CAprior to the end of calendar year 2005.

On November 24, 2004,a lawsuit was filed in the United States District Court for the District ofColorado by ITT Industries, Inc., a corporation of the State of Indiana,against DRS Tactical Systems, Inc. The plaintiff alleged DRS breached asubcontract between DRS and ITT and sought damages in excess of $5.0 million.The claim generally related to the performance by us and our predecessors, DRSTactical Systems (West), Inc. and Catalina Research Inc., under asubcontract for a component being supplied to ITT under ITT’s prime contractwith the U.S. Army. On February 14, 2005, DRS Tactical Systems, Inc.filed its answer, affirmative defenses and counterclaims. The counterclaimsalleged breach of contract and breach of duties of good faith and fair dealingand sought damages of no less than $1.8 million. We and ITT agreed to conductnonbinding mediation, as a result of which the case was settled on August 31,2005 with the execution of mutual releases and no damages due to either party.

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

On August 4,2005, the Company held its Annual Meeting of Stockholders at The HanoverMarriott, 1401 Route 10 East, Whippany, New Jersey, 07981. The followingmatters were submitted to a vote of stockholders:

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

ii.               Toratify the appointment of KPMG LLP as DRS’s independent registered publicaccounting firm

| ** **         | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|--------------------|------------|------------|------------|--------------|------------|
| Proposal (i):      |       |       |       |         |       |
| Mark S. Newman     |       | 23,212,207 |       | 2,264,858    |       |
| Donald C. Fraser   |       | 24,141,083 |       | 1,335,982    |       |
| Steven S. Honigman |       | 24,887,324 |       | 589,741      |       |

 

| ** **     | ** ** | **For**    | ** ** | **Abstain** | ** ** | **Against** | ** ** |
|----------------|------------|------------|------------|-------------|------------|-------------|------------|
| Proposal (ii): |       | 25,448,158 |       | 11,622      |       | 17,285      |       |

 

**Item 5.**                        OtherInformation

**DRSExecutive Severance Plan**

On November 3, 2005, the Board of Directors of the Companyapproved, as recommended by the Executive Compensation Committee of the Boardof Directors, the DRS Technologies, Inc. Executive Severance Plan (the“Severance Plan”). The Severance Plan provides benefits to eligible employeesof the Company, designated by the plan administrator to participate in theSeverance Plan, upon a termination of employment (other than for cause) or aresignation for good reason, in each case, within two years following a changein control of the Company. Generally, executive vice presidents withoutemployment agreements and group presidents are eligible for consideration as“level 1 employees” and corporate senior vice presidents and strategic businessunit presidents are eligible for consideration as “level 2 employees.” Althoughthe particular participants in the Severance Plan will change from time totime, upon adoption of 

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the Severance Plan, allpotentially eligible employees were designated as participants. All paymentsand benefits under the Severance Plan are conditioned upon the participant’sexecution of a written release and continued compliance with the restrictivecovenants contained in the Severance Plan.

The level of severance benefits payable to aparticular participant in the Severance Plan depends on the designation of suchindividual by the plan administrator as either a “level 1 employee” or a “level2 employee.” Except as provided in the next sentence, all payments under theSeverance Plan are paid as soon as practicable following the date oftermination, but in no event later than ten business days immediately followingthe expiration of the revocation period, if any, applicable to suchparticipant’s written release. Payments to any participant who is a “keyemployee” described in section 409A of the Internal Revenue Code of 1986 (theCode), as amended, are made as soon as practicable following the date sixmonths after the date of termination, to the extent the Company determines suchdelay is required under section 409A of the Code.

Level 1 employees who experience an eligibletermination receive the following severance benefits: (i) a lump sumpayment equal to two and one-half times the sum of such participant’s annualbase salary and the bonus paid to such participant in respect of the last fullfiscal year prior to the date of termination; (ii) a lump sum paymentequal to such participant’s target bonus for the fiscal year in whichtermination occurs, pro-rated for the period of the participant’s employmentwith the Company during the fiscal year in which the termination occurs and(iii) continued disability, accident and health insurance benefits for theshorter of (x) thirty months immediately following the termination date and (y)the period ending on the last day of the second calendar year following thecalendar year in which the termination date occurs; provided, that if earlier,the Company’s obligation to provide continued benefits shall cease on the daysuch participant commences subsequent employment.

Level 2 employees whoexperience an eligible termination receive the following severance benefits:(i) a lump sum payment equal to two times the sum of such participant’sannual base salary and the bonus paid to such participant in respect of thelast full fiscal year prior to the date of termination; (ii) a lump sum paymentequal to such participant’s target bonus for the fiscal year in whichtermination occurs, pro-rated for the period of the participant’semployment with the Company during the fiscal year in which the terminationoccurs and (iii) continued disability, accident and health insurance benefitsfor 24 months; provided, that if earlier, the Company’s obligation to providecontinued benefits shall cease on the day such participant commences subsequentemployment.

**Item 6.**                        Exhibits

(a)          Exhibits

| Exhibit No. | ** ** | **Description**                                                                                                |
|------------------|------------|----------------------------------------------------------------------------------------------------------------|
| 10.1*            |       | DRS Technologies, Inc. Executive Severance Plan,   Effective November 3, 2005                             |
| 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.   |
|------------------------------|---------------------------|
|                         | Registrant                |
| Date: November 9,  2005 | /s/ RICHARD A. SCHNEIDER  |
|                         | Richard A. Schneider      |
|                         | *Chief Financial Officer* |

 

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