**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-Q**

| x                                                                                                                                                                                                 | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------|
| For  the quarterly period ended December 31, 2005                                                                                                                                            |
| o                                                                                                                                                                                                 | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| For  the transition period from                to               |

 

Commission file number 1-8533

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**DRS Technologies, Inc.**

(Exact name of registrantas specified in its charter) 

| **Delaware**                     |   | **13-2632319**                     |
|----------------------------------|--------|------------------------------------|
| (State or other  jurisdiction of |   | (IRS Employer  Identification No.) |
| incorporation or  organization)  |   | ** **                         |

 

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

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

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

As ofFebruary 8, 2006, 39,835,295 shares of DRS Technologies, Inc. $0.01par value common stock were outstanding.

 

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIESIndex to Quarterly Report on Form 10-QFor the Quarter Ended December 31, 2005**

|            | ** ** | ** **                                                                                            | ** ** | **Page** |
|------------|------------|-------------------------------------------------------------------------------------------------------|------------|----------|
|       |       | **PART I—FINANCIAL  INFORMATION**                                                           |       |     |
| Item  1.   |       | Financial  Statements (unaudited)                                                                     |       |     |
|       |       | Consolidated Balance Sheets—December 31, 2005 and  March 31, 2005                      |       | 1        |
|       |       | Consolidated Statements of Earnings—Three and Nine  Months Ended December 31, 2005 and 2004 |       | 2        |
|       |       | Consolidated Statements of Cash Flows—Nine Months  Ended December 31, 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      |       | 34       |
| Item 3.    |       | Quantitative and Qualitative Disclosure about Market  Risk                                            |       | 50       |
| Item  4.   |       | Controls  and Procedures                                                                              |       | 51       |
|       |       | **PART II—OTHER  INFORMATION**                                                              |       |     |
| Item  1.   |       | Legal Proceedings                                                                                     |       | 52       |
| Item 6.    |       | Exhibits                                                                                              |       | 54       |
| Signatures |       | 55                                                                                                    |

 

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**PART I—FINANCIAL INFORMATION**

**Item 1.   Financial Statements**

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

| ** **                                                                                                                                                                                | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|--------------------|------------|
| ** **                                                                                                                                                                                | ** ** | **2005**              | ** ** | **2005**           | ** ** |
| **Assets**                                                                                                                                                                                | ** ** |                  | ** ** | ** **         |       | ** ** | ** ** |
| Current assets                                                                                                                                                                            |       |                  |       |               |       |   |   |
| Cash and cash equivalents                                                                                                                                                                 |       |                  | $          | 259,666            |       |   | $ | 306,852 |   |
| Accounts receivable, net of allowance for doubtful  accounts of $1,964 and $2,659 as of December 31, 2005 and March 31,  2005, respectively                                     |       |                  | 219,250    |               |       | 237,912 |   |
| Inventories, net                                                                                                                                                                          |       |                  | 251,343    |               |       | 208,141 |   |
| Prepaid expenses, deferred income taxes and other  current assets                                                                                                                         |       |                  | 53,061     |               |       | 42,134 |   |
| Total current assets                                                                                                                                                                      |       |                  | 783,320    |               |       | 795,039 |   |
| Property, plant  and equipment, less accumulated depreciation of $127,819 and $102,644 at  December 31, 2005 and March 31, 2005, respectively                                   |       |                  | 145,242    |               |       | 143,264 |   |
| Acquired  intangible assets, net                                                                                                                                                          |       |                  | 99,789     |               |       | 100,030 |   |
| Goodwill                                                                                                                                                                                  |       |                  | 824,108    |               |       | 815,407 |   |
| Other noncurrent  assets                                                                                                                                                                  |       |                  | 39,414     |               |       | 32,901 |   |
| **Total assets**                                                                                                                                                                          |       |                  | $          | 1,891,873          |       |   | $ | 1,886,641 |   |
| **Liabilities and Stockholders’ Equity**                                                                                                                                             | ** ** |                  | ** ** | ** **         |       | ** ** | ** ** |
| Current liabilities                                                                                                                                                                       |       |                  |       |               |       |   |   |
| Current installments of long-term debt (Note 7)                                                                                                                                           |       |                  | $          | 135,891            |       |   | $ | 2,652 |   |
| Accounts payable                                                                                                                                                                          |       |                  | 140,641    |               |       | 111,222 |   |
| Accrued expenses and other current liabilities                                                                                                                                            |       |                  | 251,649    |               |       | 301,361 |   |
| Total current  liabilities                                                                                                                                                                |       |                  | 528,181    |               |       | 415,235 |   |
| Long-term debt, excluding current installments (Note  7)                                                                                                                                  |       |                  | 561,520    |               |       | 727,611 |   |
| Other liabilities                                                                                                                                                                         |       |                  | 64,157     |               |       | 72,367 |   |
| **Total liabilities**                                                                                                                                                                     |       |                  | 1,153,858  |               |       | 1,215,213 |   |
| Commitments and  contingencies (Notes 2, 7, 14 and 17)                                                                                                                                    |       |                  |       |               |       |   |   |
| Stockholders’ equity                                                                                                                                                                 |       |                  |       |               |       |   |   |
| Preferred stock, $10 par value per share. Authorized  2,000,000 shares; none issued at December 31, 2005 and March 31,  2005                                                    |       |                  | —     |               |       | — |   |
| Common Stock, $.01 par value per share. Authorized  50,000,000 shares; issued 28,080,523 and 27,472,495 shares at  December 31, 2005 and March 31, 2005, respectively (Note 17) |       |                  | 281        |               |       | 275 |   |
| Additional paid-in capital                                                                                                                                                                |       |                  | 489,210    |               |       | 467,027 |   |
| Retained earnings                                                                                                                                                                         |       |                  | 250,124    |               |       | 199,924 |   |
| Accumulated other comprehensive earnings                                                                                                                                                  |       |                  | 6,340      |               |       | 6,198 |   |
| Unamortized stock compensation                                                                                                                                                            |       |                  | (7,940     | )                  |       | (1,996 | ) |
| **Total stockholders’ equity**                                                                                                                                                       |       |                  | 738,015    |               |       | 671,428 |   |
| **Total  liabilities and stockholders’ equity**                                                                                                                                      |       |                  | $          | 1,891,873          |       |   | $ | 1,886,641 |   |

 

See accompanying Notes to the Consolidated Financial Statements.

1

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

| ** **                                                                     | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                     | ** ** | **December 31,**            | ** ** | **December 31,**           | ** ** |
| ** **                                                                     | ** ** | **2005**                         | ** ** | **2004**                        | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues                                                                       |       | $                                | 389,490    |                            | $          | 338,232 |   | $ | 1,089,879 |   | $ | 947,436 |   |
| Costs and  expenses                                                            |       | 344,663                          |       | 298,983                         |       | 971,417 |   | 845,881 |   |
| Operating income                                                               |       | 44,827                           |       | 39,249                          |       | 118,462 |   | 101,555 |   |
| Interest income                                                                |       | 2,283                            |       | 389                             |       | 6,228 |   | 687 |   |
| Interest and  related expenses                                                 |       | 12,458                           |       | 9,447                           |       | 36,959 |   | 27,447 |   |
| Other expense,  net                                                            |       | 134                              |       | 303                             |       | 446 |   | 455 |   |
| Earnings from continuing operations before minority  interest and income taxes |       | 34,518                           |       | 29,888                          |       | 87,285 |   | 74,340 |   |
| Minority interest                                                              |       | 477                              |       | 551                             |       | 1,559 |   | 1,476 |   |
| Earnings from continuing operations before income  taxes                       |       | 34,041                           |       | 29,337                          |       | 85,726 |   | 72,864 |   |
| Income taxes                                                                   |       | 14,297                           |       | 12,500                          |       | 33,010 |   | 31,053 |   |
| Earnings from continuing operations                                            |       | 19,744                           |       | 16,837                          |       | 52,716 |   | 41,811 |   |
| Earnings from  discontinued operations, net of income taxes                    |       | —                           |       | 624                             |       | — |   | 1,822 |   |
| Net earnings                                                                   |       | $                                | 19,744     |                            | $          | 17,461 |   | $ | 52,716 |   | $ | 43,633 |   |
| **Net  earnings per share of common stock:**                                   |       |                             |       |                            |       |   |   |   |   |
| Basic earnings  per share:                                                     |       |                             |       |                            |       |   |   |   |   |
| Earnings from continuing operations                                            |       | $                                | 0.71       |                            | $          | 0.62 |   | $ | 1.91 |   | $ | 1.55 |   |
| Earnings from discontinued operations, net of income  taxes                    |       | $                                | —     |                            | $          | 0.02 |   | $ | — |   | $ | 0.07 |   |
| Net earnings                                                                   |       | $                                | 0.71       |                            | $          | 0.64 |   | $ | 1.91 |   | $ | 1.61 |   |
| Diluted earnings  per share:                                                   |       |                             |       |                            |       |   |   |   |   |
| Earnings from continuing operations                                            |       | $                                | 0.69       |                            | $          | 0.60 |   | $ | 1.84 |   | $ | 1.51 |   |
| Earnings from discontinued operations, net of income  taxes                    |       | $                                | —     |                            | $          | 0.02 |   | $ | — |   | $ | 0.07 |   |
| Net earnings                                                                   |       | $                                | 0.69       |                            | $          | 0.62 |   | $ | 1.84 |   | $ | 1.57 |   |
| **Dividends  per common share**                                                |       | $                                | 0.03       |                            | $          | — |   | $ | 0.09 |   | $ | — |   |

 

See accompanying Notes to the Consolidated Financial Statements.

2

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

| ** **                                                                                                                      | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                      | ** ** | **December 31,**           | ** ** |
| ** **                                                                                                                      | ** ** | **2005**                        | ** ** | **2004** | ** ** |
| **Cash Flows from Operating Activities**                                                                                        |       |                            |       |   |   |
| Earnings from continuing  operations                                                                                            |       | $                               | 52,716     |   | $ | 41,811 |   |
| Adjustments to reconcile earnings from continuing  operations to cash flows from operating activities of continuing operations: |       |                            |       |   |   |
| Depreciation and  amortization                                                                                                  |       | 31,719                          |       | 30,348 |   |
| Stock-based compensation                                                                                                        |       | 1,895                           |       | 923 |   |
| Deferred income taxes                                                                                                           |       | (500                            | )          | (378 | ) |
| Inventory reserve and  provision for doubtful accounts                                                                          |       | 766                             |       | 2,925 |   |
| Amortization and  write-off of deferred financing fees                                                                          |       | 2,846                           |       | 2,576 |   |
| Other, net                                                                                                                      |       | (439                            | )          | 1,163 |   |
| Changes in assets and liabilities, net of effects  from business combinations:                                                  |       |                            |       |   |   |
| Decrease (increase) in  accounts receivable                                                                                     |       | 22,844                          |       | (3,262 | ) |
| Increase in inventories                                                                                                         |       | (37,053                         | )          | (6,378 | ) |
| (Increase) decrease in  prepaid expenses and other current assets                                                               |       | (3,453                          | )          | 1,422 |   |
| Increase in accounts  payable                                                                                                   |       | 27,365                          |       | 16,318 |   |
| (Decrease) increase in  accrued expenses and other current liabilities                                                          |       | (30,876                         | )          | 832 |   |
| Decrease in customer  advances                                                                                                  |       | (7,981                          | )          | (4,520 | ) |
| Decrease (increase) in  pension and postretirement benefit liabilities                                                          |       | 347                             |       | (1,325 | ) |
| Other, net                                                                                                                      |       | (742                            | )          | (1,107 | ) |
| **Net  cash provided by operating activities of continuing operations**                                                         |       | 59,454                          |       | 81,348 |   |
| **Net  cash provided by operating activities of discontinued operations**                                                       |       | —                          |       | 2,697 |   |
| **Net  cash provided by operating activities**                                                                                  |       | 59,454                          |       | 84,045 |   |
| **Cash Flows from Investing Activities**                                                                                        |       |                            |       |   |   |
| Capital expenditures                                                                                                            |       | (26,311                         | )          | (20,742 | ) |
| Payments pursuant to  business combinations, net of cash acquired                                                               |       | (54,489                         | )          | (45,141 | ) |
| Disposition of property,  plant and equipment                                                                                   |       | 946                             |       | 825 |   |
| Other, net                                                                                                                      |       | 22                              |       | 468 |   |
| **Net  cash used in investing activities of continuing operations**                                                             |       | (79,832                         | )          | (64,590 | ) |
| **Net  cash used in investing activities of discontinued operations**                                                           |       | —                          |       | (596 | ) |
| **Net  cash used in investing activities**                                                                                      |       | (79,832                         | )          | (65,186 | ) |
| **Cash Flows from Financing Activities**                                                                                        |       |                            |       |   |   |
| Net borrowings of  short-term debt                                                                                              |       | —                          |       | (82 | ) |
| Proceeds from senior  subordinated notes, including advanced interest                                                           |       | —                          |       | 211,986 |   |
| Return of advanced  interest on senior subordinated notes                                                                       |       | (1,986                          | )          | — |   |
| Debt issuance costs                                                                                                             |       | (681                            | )          | (3,745 | ) |
| Repayment of long-term  debt                                                                                                    |       | (32,037                         | )          | (30,218 | ) |
| Proceeds from stock  option exercises                                                                                           |       | 9,750                           |       | 3,316 |   |
| Dividends paid                                                                                                                  |       | (2,508                          | )          | — |   |
| **Net  cash (used in) provided by financing activities of continuing operations**                                               |       | (27,462                         | )          | 181,257 |   |
| **Net  cash used in financing activities of discontinued operations**                                                           |       | —                          |       | (23 | ) |
| **Net  cash (used in) provided by financing activities**                                                                        |       | (27,462                         | )          | 181,234 |   |
| **Effect of exchange rates on  cash and cash equivalents**                                                                      |       | 654                             |       | 1,286 |   |
| **Net (decrease) increase in cash  and cash equivalents**                                                                       |       | (47,186                         | )          | 201,379 |   |
| **Cash and cash equivalents,  beginning of period**                                                                             |       | 306,852                         |       | 56,790 |   |
| **Cash and cash equivalents, end of period**                                                                                    |       | $                               | 259,666    |   | $ | 258,169 |   |

 

See accompanying Notes to the Consolidated Financial Statements.

3

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

**1.   Basis ofPresentation**

The accompanying unauditedConsolidated Financial Statements of DRS Technologies, Inc., itswholly-owned subsidiaries and a partnership of which DRS owns an 80%controlling interest (hereinafter, DRS or the Company) have been prepared inaccordance with accounting principles generally accepted in the United Statesof America and with the instructions to Form 10-Q and Article 10of Regulation S-X. In the opinion of the Company, the interim consolidatedfinancial information provided herein reflects all adjustments (consisting ofnormal and recurring adjustments) necessary for a fair presentation of theCompany’s consolidated financial position as of December 31, 2005, theresults of its operations for the three- and nine-month periods ended December 31,2005 and 2004, and its cash flows for the nine-month periods ended December 31,2005 and 2004. The results of operations for the three- and nine-month periodsended December 31, 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.

***ESSI Acquisition***

On January 31, 2006,the Company acquired all of the outstanding stock of Engineered Support Systems, Inc.(ESSI). The total transaction value was approximately $1.9 billion. See Note 17for a description of the acquisition of ESSI and its related financing. As ofDecember 31, 2005, $9.0 million of deferred acquisition fees havebeen incurred, of which $1.9 million have been paid.

***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 nine-month periodsended December 31, 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 nine months ended December 31, 2004. Allcorresponding notes reflect the discontinued operations presentation.

Asummary of the results of discontinued operations for the three- and nine-monthperiods ended December 31, 2004 follows:

| ** **                             | ** ** | **Three Months Ended  December 31, 2004** | ** ** | **Nine Months Ended  December 31, 2004** | ** ** |
|----------------------------------------|------------|---------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                             | ** ** | **(in thousands)**                                       | ** ** |
| Revenues                               |       |                                                          | $          | 8,212                                                        |       |   |   | $ | 27,759 |   |   |
| Earnings before  taxes                 |       |                                                          | $          | 1,030                                                        |       |   |   | $ | 3,020 |   |   |
| Income tax  expense                    |       |                                                          | 406        |                                                         |       |   | 1,198 |   |   |
| Earnings from  discontinued operations |       |                                                          | $          | 624                                                          |       |   |   | $ | 1,822 |   |   |

 

4

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

**2.   Acquisitions**

On April 15, 2005,DRS acquired Codem Systems, Inc. (Codem) in a stock purchase transactionfor $31.6 million in cash, with additional consideration payable of up to $5.0million upon achievement of certain annual bookings targets for a period ofthree years. In addition to the purchase price, the Company recorded $0.4 millionfor acquisition-related costs. The results of Codem’s operations have beenincluded in the Company’s financial statements since the date of acquisition.

Codem, located inMerrimack, New Hampshire, is a provider of signals intelligence (SIGINT)systems, network interface modules and high-performance antenna control systems.Management believes that the addition of Codem has enhanced DRS’s existingintelligence product base. Codem is being managed as a part of the Company’sCommand, Control, Communications, Computers and Intelligence (C4I) Group.

The Company is in theprocess of finalizing its assessment of certain acquired assets andliabilities; thus, the preliminary allocation of the purchase price may change.The Company recorded goodwill of $26.5 million, which has been allocated to theC4I Group. The Company recorded $1.9 million and $4.2 million oftechnology-based and customer-related intangibles, respectively, both of whichhave weighted average useful lives of 9 years. The Company will completeits purchase price allocation in the fourth quarter of fiscal 2006.

On June 27, 2005, DRSacquired WalkAbout Computer Systems Inc. (WalkAbout) in a stock purchasetransaction for approximately $13.8 million in cash, with additionalconsideration payable of up to $5.0 million upon achievement of certain revenuetargets for a period of two and a half years. In addition to the purchaseprice, the Company recorded $0.3 million for acquisition-related costs. Theresults of WalkAbout have been included in the Company’s financial statementssince the date of acquisition.

WalkAbout, located in WestPalm Beach, Florida, is a manufacturer of several lines of rugged, mobiletablet PCs, serving industrial, municipal, military and government markets.Management believes that the acquisition of WalkAbout has enhanced DRS’sposition in the tactical computer systems business by broadening its productofferings. WalkAbout is being managed as part of the Company’s C4I Group.

The Company is in theprocess of reviewing a third-party valuation of certain WalkAbout acquiredassets (including acquired intangible assets), as well as performing its owninternal assessment of certain other acquired assets and liabilities; thus, thepreliminary allocation of the purchase price will change. Based on preliminarypurchase price allocations, the Company has estimated goodwill to be $12.5million and has allocated the goodwill to the C4I Group. No amounts have beenallocated to acquired intangible assets pending finalization of the third-partyvaluation, however such amounts are not expected to be significant. The Companywill complete its purchase price allocation in the fourth quarter of fiscal2006.

Unaudited pro formafinancial information for the Codem and WalkAbout transactions discussed aboveis not presented because the effects of these acquisitions were not material oneither an individual or aggregate basis.

During the nine-monthperiod ended December 31, 2005, the Company paid $6.7 million inconsideration to satisfy an earn-out obligation on its acquisition of DKD, Inc.(now operating as a 

5

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

componentof DRS Infrared Technologies L.P.). The earn-out was recorded as an increase togoodwill during the fourth quarter of fiscal 2005, when it was assumed apayment was required. During the three months ended December 31, 2005, theCompany recorded an earn-out of $4.6 million for its acquisition of NightVision Equipment Co. Inc. and Excalibur Electro Optics, Inc. (collectively NVECand Affiliate). The earn-out, which was recorded as an increase to goodwill, isexpected to be paid in the fourth quarter of fiscal 2006.

**3.   Stock-BasedCompensation**

The Company has onestock-based compensation plan, the 1996 Omnibus Plan (Omnibus Plan). Under theterms of the Omnibus Plan, stock options and restricted stock may be granted tokey employees, directors and consultants of the Company. The Company accountsfor stock options granted to employees and directors under the recognition andmeasurement principles of Accounting Principles Board Opinion (APB) No. 25,“Accounting for Stock Issued to Employees” and related interpretations.Compensation expense for stock options granted to an employee or director isrecognized in earnings based on the excess, if any, of the quoted market priceof DRS common stock at the date of the grant, or other measurement date, overthe amount an employee or director must pay to acquire the common stock. When theexercise price of the option granted to an employee or director equals orexceeds the quoted market price of DRS common stock at the date of grant, theCompany does not recognize compensation expense. Compensation cost forrestricted stock is recorded based on the quoted market price of DRS commonstock on the date of grant.

The Company elected not toadopt the fair-value-based method of accounting for stock-based employeecompensation, as permitted by Statement of Financial Accounting Standards(SFAS) No. 123, “Accounting for Stock-Based Compensation,” as amended bySFAS No. 148, “Accounting for Stock-Based Compensation—Transition andDisclosure, an amendment of SFAS No. 123.” Had the Company adopted thefair-value-based method provisions of SFAS No. 123, it would have recordeda non-cash expense for the estimated fair value of the stock options that theCompany had granted to its employees and directors.

6

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

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. Option forfeitures are accounted for as they occurred and noamounts of compensation expense have been capitalized into inventory or otherassets, but instead are considered period expenses.

| ** **                                                                                                           | ** ** | **Three Months Ended  December 31,**           | ** ** | **Nine Months Ended  December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                                           | ** ** | **2005**                                                      | ** ** | **2004**                                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                           | ** ** | **(in thousands, except per-share data)** | ** ** |
| Net earnings, as  reported                                                                                           |       | $                                                             | 19,744     |                                               | $          | 17,461 |   | $ | 52,716 |   | $ | 43,633 |   |
| Add: Stock-based  compensation expense included in reported net earnings, net of taxes                               |       | 478                                                           |       | 173                                                |       | 1,145 |   | 549 |   |
| Less: Total  stock-based compensation expense determined under fair-value-based method for  all awards, net of taxes |       | (2,601                                                        | )          | (1,426                                             | )          | (6,860 | ) | (3,897 | ) |
| Pro forma net  earnings                                                                                              |       | $                                                             | 17,621     |                                               | $          | 16,208 |   | $ | 47,001 |   | $ | 40,285 |   |
| Earnings per  share:                                                                                                 |       |                                                          |       |                                               |       |   |   |   |   |
| Basic—as reported                                                                                               |       | $                                                             | 0.71       |                                               | $          | 0.64 |   | $ | 1.91 |   | $ | 1.61 |   |
| Basic—pro forma                                                                                                 |       | $                                                             | 0.63       |                                               | $          | 0.60 |   | $ | 1.70 |   | $ | 1.49 |   |
| Diluted—as reported                                                                                             |       | $                                                             | 0.69       |                                               | $          | 0.62 |   | $ | 1.84 |   | $ | 1.57 |   |
| Diluted—pro forma                                                                                               |       | $                                                             | 0.61       |                                               | $          | 0.59 |   | $ | 1.65 |   | $ | 1.47 |   |

 

In December 2004, the Financial AccountingStandards Board  (FASB) issued SFAS No. 123(revised 2004), “Share-Based Payment” (SFAS No. 123R), which replaces SFASNo. 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 restricted 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 beginning ofthe year of adoption or for all periods presented. The prospective methodrequires that compensation expense be recorded for all unvested stock optionsand restricted stock 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 onthe Company’s consolidated results of operations and earnings per share. TheCompany has not yet determined the method of adoption or the 

7

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

effect of adopting SFAS No. 123R,and it has not determined whether the adoption will result in amounts that aresimilar 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 4-01a of regulation S-X regarding the compliancedate for SFAS No. 123R. The SEC Release amends the effective date forcompliance with SFAS No. 123R to the beginning of the first fiscal yearfollowing June 15, 2005, which is the fiscal year beginning on April 1,2006 for DRS. On March 29, 2005, the SEC issued Staff Accounting Bulletin(SAB) No. 107, “Share-Based Payment” (SAB 107). SAB 107 provides guidanceto assist registrants in the initial implementation of SFAS No. 123R. SAB107 includes, but is not limited to, interpretive guidance related toshare-based payment transactions with non-employees, valuation methods andunderlying expected volatility and expected term assumptions, theclassification of compensation expenses and accounting for the income taxeffects of share-based arrangements upon adopting the SFAS No. 123R. TheCompany currently is assessing the guidance provided in SAB 107 in connectionwith its implementation of SFAS No. 123R.

In November 2005, theFASB issued FSP FAS123(R)-3, “Transition Election toAccounting for the Tax Effects of Share Based Payment Awards.”**ThisFSP requires an entity to follow either the transition guidance for theadditional paid-in capital pool as prescribed in SFAS No. 123R, or thealternative transition method as described in the FSP. An entity that adoptsSFAS No. 123R using the modified prospective application may make a one-time election to adopt thetransition method described in this FSP. An entity may take up to oneyear from the later of its initial adoption of SFAS No. 123R or theeffective date of this FSP to evaluate its available transition alternativesand make its one-time election. This FSP becameeffective in November 2005. The Company is evaluating the impact ofthe adoption of this FSP in connection with its adoption ofSFAS No. 123R.

**4.   Inventories**

Inventoriesare summarized as follows:

| ** **                                             | ** ** | **December 31,**   | ** ** | **March 31,** | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|--------------------|------------|
| ** **                                             | ** ** | **2005**                | ** ** | **2005**           | ** ** |
| ** **                                             | ** ** | **(in thousands)** | ** ** |
| Work-in-process                                        |       |                    | $          | 293,042            |       |   | $ | 211,914 |   |
| General and  administrative costs                      |       |                    | 50,274     |               |       | 47,365 |   |
| Raw material and  finished goods                       |       |                    | 50,658     |               |       | 33,127 |   |
|                                                   |       |                    | 393,974    |               |       | 292,406 |   |
| Less: Progress  payments and certain customer advances |       |                    | 136,165    |               |       | 75,541 |   |
| Inventory reserve                                      |       |                    | 6,466      |               |       | 8,724 |   |
| Total                                                  |       |                    | $          | 251,343            |       |   | $ | 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 Consolidated Financial Statements (Continued) (Unaudited)**

Thetable below presents a summary of G&A, IRAD and B&P costs included ininventoried contract costs and changes to them, including amounts used in thedetermination of costs and expenses. The cost data in the table below does notinclude the G&A, IRAD and B&P costs for the Company’s lines ofbusinesses that are not primarily contracted with the U.S. government, whichare expensed as incurred.

| ** **                                   | ** ** | **Three Months Ended  December 31,** | ** ** | **Nine Months Ended  December 31,** | ** ** |
|----------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                   | ** ** | **2005**                                            | ** ** | **2004**                                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                   | ** ** | **(in thousands)**                             | ** ** |
| Balance beginning  of period                 |       | $                                                   | 50,813     |                                               | $          | 43,307 |   | $ | 47,365 |   | $ | 37,854 |   |
| Add: Incurred costs                          |       | 57,697                                              |       | 50,729                                             |       | 162,970 |   | 150,068 |   |
| Less: Amounts included in costs and expenses |       | (58,236                                             | )          | (50,856                                            | )          | (160,061 | ) | (144,742 | ) |
| Balance in inventory at  December 31,   |       | $                                                   | 50,274     |                                               | $          | 43,180 |   | $ | 50,274 |   | $ | 43,180 |   |

 

Total expenditures forIRAD amounted to approximately $12.1 million and $9.2 million for thethree-month periods ended December 31, 2005 and 2004, respectively, and$33.5 million and $26.1 million, respectively, for the nine-month periods thenended.

**5.   Goodwill and Intangible Assets**

Thefollowing disclosure presents certain information regarding the Company’sacquired intangible assets as of December 31, 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 December 31, 2005**         | ** ** |                    | ** ** | ** **                                  |       | ** **                  | ** ** |                          | ** ** | ** **           |       |   | ** ** | ** ** |   |
| Technology-based intangibles             |       |                    | 18 years   | ** **                                  |       | $                           | 47,861     |                          |       | $                    | (13,360    | ) |   |   | $ | 34,501 | ** ** |   |
| Customer-related intangibles             |       |                    | 17 years   | ** **                                  |       | 79,790                      |       |                          | (14,502    | )                    |       |   | 65,288 | ** ** |   |
| Total                                    |       |                    |       | ** **                                  |       | $                           | 127,651    |                          |       | $                    | (27,862    | ) |   |   | $ | 99,789 | ** ** |   |
| **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 December 31, 2005 and 2004 was$2.2 million and $1.7 million, respectively, and for the nine-month periodsended December 31, 2005 and 2004 was $6.3 million and $5.0 million, respectively.The estimated acquired intangible amortization expense, based on gross carryingamounts at December 31, 2005, is estimated to be $2.2 million for theremainder of 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 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 December 31,2005.

| ** **                                                                  | ** ** | **C4I  Group**          | ** ** | **SR  Group** | ** ** | **Total** | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------------|------------|---------------|------------|-----------|------------|
| ** **                                                                  | ** ** | **(in thousands)** | ** ** |
| Balance as of  March 31, 2005                                          |       | $                       | 447,631    |          | $          | 367,776   |       | $ | 815,407 |   |
| Codem acquisition                                                           |       | 26,481                  |       | —        |       | 26,481    |       |
| WalkAbout  acquisition                                                      |       | 12,507                  |       | —        |       | 12,507    |       |
| Deferred tax  adjustments related to prior acquisitions(A)                  |       | (9,460                  | )          | (24,219       | )          | (33,679   | )          |
| Accrued  acquisition earn-out, Night Vision Equipment Company               |       | —                  |       | 4,564         |       | 4,564     |       |
| Expiration of  unexercised contract options relating to the IDT acquisition |       | —                  |       | (566          | )          | (566      | )          |
| Other Adjustments                                                           |       | 94                      |       | (328          | )          | (234      | )          |
| Foreign currency  translation adjustment                                    |       | (372                    | )          | —        |       | (372      | )          |
| Balance as of December 31,  2005                                       |       | $                       | 476,881    |          | $          | 347,227   |       | $ | 824,108 |   |

----

(A)       TheCompany operates in multiple taxing jurisdictions, both within the UnitedStates and outside the United States, and faces audits from these various taxauthorities regarding the amount of taxes due. Such audits can involve complexissues and may require an extended period of time to resolve. In the secondquarter of fiscal 2006, the Company’s income tax provision was reduced by $3.0million predominately due to the resolution of the IRS’s examination of the 1999-2001tax years. Also in connection with the resolution of the 1999-2001 taxaudits, the Company adjusted certain acquired deferred tax assets andliabilities and certain other pre-acquisition related tax amounts, totaling$33.7 million, with a corresponding net decrease to goodwill.

**6.   Product Warranties**

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 nine monthsended December 31, 2005 and 2004, which are included in accrued expensesand other current liabilities.

| ** **                                                | ** ** | **Nine Months Ended  December 31,** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                | ** ** | **2005**                                           | ** ** | **2004** | ** ** |
| ** **                                                | ** ** | **(in thousands)**                            | ** ** |
| Balance at  March 31,                                |       | $                                                  | 21,839     |   | $ | 23,279 |   |
| Acquisitions during the period                            |       | 360                                                |       | 25 |   |
| Accruals for product warranties issued during the  period |       | 6,853                                              |       | 5,695 |   |
| Settlements made during the period                        |       | (9,388                                             | )          | (5,657 | ) |
| Other                                                     |       | 31                                                 |       | 179 |   |
| Balance at  December 31,                             |       | $                                                  | 19,695     |   | $ | 23,521 |   |

 

10

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

**7.   Debt**

| ** **                                                                                                                               | ** ** | **December 31,  2005** | ** ** | **March 31,  2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| ** **                                                                                                                               | ** ** | **(in thousands)**     | ** ** |
| Senior  subordinated notes, including bond premium of $8,868 and $9,716 at  December 31, 2005 and March 31, 2005, respectively |       |                        | $          | 558,868                  |       |   | $ | 559,716 |   |
| Term loan                                                                                                                                |       |                        | 135,690    |                     |       | 167,460 |   |
| Other obligations                                                                                                                        |       |                        | 2,853      |                     |       | 3,087 |   |
|                                                                                                                                     |       |                        | 697,411    |                     |       | 730,263 |   |
| Less:                                                                                                                                    |       |                        |       |                     |       |   |   |
| Current installments of long-term debt                                                                                                   |       |                        | 135,891    |                     |       | 2,652 |   |
| Total long-term debt                                                                                                                     |       |                        | $          | 561,520                  |       |   | $ | 727,611 |   |

 

On October 30, 2003, the Company issued $350.0million aggregate 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 the Company’s ability and theability of its subsidiaries to incur more debt, make certain investments,repurchase stock, create liens, enter into transactions with affiliates, enterinto sale lease-back transactions, merge or consolidate, pay dividends, andtransfer or sell assets. The Notes are unconditionally guaranteed, jointly andseverally, by DRS’s current and future wholly-owned domestic subsidiaries. Theforeign subsidiaries and certain domestic subsidiaries of DRS do not guaranteethe Notes. See Note 15, “Guarantor and Non-guarantor Financial Statements” foradditional 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 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 December 31, 2005 was approximately $558.9 millionand $522.5 million, respectively.

At December 31, 2005, the Company had a $411.0million credit facility (the Credit Facility), consisting of a $175.0 millionsenior secured revolving line of credit and a $236.0 million senior securedterm loan. As of December 31, 2005 and March 31, 2005, the Companyhad $135.7 million and $167.5 million, respectively, of term loans outstandingagainst the Credit Facility. The Credit Facility was 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 would have matured on November 2010and November 2008, respectively. The weighted average interest rate on theCompany’s term loans was 5.9% as 

11

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

of December 31, 2005(4.4% as of March 31, 2005), excluding the impact of the amortization ofdebt issuance costs. As of December 31, 2005, the Company had $139.5million available under its revolving line of credit. There were no borrowingsunder the Company’s revolving line of credit as of December 31, 2005 and March 31,2005.

During the nine months ended December 31, 2005,the Company repaid $30.0 million of its term loan, at its discretion, andrecorded a $0.6 million charge to interest and related expenses during thatperiod for the related write-off of a portion of the debt issuance costs. Duringthe three months ended December 31, 2005, the Company decided to prepaythe remaining balance of its term loan in the fourth quarter of fiscal 2006. Asfurther described in Note 17, “Subsequent Events,” the term loan was repaid duringthe week of January 9, 2006. As a result, the term loan has beenclassified as a current liability on the December 31, 2005 consolidatedbalance sheet.

From time to time, the Company enters into standbyletters-of-credit and bank guarantee agreements with financial institutions andcustomers, primarily relating to the guarantee of its future performance oncertain contracts to provide products and services and to secure advancepayments it has received from its customers. As of December 31, 2005, anaggregate of $36.8 million was contingently payable under letters of credit andbank guarantees. Approximately $0.9 million and $0.4 million in letters ofcredit and bank guarantees, respectively, as of December 31, 2005 wereissued outside of the Credit Facility and by a bank agreement for the Company’sU.K. subsidiary, respectively, that are not considered when determining theavailability under the Company’s revolving line of credit.

The Company has a mortgage note payable that issecured by a lien on its facility located in Palm Bay, Florida, and bearsinterest at a rate equal to the one-month LIBOR plus 1.65%. The balance of themortgage as of December 31, 2005 and March 31, 2005 was $2.8 millionand $3.0 million, respectively. Monthly payments of principal and interesttotaling approximately $34 thousand will continue through December 1,2016.

Accrued interest expenseat December 31, 2005 and March 31, 2005 was approximately $7.1 millionand $16.5 million, respectively.

12

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

**8.**   Earnings per Share

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

| ** **                                                        | ** ** | **Three Months Ended  December 31,**           | ** ** | **Nine Months Ended  December 31,** | ** ** |
|-------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                        | ** ** | **2005**                                                      | ** ** | **2004**                                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                        | ** ** | **(in thousands, except per-share data)** | ** ** |
| **Basic EPS computation**                                         |       |                                                          |       |                                               |       |   |   |   |   |
| Earnings from continuing operations                               |       | $                                                             | 19,744     |                                               | $          | 16,837 |   | $ | 52,716 |   | $ | 41,811 |   |
| Earnings from discontinued operations, net of income  taxes       |       | —                                                        |       | 624                                                |       | — |   | 1,822 |   |
| Net earnings                                                      |       | $                                                             | 19,744     |                                               | $          | 17,461 |   | $ | 52,716 |   | $ | 43,633 |   |
| Weighted average common shares outstanding                        |       | 27,778                                                        |       | 27,116                                             |       | 27,645 |   | 27,042 |   |
| Basic earnings  per share                                         |       |                                                          |       |                                               |       |   |   |   |   |
| Earnings from continuing operations                               |       | $                                                             | 0.71       |                                               | $          | 0.62 |   | $ | 1.91 |   | $ | 1.55 |   |
| Earnings from discontinued operations, net of income  taxes  |       | $                                                             | —     |                                               | $          | 0.02 |   | $ | — |   | $ | 0.07 |   |
| Net earnings                                                      |       | $                                                             | 0.71       |                                               | $          | 0.64 |   | $ | 1.91 |   | $ | 1.61 |   |
| **Diluted  EPS computation**                                      |       |                                                          |       |                                               |       |   |   |   |   |
| Earnings from continuing operations                               |       | $                                                             | 19,744     |                                               | $          | 16,837 |   | $ | 52,716 |   | $ | 41,811 |   |
| Earnings from discontinued operations, net of income  taxes       |       | —                                                        |       | 624                                                |       | — |   | 1,822 |   |
| Net earnings                                                      |       | $                                                             | 19,744     |                                               | $          | 17,461 |   | $ | 52,716 |   | $ | 43,633 |   |
| Diluted common  shares outstanding                                |       |                                                          |       |                                               |       |   |   |   |   |
| Weighted average common shares outstanding                        |       | 27,778                                                        |       | 27,116                                             |       | 27,645 |   | 27,042 |   |
| Stock options and restricted stock                                |       | 942                                                           |       | 846                                                |       | 951 |   | 688 |   |
| Diluted common shares outstanding                                 |       | 28,720                                                        |       | 27,962                                             |       | 28,596 |   | 27,730 |   |
| Diluted earnings  per share                                       |       |                                                          |       |                                               |       |   |   |   |   |
| Earnings from continuing operations                               |       | $                                                             | 0.69       |                                               | $          | 0.60 |   | $ | 1.84 |   | $ | 1.51 |   |
| Earnings from discontinued operations, net of income  taxes       |       | $                                                             | —     |                                               | $          | 0.02 |   | $ | — |   | $ | 0.07 |   |
| Net earnings                                                      |       | $                                                             | 0.69       |                                               | $          | 0.62 |   | $ | 1.84 |   | $ | 1.57 |   |

 

At December 31, 2005there were 22,500 options that were excluded from the diluted EPS calculationbecause their inclusion would have had an antidilutive effect on EPS.

13

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

**9.**   Comprehensiveearnings

Thecomponents of comprehensive earnings for the three- and nine-month periodsended December 31, 2005 and 2004 consisted of the following:

| ** **                                                                                | ** ** | **Three Months Ended  December 31,** | ** ** | **Nine Months Ended  December 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                | ** ** | **2005**                                            | ** ** | **2004**                                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                | ** ** | **(in thousands)**                             | ** ** |
| Net earnings                                                                              |       | $                                                   | 19,744     |                                               | $          | 17,461 |   | $ | 52,716 |   | $ | 43,633 |   |
| Other comprehensive  earnings:                                                            |       |                                                |       |                                               |       |   |   |   |   |
| Foreign currency translation adjustments                                                  |       | (562                                                | )          | 2,969                                              |       | 283 |   | 3,831 |   |
| Unrealized net gains on hedging instruments arising  during the period, net of income tax |       | —                                              |       | 187                                                |       | — |   | 789 |   |
| Amortization of unrealized gain on terminated instruments,  net of income taxes           |       | (49                                                 | )          | —                                             |       | (141 | ) | — |   |
| Comprehensive earnings                                                                    |       | $                                                   | 19,133     |                                               | $          | 20,617 |   | $ | 52,858 |   | $ | 48,253 |   |

 

**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- andnine-month periods ended December 31, 2005 and 2004. These plans are morefully described in Note 12 to the Company’s Consolidated Financial Statementsfor the year ended March 31, 2005.

| ** **                                       | ** ** | ** **                                              | ** ** | ** **             | ** ** | **Unfunded**              | ** ** |
|--------------------------------------------------|------------|---------------------------------------------------------|------------|------------------------|------------|---------------------------|------------|
| ** **                                       | ** ** | **Funded**                                              | ** ** | **Postretirement**     | ** ** | **Supplemental**          | ** ** |
| ** **                                       | ** ** | **Pension Plans**                                  | ** ** | **Benefit Plans** | ** ** | **Retirement Plans** | ** ** |
| ** **                                       | ** ** | **Three Months Ended December 31,** | ** ** |
| ** **                                       | ** ** | **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 |       | 1                                                       |       | 1                      |       | —                    |       | — |   | 194 |   | 194 |   |
| Net periodic benefit  cost                       |       | $                                                       | 774        |                   | $          | 849                       |       | $ | 374 |   | $ | 381 |   | $ | 651 |   | $ | 540 |   |
|                                                  |            |                                                         |            |                        |            |                           |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

14

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

 

| ** **                                       | ** ** | ** **                                             | ** ** | ** **             | ** ** | **Unfunded**              | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------------|------------|------------------------|------------|---------------------------|------------|
| ** **                                       | ** ** | **Funded**                                             | ** ** | **Postretirement**     | ** ** | **Supplemental**          | ** ** |
| ** **                                       | ** ** | **Pension Plans**                                 | ** ** | **Benefit Plans** | ** ** | **Retirement Plans** | ** ** |
| ** **                                       | ** ** | **Nine Months Ended December 31,** | ** ** |
| ** **                                       | ** ** | **2005**                                               | ** ** | **2004**               | ** ** | **2005**                  | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                       | ** ** | **(in thousands)**                                | ** ** |
| Service cost                                     |       | $                                                      | 2,964      |                   | $          | 2,883                     |       | $ | 450 |   | $ | 402 |   | $ | 408 |   | $ | 312 |   |
| Interest cost                                    |       | 4,533                                                  |       | 4,365                  |       | 723                       |       | 714 |   | 837 |   | 723 |   |
| Expected return  on plan assets                  |       | (5,307                                                 | )          | (4,800                 | )          | (126                      | )          | (69 | ) | — |   | — |   |
| Amortization of  unrecognized loss (gain)        |       | 129                                                    |       | 96                     |       | (6                        | )          | 69 |   | 126 |   | 3 |   |
| Amortization of  transition obligation           |       | —                                                 |       | —                 |       | 81                        |       | 27 |   | — |   | — |   |
| Amortization of  unrecognized prior-service cost |       | 3                                                      |       | 3                      |       | —                    |       | — |   | 582 |   | 582 |   |
| Net periodic benefit  cost                       |       | $                                                      | 2,322      |                   | $          | 2,547                     |       | $ | 1,122 |   | $ | 1,143 |   | $ | 1,953 |   | $ | 1,620 |   |

 

Excluding the impact ofthe ESSI acquisition, the Company expects to contribute $4.1 million and $1.8million to its pension and postretirement plans, respectively, during thefiscal year ended March 31, 2006, of which $3.3 million and $1.7 million,were contributed during the nine-month period ended December 31, 2005.

**11.**   Operating Segments

At December 31, 2005, the Company had twoprincipal operating segments, on the basis of products and services offered:the Command, Control, Communications, Computers and Intelligence (C4I) Groupand the Surveillance and Reconnaissance (SR) Group. All other operations aregrouped 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, electronicmanufacturing and system integration services, and secure voice and datacommunications; 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 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, 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.

15

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to 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 nine-month periods ended December 31, 2005 and 2004 isas follows:

| ** **                                | ** ** | **C4I Group**      | ** ** | **SR Group** | ** ** | **Other** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|-------------------------|------------|-------------------|------------|-----------|------------|-----------|------------|
| ** **                                | ** ** | **(in thousands)** | ** ** |
| **Three Months Ended December 31,  2005** |       |                    |       |              |       |      |       |      |       |
| Total revenues                            |       | $                       | 203,977    |              | $          | 187,218   |       | $         | —     |   | $ | 391,195 |   |
| Intersegment revenues                     |       | (1,062                  | )          | (643              | )          | —    |       | (1,705    | )          |
| External revenues                         |       | $                       | 202,915    |              | $          | 186,575   |       | $         | —     |   | $ | 389,490 |   |
| Operating income (loss)                   |       | $                       | 23,866     |              | $          | 20,979    |       | $         | (18        | ) | $ | 44,827 |   |
| Total assets                              |       | $                       | 844,775    |              | $          | 730,323   |       | $         | 316,775    |   | $ | 1,891,873 |   |
| Depreciation and amortization             |       | $                       | 3,725      |              | $          | 5,981     |       | $         | 1,072      |   | $ | 10,778 |   |
| Capital expenditures                      |       | $                       | 2,186      |              | $          | 6,020     |       | $         | 1,851      |   | $ | 10,057 |   |
| **Three  Months Ended December 31, 2004** |       |                    |       |              |       |      |       |      |       |
| Total revenues                            |       | $                       | 189,589    |              | $          | 151,745   |       | $         | —     |   | $ | 341,334 |   |
| Intersegment revenues                     |       | (556                    | )          | (2,546            | )          | —    |       | (3,102    | )          |
| External revenues                         |       | $                       | 189,033    |              | $          | 149,199   |       | $         | —     |   | $ | 338,232 |   |
| Operating income (loss)                   |       | $                       | 23,095     |              | $          | 16,173    |       | $         | (19        | ) | $ | 39,249 |   |
| Assets of continuing operations           |       | $                       | 778,182    |              | $          | 748,782   |       | $         | 276,619    |   | $ | 1,803,583 |   |
| Depreciation and amortization             |       | $                       | 3,145      |              | $          | 5,831     |       | $         | 725        |   | $ | 9,701 |   |
| Capital expenditures                      |       | $                       | 3,033      |              | $          | 3,431     |       | $         | 698        |   | $ | 7,162 |   |
| **Nine  Months Ended December 31, 2005**  |       |                    |       |              |       |      |       |      |       |
| Total revenues                            |       | $                       | 589,855    |              | $          | 503,499   |       | $         | —     |   | $ | 1,093,354 |   |
| Intersegment revenues                     |       | (2,030                  | )          | (1,445            | )          | —    |       | (3,475    | )          |
| External revenues                         |       | $                       | 587,825    |              | $          | 502,054   |       | $         | —     |   | $ | 1,089,879 |   |
| Operating income (loss)                   |       | $                       | 63,072     |              | $          | 57,844    |       | $         | (2,454     | ) | $ | 118,462 |   |
| Total assets                              |       | $                       | 844,775    |              | $          | 730,323   |       | $         | 316,775    |   | $ | 1,891,873 |   |
| Depreciation and amortization             |       | $                       | 10,817     |              | $          | 17,971    |       | $         | 2,931      |   | $ | 31,719 |   |
| Capital expenditures                      |       | $                       | 8,059      |              | $          | 14,130    |       | $         | 4,122      |   | $ | 26,311 |   |
| **Nine  Months Ended December 31, 2004**  |       |                    |       |              |       |      |       |      |       |
| Total revenues                            |       | $                       | 517,207    |              | $          | 438,631   |       | $         | —     |   | $ | 955,838 |   |
| Intersegment revenues                     |       | (1,466                  | )          | (6,936            | )          | —    |       | (8,402    | )          |
| External revenues                         |       | $                       | 515,741    |              | $          | 431,695   |       | $         | —     |   | $ | 947,436 |   |
| Operating income (loss)                   |       | $                       | 55,772     |              | $          | 45,888    |       | $         | (105       | ) | $ | 101,555 |   |
| Assets of continuing operations           |       | $                       | 778,182    |              | $          | 748,782   |       | $         | 276,619    |   | $ | 1,803,583 |   |
| Depreciation and amortization             |       | $                       | 9,591      |              | $          | 18,721    |       | $         | 2,036      |   | $ | 30,348 |   |
| Capital  expenditures                     |       | $                       | 6,993      |              | $          | 11,799    |       | $         | 1,950      |   | $ | 20,742 |   |

 

16

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

The table belowprovides a reconciliation of total consolidated assets to total assets ofcontinuing operations presented above:

| ** **                         | ** ** | **December 31,**   | ** ** |
|------------------------------------|------------|-------------------------|------------|
| ** **                         | ** ** | **2004**                | ** ** |
| ** **                         | ** ** | **(in thousands)** | ** ** |
| Assets of  continuing operations   |       |                    | $          | 1,803,583 |   |   |
| Assets of  discontinued operations |       |                    | 38,864     |   |   |
| Total assets                       |       |                    | $          | 1,842,447 |   |   |

 

**12.**   SupplementalCash Flow Information

| ** **                                                                           | ** ** | **Nine Months Ended  December 31,** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                           | ** ** | **2005**                                           | ** ** | **2004** | ** ** |
| ** **                                                                           | ** ** | **(in thousands)**                            | ** ** |
| Cash paid for:                                                                       |       |                                               |       |   |   |
| Income taxes                                                                         |       | $                                                  | 35,624     |   | $ | 7,271 |   |
| Interest                                                                             |       | $                                                  | 43,038     | * | $ | 30,523 |   |
| Supplemental  disclosure of significant non-cash investing and financing activities: |       |                                               |       |   |   |
| Acquisition costs for business combinations, net                                     |       | $                                                  | 11,848     |   | $ | 4,946 |   |

----

*                    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 November 3, 2005,the Board of Directors declared a $0.03 per common share cash dividend, whichwas paid on December 30, 2005 to stockholders of record as of December 15,2005. Cash dividends of $0.8 million were paid in each of the first, second andthird quarters of fiscal 2006. On February 8, 2006, the Board of Directorsdeclared a $0.03 per common share cash dividend, payable on March 30, 2006to stockholders of record as of March 15, 2006.

**14.   Contingenciesand Related Party Transactions**

**Contingencies****  **The Company is party to variouslegal actions and claims arising in the ordinary course of its business. In theCompany’s opinion, the Company has adequate legal defenses for each of theactions and claims.

Various legal actions, claims, assessments and othercontingencies arising in the normal course of the Company’s business, includingcertain matters described below, are pending against the Company and certain ofits subsidiaries. These matters are subject to many uncertainties, and it ispossible that some of these matters could be ultimately decided, resolved orsettled adversely. The Company has recorded accruals totaling $4.5 million and$10.2 million at December 31, 2005 and March 31, 2005, respectively,for losses related to those matters that it considers to be probable and thatcan be reasonably estimated (certain legal and environmental matters arediscussed in detail below). Although the ultimate amount of liability at December 31,2005 that may result from those matters for which the Company has recordedaccruals is not ascertainable, the Company believes that any amounts exceedingthe Company’s recorded 

17

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

accruals should notmaterially affect the Company’s financial condition or liquidity. It ispossible, however, that the ultimate resolution of those matters could resultin a material adverse effect on the Company’s results of operations for aparticular reporting period.

**Legaland Environmental**   On October 3, 2001, alawsuit was filed by Miltope Corporation and IV Phoenix Group, Inc.,against DRS Technologies, Inc., DRS Electronic Systems, Inc. and anumber of individual defendants, several of whom had been employed by DRSElectronic Systems, Inc. The plaintiffs’ claims against DRS relatedgenerally to the activities of certain former employees of IV Phoenix Group andthe hiring of some of those employees by the Company. On May 4, 2005, DRSentered into a settlement agreement, pursuant to which the Company agreed topay $7.5 million to the plaintiffs, and litigation involving the parties wasresolved to their satisfaction, with the elimination of all outstanding claims.A charge of $6.5 million was recorded in the fourth quarter of fiscal 2005 toincrease the Company’s accrual for the matter to $7.5 million as of March 31,2005. The settlement payment was made on May 5, 2005.

Some environmental laws, such as the ComprehensiveEnvironmental Response, Compensation and Liability Act of 1980 (also known asCERCLA or the Superfund law) and similar state statutes, can impose liabilityfor the entire cost of the clean up of contaminated sites upon any of thecurrent or former site owners or operators (or upon parties who send waste tothese sites), regardless of the lawfulness of the original activities that ledto the contamination. In July 2000, prior to its acquisition by IDT, andprior to DRS’s acquisition of IDT, Tech-Sym Corporation received a Section 104(e) Requestfor Information from the National Park Service (NPS), pursuant to CERCLA,regarding a site known as the Orphan Mine site in the Grand Canyon NationalPark, Arizona, which is the subject of an NPS investigation regarding thepresence of residual radioactive materials and contamination. A corporation ofwhich Tech-Sym is an alleged successor operated this uranium mine from 1956 to1967. In 1962, the land was sold to the U.S. government and the allegedpredecessor of Tech-Sym was given a 25-year mining lease.  In 1967, the mining rights were transferred toa third party by a trustee in bankruptcy, and the Company believes that themine was 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. The initial remediationestimate for the CERCLA related cleanup of the Operable Unit 1 (the upper minearea) site was $0.8 million and a second, independent evaluation estimatedremediation costs at $1.0 million. On February 6, 2005, the NPS sent theCompany an Engineering Evaluation/Cost Analysis Work Plan under CERCLA (the ‘‘CERCLALetter’’) with regards to Operable Unit 1 of the Orphan Mine site. In theCompany’s view, this Work Plan included additional cleanup not covered byCERCLA. The CERCLA Letter also requested (a) payment of $0.5 million forcosts incurred by the NPS related to the Orphan Mine, and (b) a ‘‘goodfaith offer’’ to conduct the response activity outlined by the NPS and toreimburse the NPS for future costs. The NPS advised that a similar letter hasbeen sent to another PRP. The Company initiated discussions with the other PRPand with NPS, and engaged a technical consultant to evaluate the existingdocumentation and the site in depth.   Asa result, on September 29, 2005, the technical consultant submitted to theNPS, on behalf of the 

18

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

Company and the other PRP,an alternative Engineering Evaluation/Cost Analysis Work Plan (the “EE/CA”)with regards to Operating Units 1 and 2 of the Orphan Mine Site.

On December 6, 2005 the PRPs and NPS met todiscuss the alternative EE/CA. The meeting focused on the technical merits ofthe alternative EE/CA and certain differences between the alternative EE/CA andthe NPS EE/CA provided with the CERCLA Letter. The differences included analternative sampling technique and the inclusion of Operable Unit 2 (the lowermine area) in the EE/CA. In addition, certain legal issues relating to theprocess for implementing an agreed upon EE/CA were discussed. It is anticipatedthat further meetings will be held between the PRPs and NPS early in 2006. Thepotential liability can change substantially due to such factors as additionalinformation on the nature or extent of contamination, methods of remediationrequired, changes in the apportionment of costs among the responsible partiesand other actions by governmental agencies or private parties.

On November 24, 2004, a lawsuit was filed in theUnited States District Court for the District of Colorado by ITT Industries, Inc.,a corporation of the State of Indiana, against DRS Tactical Systems, Inc.The plaintiff alleged DRS breached a subcontract between DRS and ITT and soughtdamages in excess of $5.0 million. The claim generally related to theperformance by DRS and its predecessors, DRS Tactical Systems (West), Inc.and Catalina Research Inc., under a subcontract for a component being suppliedto ITT under ITT’s prime contract with the U.S. Army. On February 14,2005, DRS Tactical Systems, Inc. filed its answer, affirmative defensesand counterclaims. The counterclaims alleged breach of contract and breach ofduties of good faith and fair dealing and sought damages of no less than $1.8million. The Company and ITT agreed to conduct nonbinding mediation, as aresult of which the case was settled on August 31, 2005 with the executionof mutual releases and no damages due to either party.

**RelatedParty Transactions****  **TheCompany currently leases a building in Oakland, New Jersey, owned by LDR RealtyCo., a partnership that was wholly owned in equal amounts by David E. Gross,DRS’s cofounder and the former President and Chief Technical Officer, and thelate Leonard Newman, DRS’s cofounder, the former Chairman of the Board, ChiefExecutive Officer, and Secretary and the father of Mark S. Newman, the Company’scurrent Chairman of the Board, President and Chief Executive Officer. The leaseagreement with a monthly rental of $21.2 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 nine months ended December 31, 2005 and 2004. Fees paidto Skadden, Arps, Slate, Meagher & Flom LLP for the nine months ended December 31,2005 and 2004 were $2.2 million and $0.7 million, respectively.

Kronish Lieb Weiner &Hellman LLP, a law firm of which Alison Newman, sister of Mark S. Newman, is apartner, provided legal services to DRS during the nine months ended December 31,2005. The fees paid to Kronish Lieb Weiner & Hellman LLP were $0.2million for the nine months ended December 31, 2005.

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

As furtherdiscussed in Note 7, “Debt,” at December 31, 2005, the Company has $550.0million of 67¤8%Senior Subordinated Notes outstanding. The Notes are fully and unconditionallyguaranteed, jointly 

19

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

andseverally, by the Company’s wholly-owned domestic subsidiaries (theGuarantor Subsidiaries). The foreign subsidiaries and certain domestic subsidiariesof DRS (the Non-Guarantor Subsidiaries) do not guarantee the Notes. Thefollowing condensed consolidating financial information presents the Condensed ConsolidatingBalance Sheets, as of December 31, 2005 and March 31, 2005, theCondensed Consolidating Statements of Earnings for the three- and nine-monthperiods ended December 31, 2005 and 2004, and the Condensed ConsolidatingStatements of Cash Flows for the nine months ended December 31, 2005 and2004 for:

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

b)              the GuarantorSubsidiaries,

c)               the Non-guarantorSubsidiaries, and

d)              DRS Technologies, Inc.on a consolidated basis

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

The Guarantor and Non-guarantor Subsidiaries arepresented on a combined basis. The principal elimination entries eliminateinvestments in subsidiaries and intercompany balances and transactions.Separate financial statement information for each of the Guarantor andNon-guarantor Subsidiaries are not presented because management believes suchfinancial statements would not be meaningful to investors.

20

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

**Condensed Consolidating Balance Sheet As of December 31, 2005 (in thousands)**

| ** **                                           | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                           |       |                |       |                        |       |                            |       |             |       |             |       |   |   |   |   |
| **Current assets**                                   |       |                |       |                        |       |                            |       |             |       |             |       |   |   |   |   |
| Cash and cash equivalents                            |       | $                   | 241,077    |                        | $          | (398                            | )          |             | $          | 18,987           |       |   | $ | — |   |   | $ | 259,666 |   |   |
| Accounts receivable, net                             |       | 4                   |       | 195,633                     |       |                            | 23,613     |             |       | —           |       |   | 219,250 |   |   |
| Inventories, net                                     |       | —              |       | 208,485                     |       |                            | 42,885     |             |       | (27              | )          |   | 251,343 |   |   |
| Prepaid expenses and other current assets            |       | 5,221               |       | 48,302                      |       |                            | 1,768      |             |       | (2,230           | )          |   | 53,061 |   |   |
| Intercompany receivables                             |       | 753,266             |       | —                      |       |                            | 23,926     |             |       | (777,192         | )          |   | — |   |   |
| **Total current assets**                             |       | 999,568             |       | 452,022                     |       |                            | 111,179    |             |       | (779,449         | )          |   | 783,320 |   |   |
| Property, plant and equipment, net                   |       | 13,266              |       | 126,245                     |       |                            | 5,731      |             |       | —           |       |   | 145,242 |   |   |
| Acquired  intangibles, net                           |       | —              |       | 99,789                      |       |                            | —     |             |       | —           |       |   | 99,789 |   |   |
| Goodwill                                             |       | 23,926              |       | 777,190                     |       |                            | 22,992     |             |       | —           |       |   | 824,108 |   |   |
| Deferred income  taxes and other noncurrent assets   |       | 36,906              |       | 4,541                       |       |                            | 2,382      |             |       | (4,415           | )          |   | 39,414 |   |   |
| Investment in  subsidiaries                          |       | 403,911             |       | 49,635                      |       |                            | —     |             |       | (453,546         | )          |   | — |   |   |
| **Total assets**                                     |       | $                   | 1,477,577  |                        | $          | 1,509,422                       |       |             | $          | 142,284          |       |   | $ | (1,237,410 | ) |   | $ | 1,891,873 |   |   |
| **Liabilities and Stockholders’ Equity**        |       |                |       |                        |       |                            |       |             |       |             |       |   |   |   |   |
| **Current liabilities**                              |       |                |       |                        |       |                            |       |             |       |             |       |   |   |   |   |
| Current installments of long-term debt          |       | $                   | 135,690    |                        | $          | 201                             |       |             | $          | —           |       |   | $ | — |   |   | $ | 135,891 |   |   |
| Accounts payable                                     |       | 5,896               |       | 115,932                     |       |                            | 18,813     |             |       | —           |       |   | 140,641 |   |   |
| Accrued expenses and other current liabilities       |       | 28,456              |       | 205,163                     |       |                            | 20,269     |             |       | (2,239           | )          |   | 251,649 |   |   |
| Intercompany payables                                |       | —              |       | 476,744                     |       |                            | 12,627     |             |       | (489,371         | )          |   | — |   |   |
| Total current liabilities                            |       | 170,042             |       | 798,040                     |       |                            | 51,709     |             |       | (491,610         | )          |   | 528,181 |   |   |
| Long-term debt, excluding current installments       |       | 558,868             |       | 2,652                       |       |                            | —     |             |       | —           |       |   | 561,520 |   |   |
| Other liabilities                                    |       | 10,652              |       | 45,282                      |       |                            | 12,638     |             |       | (4,415           | )          |   | 64,157 |   |   |
| **Total liabilities**                                |       | 739,562             |       | 845,974                     |       |                            | 64,347     |             |       | (496,025         | )          |   | 1,153,858 |   |   |
| **Total stockholders’ equity**                  |       | 738,015             |       | 663,448                     |       |                            | 77,937     |             |       | (741,385         | )          |   | 738,015 |   |   |
| **Total  liabilities and stockholders’ equity** |       | $                   | 1,477,577  |                        | $          | 1,509,422                       |       |             | $          | 142,284          |       |   | $ | (1,237,410 | ) |   | $ | 1,891,873 |   |   |

 

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

**CondensedConsolidating Balance Sheet As 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                             |       | 5                   |       | 202,516                     |       |                            | 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                             |       | 667,987             |       | 23,269                      |       |                            | 49,876     |             |       | (741,132         | )          |   | — |   |   |
| **Total current assets**                             |       | 973,425             |       | 417,729                     |       |                            | 145,017    |             |       | (741,132         | )          |   | 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**                                     |       | $                   | 1,436,827  |                        | $          | 1,464,922                       |       |             | $          | 175,476          |       |   | $ | (1,190,584 | ) |   | $ | 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       |       | 26,109              |       | 257,028                     |       |                            | 18,193     |             |       | 31               |       |   | 301,361 |   |   |
| Intercompany payables                                |       | —              |       | 465,948                     |       |                            | 46,772     |             |       | (512,720         | )          |   | — |   |   |
| Total current liabilities                            |       | 31,615              |       | 809,190                     |       |                            | 87,119     |             |       | (512,689         | )          |   | 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**                                |       | 765,399             |       | 863,900                     |       |                            | 101,250    |             |       | (515,336         | )          |   | 1,215,213 |   |   |
| **Total stockholders’ equity**                  |       | 671,428             |       | 601,022                     |       |                            | 74,226     |             |       | (675,248         | )          |   | 671,428 |   |   |
| **Total  liabilities and stockholders’ equity** |       | $                   | 1,436,827  |                        | $          | 1,464,922                       |       |             | $          | 175,476          |       |   | $ | (1,190,584 | ) |   | $ | 1,886,641 |   |   |

 

22

----

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

**Condensed Consolidating Statements of Earnings Three Months Ended December 31,2005 (in thousands)**

| ** **                                         | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **Revenues**                                       |       |                | $          | —                      |       |                            |       | $                | 344,049    |             |       |   | $ | 51,528 |   |   |   | $ | (6,087 | ) |   |   | $ | 389,490 |   |   |
| Cost and expenses                                  |       |                | 19         |                        |       |                            | 301,347    |             |       |             | 49,372     |   |   |   | (6,075 | ) |   |   | 344,663 |   |   |
| Operating income                                   |       |                | (19        | )                           |       |                            | 42,702     |             |       |             | 2,156      |   |   |   | (12 | ) |   |   | 44,827 |   |   |
| Interest income                                    |       |                | 2,163      |                        |       |                            | (3         | )                |       |             | 123        |   |   |   | — |   |   |   | 2,283 |   |   |
| Interest and  related expense                      |       |                | 12,432     |                        |       |                            | 43         |             |       |             | (17        | ) |   |   | — |   |   |   | 12,458 |   |   |
| Other income  (expense), net                       |       |                | 26         |                        |       |                            | (204       | )                |       |             | 37         |   |   |   | 7 |   |   |   | (134 | ) |   |
| Management fees                                    |       |                | 561        |                        |       |                            | (513       | )                |       |             | (48        | ) |   |   | — |   |   |   | — |   |   |
| Royalties                                          |       |                | 360        |                        |       |                            | —     |             |       |             | (360       | ) |   |   | — |   |   |   | — |   |   |
| Intercompany  interest                             |       |                | 5,825      |                        |       |                            | (5,990     | )                |       |             | 165        |   |   |   | — |   |   |   | — |   |   |
| Earnings before minority interest and income taxes |       |                | (3,516     | )                           |       |                            | 35,949     |             |       |             | 2,090      |   |   |   | (5 | ) |   |   | 34,518 |   |   |
| Minority interest                                  |       |                | —     |                        |       |                            | —     |             |       |             | 477        |   |   |   | — |   |   |   | 477 |   |   |
| Earnings before income taxes                       |       |                | (3,516     | )                           |       |                            | 35,949     |             |       |             | 1,613      |   |   |   | (5 | ) |   |   | 34,041 |   |   |
| Income taxes                                       |       |                | (1,527     | )                           |       |                            | 15,079     |             |       |             | 750        |   |   |   | (5 | ) |   |   | 14,297 |   |   |
| Earnings (losses)  from subsidiary   entities      |       |                | 21,733     |                        |       |                            | —     |             |       |             | —     |   |   |   | (21,733 | ) |   |   | — |   |   |
| **Net  earnings**                                  |       |                | $          | 19,744                      |       |                            |       | $                | 20,870     |             |       |   | $ | 863 |   |   |   | $ | (21,733 | ) |   |   | $ | 19,744 |   |   |

 

23

----

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

**Condensed Consolidating Statements of EarningsThree Months Ended December 31, 2004(in thousands)**

| ** **                                                  | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **Revenues**                                                |       |                | $          | —                      |       |                            |       | $                | 288,772    |             |       |   | $ | 55,703 |   |   |   | $ | (6,243 | ) |   |   | $ | 338,232 |   |   |
| Cost and expenses                                           |       |                | 19         |                        |       |                            | 252,313    |             |       |             | 52,896     |   |   |   | (6,245 | ) |   |   | 298,983 |   |   |
| Operating income                                            |       |                | (19        | )                           |       |                            | 36,459     |             |       |             | 2,807      |   |   |   | 2 |   |   |   | 39,249 |   |   |
| Interest income                                             |       |                | 302        |                        |       |                            | 62         |             |       |             | 25         |   |   |   | — |   |   |   | 389 |   |   |
| Interest and  related expense                               |       |                | 9,334      |                        |       |                            | 69         |             |       |             | 44         |   |   |   | — |   |   |   | 9,447 |   |   |
| Other income  (expense), net                                |       |                | 27         |                        |       |                            | (124       | )                |       |             | (206       | ) |   |   | — |   |   |   | (303 | ) |   |
| Management fees                                             |       |                | 485        |                        |       |                            | (446       | )                |       |             | (39        | ) |   |   | — |   |   |   | — |   |   |
| Royalties                                                   |       |                | 586        |                        |       |                            | —     |             |       |             | (586       | ) |   |   | — |   |   |   | — |   |   |
| Intercompany  interest                                      |       |                | 6,289      |                        |       |                            | (6,303     | )                |       |             | 14         |   |   |   | — |   |   |   | — |   |   |
| Earnings before minority interest and income taxes          |       |                | (1,664     | )                           |       |                            | 29,579     |             |       |             | 1,971      |   |   |   | 2 |   |   |   | 29,888 |   |   |
| Minority interest                                           |       |                | —     |                        |       |                            | —     |             |       |             | 551        |   |   |   | — |   |   |   | 551 |   |   |
| Earnings before income taxes                                |       |                | (1,664     | )                           |       |                            | 29,579     |             |       |             | 1,420      |   |   |   | 2 |   |   |   | 29,337 |   |   |
| Income taxes                                                |       |                | (709       | )                           |       |                            | 12,603     |             |       |             | 604        |   |   |   | 2 |   |   |   | 12,500 |   |   |
| Earnings (losses)  from subsidiary  entities                |       |                | 18,416     |                        |       |                            | —     |             |       |             | —     |   |   |   | (18,416 | ) |   |   | — |   |   |
| Earnings from  continuing operations                        |       |                | 17,461     |                        |       |                            | 16,976     |             |       |             | 816        |   |   |   | (18,416 | ) |   |   | 16,837 |   |   |
| Earnings from  discontinued operations, net of income taxes |       |                | —     |                        |       |                            | 624        |             |       |             | —     |   |   |   | — |   |   |   | 624 |   |   |
| **Net  earnings**                                           |       |                | $          | 17,461                      |       |                            |       | $                | 17,600     |             |       |   | $ | 816 |   |   |   | $ | (18,416 | ) |   |   | $ | 17,461 |   |   |

 

24

----

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

**CondensedConsolidating Statements of EarningsNine Months Ended December 31, 2005 (in thousands)**

| ** **                                         | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **Revenues**                                       |       | $                   | —     |                        |       | $                               | 946,165    |             |       |             | $          | 159,614 |   |   |   | $ | (15,900 | ) |   |   | $ | 1,089,879 |   |   |
| Cost and expenses                                  |       | 2,455               |       |                        | 835,122    |                            |       |             | 149,714    |             |       |   | (15,874 | ) |   |   | 971,417 |   |   |
| Operating income                                   |       | (2,455              | )          |                        | 111,043    |                            |       |             | 9,900      |             |       |   | (26 | ) |   |   | 118,462 |   |   |
| Interest income                                    |       | 5,907               |       |                        | 54         |                            |       |             | 267        |             |       |   | — |   |   |   | 6,228 |   |   |
| Interest and  related expense                      |       | 36,849              |       |                        | 126        |                            |       |             | (16        | )                |       |   | — |   |   |   | 36,959 |   |   |
| Other income  (expense), net                       |       | 85                  |       |                        | (140       | )                               |       |             | (407       | )                |       |   | 16 |   |   |   | (446 | ) |   |
| Management fees                                    |       | 1,614               |       |                        | (1,485     | )                               |       |             | (129       | )                |       |   | — |   |   |   | — |   |   |
| Royalties                                          |       | 1,390               |       |                        | —     |                            |       |             | (1,390     | )                |       |   | — |   |   |   | — |   |   |
| Intercompany  interest                             |       | 19,149              |       |                        | (19,645    | )                               |       |             | 496        |             |       |   | — |   |   |   | — |   |   |
| Earnings before minority interest and income taxes |       | (11,159             | )          |                        | 89,701     |                            |       |             | 8,753      |             |       |   | (10 | ) |   |   | 87,285 |   |   |
| Minority interest                                  |       | —              |       |                        | —     |                            |       |             | 1,559      |             |       |   | — |   |   |   | 1,559 |   |   |
| Earnings before income taxes                  |       | (11,159             | )          |                        | 89,701     |                            |       |             | 7,194      |             |       |   | (10 | ) |   |   | 85,726 |   |   |
| Income taxes                                       |       | (4,291              | )          |                        | 34,541     |                            |       |             | 2,770      |             |       |   | (10 | ) |   |   | 33,010 |   |   |
| Earnings (losses)  from subsidiary entities        |       | 59,584              |       |                        | —     |                            |       |             | —     |             |       |   | (59,584 | ) |   |   | — |   |   |
| **Net  earnings**                                  |       | $                   | 52,716     |                        |       | $                               | 55,160     |             |       |             | $          | 4,424 |   |   |   | $ | (59,584 | ) |   |   | $ | 52,716 |   |   |

 

25

----

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

**Condensed Consolidating Statements of EarningsNine Months Ended December 31, 2004(in thousands)**

| ** **                                                  | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **Revenues**                                                |       |                | $          | —                      |       |                            |       | $                | 808,499    |             |       |   | $ | 153,822 |   |   |   | $ | (14,885 | ) |   |   | $ | 947,436 |   |   |
| Cost and expenses                                           |       |                | 102        |                        |       |                            | 712,866    |             |       |             | 147,881    |   |   |   | (14,968 | ) |   |   | 845,881 |   |   |
| Operating income                                            |       |                | (102       | )                           |       |                            | 95,633     |             |       |             | 5,941      |   |   |   | 83 |   |   |   | 101,555 |   |   |
| Interest income                                             |       |                | 575        |                        |       |                            | 62         |             |       |             | 50         |   |   |   | — |   |   |   | 687 |   |   |
| Interest and  related expense                               |       |                | 27,194     |                        |       |                            | 128        |             |       |             | 125        |   |   |   | — |   |   |   | 27,447 |   |   |
| Other income  (expense), net                                |       |                | 167        |                        |       |                            | (82        | )                |       |             | (494       | ) |   |   | (46 | ) |   |   | (455 | ) |   |
| Management fees                                             |       |                | 1,320      |                        |       |                            | (1,212     | )                |       |             | (108       | ) |   |   | — |   |   |   | — |   |   |
| Royalties                                                   |       |                | 1,378      |                        |       |                            | —     |             |       |             | (1,378     | ) |   |   | — |   |   |   | — |   |   |
| Intercompany  interest                                      |       |                | 20,647     |                        |       |                            | (20,298    | )                |       |             | (349       | ) |   |   | — |   |   |   | — |   |   |
| Earnings before minority interest and income taxes          |       |                | (3,209     | )                           |       |                            | 73,975     |             |       |             | 3,537      |   |   |   | 37 |   |   |   | 74,340 |   |   |
| Minority interest                                           |       |                | —     |                        |       |                            | —     |             |       |             | 1,476      |   |   |   | — |   |   |   | 1,476 |   |   |
| Earnings before income taxes                                |       |                | (3,209     | )                           |       |                            | 73,975     |             |       |             | 2,061      |   |   |   | 37 |   |   |   | 72,864 |   |   |
| Income taxes                                                |       |                | (1,386     | )                           |       |                            | 31,524     |             |       |             | 878        |   |   |   | 37 |   |   |   | 31,053 |   |   |
| Earnings (losses)  from subsidiary   entities               |       |                | 45,456     |                        |       |                            | —     |             |       |             | —     |   |   |   | (45,456 | ) |   |   | — |   |   |
| Earnings from  continuing operations                        |       |                | 43,633     |                        |       |                            | 42,451     |             |       |             | 1,183      |   |   |   | (45,456 | ) |   |   | 41,811 |   |   |
| Earnings from  discontinued operations, net of income taxes |       |                | —     |                        |       |                            | 1,822      |             |       |             | —     |   |   |   | — |   |   |   | 1,822 |   |   |
| **Net  earnings**                                           |       |                | $          | 43,633                      |       |                            |       | $                | 44,273     |             |       |   | $ | 1,183 |   |   |   | $ | (45,456 | ) |   |   | $ | 43,633 |   |   |

 

26

----

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

**CondensedConsolidating Statements of Cash Flows Nine Months Ended December 31, 2005 (in thousands)**

| ** **                                                              | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Net  cash provided by operating activities**                          |       | $                   | 10,344     |                        |       | $                                 | 30,787     |             |       |             | $          | 18,323 |   |   |   | $ | — |   |   |   | $ | 59,454 |   |   |
| **Cash  Flows from Investing Activities**                               |       |                |       |                        |       |                              |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Capital expenditures                                                    |       | (4,123              | )          |                        | (20,653    | )                                 |       |             | (1,535     | )                |       |   | — |   |   |   | (26,311 | ) |   |
| Payments pursuant to business combinations, net of  cash acquired  |       | (54,489             | )          |                        | —     |                              |       |             | —     |             |       |   | — |   |   |   | (54,489 | ) |   |
| Other investing activities                                              |       | 22                  |       |                        | (180       | )                                 |       |             | 1,126      |             |       |   | — |   |   |   | 968 |   |   |
| **Net cash used in investing activities**                               |       | (58,590             | )          |                        | (20,833    | )                                 |       |             | (409       | )                |       |   | — |   |   |   | (79,832 | ) |   |
| **Cash  Flows from Financing Activities**                               |       |                |       |                        |       |                              |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Return of advanced interest on senior subordinated  notes               |       | (1,986              | )          |                        | —     |                              |       |             | —     |             |       |   | — |   |   |   | (1,986 | ) |   |
| Debt issuance costs                                                     |       | (681                | )          |                        | —     |                              |       |             | —     |             |       |   | — |   |   |   | (681 | ) |   |
| Repayments of long-term debt                                            |       | (31,771             | )          |                        | (266       | )                                 |       |             | —     |             |       |   | — |   |   |   | (32,037 | ) |   |
| Proceeds from exercise of stock options and warrants                    |       | 9,750               |       |                        | —     |                              |       |             | —     |             |       |   | — |   |   |   | 9,750 |   |   |
| Dividends paid                                                          |       | (2,508              | )          |                        | —     |                              |       |             | —     |             |       |   | — |   |   |   | (2,508 | ) |   |
| Repayments to (borrowings from) Parent                                  |       | 15,731              |       |                        | (1,814     | )                                 |       |             | (13,917    | )                |       |   | — |   |   |   | — |   |   |
| **Net cash used in financing activities**                               |       | (11,465             | )          |                        | (2,080     | )                                 |       |             | (13,917    | )                |       |   | — |   |   |   | (27,462 | ) |   |
| **Effects  of exchange rates on cash and cash equivalents**             |       | —              |       |                        | —     |                              |       |             | 654        |             |       |   | — |   |   |   | 654 |   |   |
| **Net (decrease) increase in cash and cash  equivalents**               |       | (59,711             | )          |                        | 7,874      |                              |       |             | 4,651      |             |       |   | — |   |   |   | (47,186 | ) |   |
| **Cash  and cash equivalents, beginning of period**                     |       | 300,788             |       |                        | (8,272     | )                                 |       |             | 14,336     |             |       |   | — |   |   |   | 306,852 |   |   |
| **Cash and cash equivalents, end  of period**                           |       | $                   | 241,077    |                        |       | $                                 | (398       | )                |       |             | $          | 18,987 |   |   |   | $ | — |   |   |   | $ | 259,666 |   |   |

 

27

----

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

**CondensedConsolidating Statements of Cash Flows Nine Months Ended December 31, 2004 (in thousands)**

| ** **                                                                        | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Net cash provided by operating activities of  continuing operations**           |       | $                   | 15,736     |                        |       | $                                 | 51,555     |             |       |             | $          | 14,057 |   |   |   | $ | — |   |   |   | $ | 81,348 |   |   |
| **Net cash  provided by operating activities of discontinued operations**         |       | —              |       |                        | 2,697      |                              |       |             | —     |             |       |   | — |   |   |   | 2,697 |   |   |
| **Net cash  provided by operating activities**                                    |       | 15,736              |       |                        | 54,252     |                              |       |             | 14,057     |             |       |   | — |   |   |   | 84,045 |   |   |
| **Cash  Flows from Investing Activities**                                         |       |                |       |                        |       |                              |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Capital expenditures                                                              |       | (1,950              | )          |                        | (17,348    | )                                 |       |             | (1,444     | )                |       |   | — |   |   |   | (20,742 | ) |   |
| Payments pursuant to business combinations, net of  cash acquired                 |       | (494                | )          |                        | (44,647    | )                                 |       |             | —     |             |       |   | — |   |   |   | (45,141 | ) |   |
| Other investing activities                                                        |       | 39                  |       |                        | 1,114      |                              |       |             | 140        |             |       |   | — |   |   |   | 1,293 |   |   |
| **Net cash  used in investing activities of continuing operations**               |       | (2,405              | )          |                        | (60,881    | )                                 |       |             | (1,304     | )                |       |   | — |   |   |   | (64,590 | ) |   |
| **Net cash  used in investing activities of discontinued operations**             |       | —              |       |                        | (596       | )                                 |       |             | —     |             |       |   | — |   |   |   | (596 | ) |   |
| **Net cash  used in investing activities**                                        |       | (2,405              | )          |                        | (61,477    | )                                 |       |             | (1,304     | )                |       |   | — |   |   |   | (65,186 | ) |   |
| **Cash  Flows from Financing Activities**                                         |       |                |       |                        |       |                              |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Net payments of short-term debt                                                   |       | —              |       |                        | —     |                              |       |             | (82        | )                |       |   | — |   |   |   | (82 | ) |   |
| Repayment of long-term debt                                                       |       | (29,793             | )          |                        | (425       | )                                 |       |             | —     |             |       |   | — |   |   |   | (30,218 | ) |   |
| Proceeds from senior subordinated notes                                           |       | 211,986             |       |                        | —     |                              |       |             | —     |             |       |   | — |   |   |   | 211,986 |   |   |
| Debt and bond issuance costs                                                      |       | (3,745              | )          |                        |       |                              |       |             |       |             |       |   |   |   |   |   | (3,745 | ) |   |
| Repayments to (borrowings from) Parent                                            |       | (6,746              | )          |                        | 15,284     |                              |       |             | (8,538     | )                |       |   | — |   |   |   | — |   |   |
| Proceeds from exercise of stock options                                           |       | 3,316               |       |                        | —     |                              |       |             | —     |             |       |   | — |   |   |   | 3,316 |   |   |
| **Net cash provided by (used in) financing  activities of continuing operations** |       | 175,018             |       |                        | 14,859     |                              |       |             | (8,620     | )                |       |   | — |   |   |   | 181,257 |   |   |
| **Net cash used in financing activities of  discontinued operations**             |       | —              |       |                        | (23        | )                                 |       |             | —     |             |       |   | — |   |   |   | (23 | ) |   |
| **Net cash provided by (used in) financing  activities**                          |       | 175,018             |       |                        | 14,836     |                              |       |             | (8,620     | )                |       |   | — |   |   |   | 181,234 |   |   |
| **Effects  of exchange rates on cash and cash equivalents**                       |       | —              |       |                        | —     |                              |       |             | 1,286      |             |       |   | — |   |   |   | 1,286 |   |   |
| **Net increase in cash and cash equivalents**                                     |       | 188,349             |       |                        | 7,611      |                              |       |             | 5,419      |             |       |   | — |   |   |   | 201,379 |   |   |
| **Cash and  cash equivalents, beginning of period**                          |       | 55,342              |       |                        | (5,630     | )                                 |       |             | 7,078      |             |       |   |   |   |   |   | 56,790 |   |   |
| **Cash and cash equivalents, end  of period**                                     |       | $                   | 243,691    |                        |       | $                                 | 1,981      |             |       |             | $          | 12,497 |   |   |   | $ | — |   |   |   | $ | 258,169 |   |   |

 

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to 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. 151 clarifies that abnormalinventory costs, such as costs of idle facilities, excess freight and handlingcosts, and wasted materials (spoilage), are required to be recognized ascurrent period charges. Additionally, SFAS No. 151 requires that theallocation of fixed production overheads to the costs of conversion be based onthe normal capacity of the production facility. The provisions of SFAS No. 151are effective for the Company’s fiscal year beginning April 1, 2006. TheCompany is evaluating the provisions of SFAS No. 151 and does not expectthat the adoption will have a material impact on the Company’s consolidatedfinancial 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 theexception from fair value measurement for nonmonetary exchanges of similarproductive assets in paragraph 21(b) of APB Opinion No. 29, “Accountingfor Nonmonetary Transactions,” and replaces it with an exception for exchangesthat do 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. TheCompany adopted SFAS No. 153 beginning on July 1, 2005 and itsadoption had no impact on its consolidated results of operations and financialcondition.

The U.S. enacted the American Jobs Creation Act of2004 (the Jobs Act) in October 2004 which contains many provisionsaffecting corporate taxation. The American Jobs Creation Act phases out theextraterritorial income (ETI) exclusion benefit for export sales and phases ina new tax deduction for income from qualified domestic production activities(QPA) over a transition period beginning in 2005. In December 2004, theFASB issued FASB Staff Position 109-1 (FSP 109-1), which providesguidance that the QPA deduction should be treated as a special income taxdeduction in the period earned and not as a tax-rate reduction. As such, QPAhas 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 Jobs Act, and has determined that thebenefit from the phase-in of the QPA deduction will slightly exceed the lostbenefit from the phase-out of the ETI exclusion.

The Jobs Act includes a provision that encouragescompanies to reinvest foreign earnings in the U.S. by temporarily makingcertain dividends received by a U.S. corporation from controlled foreigncorporations eligible for an 85% dividends-received deduction. The Company mayelect to take this special one-time deduction for dividends received during thefiscal year ending March 31, 2006. FSP 109-2 permits time beyond the financialreporting period of enactment date to evaluate the effect of the Jobs Act onits plan for reinvestment or repatriation of foreign earnings for purposes ofapplying SFAS No. 109. Through December 31, 2005, the Company has notprovided deferred taxes on foreign earnings because the Company considersearnings of its foreign subsidiaries to be reinvested permanently. Whether theCompany ultimately will take advantage of the temporary repatriation incentivedepends on a number of factors, including analyzing IRS guidance. The Companyexpects to be in a position to finalize its decision regarding the temporaryincentive during the fourth quarter fiscal of 2006. The related range of incometax effects of such repatriation cannot be reasonably estimated at the time ofissuance of these financial statements. As provided for in FSP 109-2, therehave been no amounts recognized under the repatriation 

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

provision to date and,accordingly, there has been no effect on income tax expense (or benefit)included in these consolidated financial statements as of and for the ninemonths ended December 31, 2005. If it becomes apparent that the Company willrepatriate all or any of its eligible earnings, a one-time tax charge to theCompany’s consolidated results of operations could occur.

In May 2005, the FASB issued SFAS 154, “AccountingChanges and Error Corrections—a replacement of APB Opinion No. 20 and FASBStatement No. 3.”  This Statementreplaces APB Opinion No. 20, “Accounting Changes,” and FASB Statement No. 3,“Reporting Accounting Changes in Interim Financial Statements.” SFAS 154changes the requirements for the accounting for and reporting of a change inaccounting principle. Previously, most voluntary changes in accountingprinciples required recognition through a cumulative adjustment within netincome of the period of the change. SFAS 154 requires retrospective applicationto prior periods’ financial statements, unless it is impracticable to determineeither the period-specific effects or the cumulative effect of the change. SFAS154 is effective for accounting changes made in fiscal years beginning after December 15,2005; however, the Statement does not change the specific transition provisionsof any existing or future accounting pronouncements. The Company does notbelieve adoption of SFAS 154 will have a material effect on its consolidatedfinancial position and results of operations.

**17.   Subsequent Events**

***Debt Repayment***

***During the week of January 9, 2006the Company prepaid the remaining $135.7 million balance of its term loan, atits discretion, and will recognize a $1.1 million charge to interest andrelated expenses in the fourth quarter of fiscal 2006 for the  write-off of the balance of the term loan debtissuance costs, net of the recognition of a previously deferred gain for thetermination of related interest rate swap agreements.***

***Acquisition of Engineered Support Systems, Inc.***

On January 31, 2006 the Company completed itsacquisition of Engineered Support Systems, Inc. (ESSI). In the transaction, awholly-owned subsidiary of DRS was merged with ESSI, forming DRS’s thirdoperating segment - the Sustainment Systems & Services Group. The acquisitionwill be accounted for under the purchase method.

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. The addition of ESSI isexpected to contribute a significant base of systems, products and servicesfocused on military force sustainment, technical and logistics support,integrated military electronics and field support equipment.

In the merger, each shareof ESSI common stock was converted into the right to receive a combination of$30.10 in cash and 0.2628 of a share of DRS common stock. The cash portion ofthe acquisition aggregated approximately $1.3 billion at closing and theCompany issued approximately 11.7 million shares of common stock. Totalconsideration for the acquisition was $1.9 billion, and the assumption of$74.0 million of ESSI’s net debt at closing. In addition to the purchaseprice, the estimated costs related to the acquisition approximated $22.5 million.

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

***Financing of ESSI Acquisition***

The Company financed the cash portion of the acquisitionby utilizing existing excess cash on hand, revolving credit borrowings,  $275.0 million in term debt and $900 millionof new debt securities, including $350 million aggregate principal amount of 65/8% senior notes due 2016, $250 millionaggregate principal amount of 75/8% senior subordinated notes due2018 and $300 million aggregate principal amount of 2.0% convertible seniornotes due 2026.

Simultaneously with the closing of our acquisition ofESSI, the Company entered into an amended and restated senior secured credit facilityfor up to an aggregate amount of $675.0 million, replacing the Company’s thenexisting Credit Facility. The amended and restated senior secured creditfacility consists of (i) a seven-year term loan facility in an aggregate principalamount equal to $275.0 million, with principal repayable in quarterlyinstallments at a rate of 1.00% per year and the balance to be repaid in equalquarterly installments beginning six years following the completion of theacquisition, and (ii) a six-year revolving credit facility in an aggregateprincipal amount of $400.0 million, to be repaid in full on the sixthanniversary of the closing date of the facility. Borrowings under the amendedand restated senior secured credit facility will bear interest, at our option,at either the base rate (the higher of the prime rate announced by thecommercial bank to be selected by the administrative agent to the facility orthe federal funds effective rate plus 0.50%), plus an applicable margin, or atthe rate at which Eurodollar deposits for one, two, three or six months areoffered in the interbank Eurodollar market, which is referred to as theEurodollar Rate, plus an applicable margin.

The Convertible Notes will be senior unsecuredobligations and will rank equally in right of payment with all of the Company’ssenior indebtedness.  The Company willpay contingent interest to the holders of the Convertible Notes during anysix-month period from February 1 to July 31, and from August 1 to January 31,commencing with the six-month period beginning on February 1, 2011, if thetrading price of a note for each of the five trading-day period ending on thethird trading day immediately preceding the first day of the relevant six-monthperiod equals 120% or more of the principal amount of the note. The amount ofcontingent interest payable per Convertible Note with respect to any six-monthperiod will equal 0.50% per annum of the average market price of such note forthe five trading day period referred to above. The Company’s payment obligations under the Convertible Notes will befully and unconditionally guaranteed, jointly and severally, on a seniorunsecured basis by certain of the Company’s existing and future domesticsubsidiaries.  The Convertible Notes willmature on February 1, 2026, unless earlier converted, redeemed or repurchased.

The ConvertibleNotes may be converted into cash and, if applicable, shares of DRS’s commonstock, based on a conversion rate of 16.7504 shares per $1,000 principal amountof Convertible Notes (representing a conversion price of approximately $59.70per share of common stock), subject to adjustment only under the circumstancesdescribed below. On or prior to February 1, 2010, the Convertible Notes may beconverted by the holder only under the following circumstances:

·       duringthe five consecutive business-day period following any five consecutivetrading-day period in which the average trading price for the Convertible Noteswas less than 103% of the average of the closing sale price of the Company’scommon stock during such five trading-day period multiplied by the applicableconversion rate;

·       duringprescribed periods, upon the occurrence of specified corporate transactions orfundamental changes as described in the debt agreement; or

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

·       ifthe Company has called the Convertible Notes for redemption, until the secondbusiness day immediately preceding the redemption date.

After February 1, 2010,the Convertible Notes may be converted by the holder into cash and shares, ifany, of DRS’s common stock (as provided below) initially at a conversion rateof 16.7504 shares per $1,000 principal amount of Convertible Notes (equal to aninitial conversion price of approximately $59.70 per share of common stock),only under the following circumstances:

·       duringany calendar quarter (and only during such calendar quarter) commencing afterDecember 31, 2009, if the closing sale price of DRS’s common stock for atleast 20 trading days in the period of 30 consecutive trading days ending onthe last trading day of the preceding calendar quarter, is greater than orequal to 110% of the applicable conversion price;

·       onor after February 1, 2025;

·       duringthe five consecutive business-day period following any five consecutivetrading-day period in which the average trading price for the Convertible Noteswas less than 98% of the average of the closing sale price of DRS’s commonstock during such five trading-day period multiplied by the applicable currentconversion rate;

·       duringprescribed periods, upon the occurrence of specified corporate transactions orfundamental changes described in this offering memorandum; or

·       ifthe Company has called the Convertible Notes for redemption, until the secondbusiness day immediately preceding the redemption date.

Uponany conversion, the Company will deliver cash and shares of DRS’s common stock,if any, with an aggregate value (the ‘‘*conversion value*’’) equal to the applicableconversion rate multiplied by the average of the closing sale prices of theCompany’s common stock for each trading day in the 20 consecutive trading dayperiod commencing after (and including) the third trading day following thedate the Convertible Notes are tendered for conversion (the ‘‘applicableconversion period’’) as follows: 

·  an amount in cash equal to the lesser of (a)the principal amount of Convertible Notes surrendered for conversion and (b)the conversion value, and

·  if the conversion value is greater than theprincipal amount of the Convertible Notes, an amount of whole shares of ourcommon stock (the ‘‘*excess value*’’) equal tothe sum of the daily share amounts for each trading day during the applicableconversion period. The Company will pay the excess value in shares of DRScommon stock.

The Company may redeem theConvertible Notes in whole or in part for cash, upon not less than 30 days’ normore than 60 days’ notice before the redemption date, at any time on or afterFebruary 1, 2009 and prior to February 4, 2011, if the sale price ofDRS’s common stock has exceeded 130% of the conversion price for at least 20trading days in any consecutive 30-day trading period ending on the trading dayprior to providing notice of redemption, at a redemption price equal to 100% ofthe principal amount of the Convertible Notes to be redeemed plus any accruedand unpaid interest (including contingent interest and additional interest, ifany) up to but not including the redemption date and a ‘‘make-whole’’premium.  The Company may, at any time afterFebruary 4, 2011, redeem the Convertible Notes in whole or in part forcash, upon not less than 30 days’ nor more than 60 days’ notice before theredemption date, at a redemption price equal to 100% of the principal amount ofthe Convertible Notes to be redeemed plus any accrued and unpaid interest(including contingent interest and additional interest, if any) up to but notincluding the redemption date.

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

Holders have the right torequire the Company to purchase all or a portion of their Convertible Notes forcash on February 1, 2011, February 1, 2016 and February 1, 2021, at apurchase price equal to 100% of the principal amount of the Convertible Notesplus accrued and unpaid interest (including additional interest, if any) to butnot including the purchase date.

On February 8, 2006the Company sold an additional $45.0 million of Convertible Notes,pursuant to an over-allotment option exercised by the initial purchaser of the ConvertibleNotes.

***ESSI Legal Matters***

In connection ESSIacquisition, the Company has been made aware of certain legal actions, claims,assessments and other contingencies, certain of which are described below andcould be deemed material.

In December 2004, ESSI wasnotified by the Enforcement Division of the SEC of the issuance of a formalorder directing a private investigation captioned *In theMatter of Engineered Support Systems, Inc.* and was notified that theSEC had issued subpoenas to various individuals associated with ESSI to producecertain documents.  The SEC staff alsorequested that ESSI produce certain documents in connection with theinvestigation.  The subpoenas related totrading in ESSI stock around ESSI’s earnings releases in 2003 and to theadequacy of certain disclosures made by ESSI regarding related-partytransactions in 2002 and 2003 involving insurance policies placed by ESSIthrough an insurance brokerage firm in which an ESSI director was a principalat the time of the transactions.

On or about September 23,2005, the SEC staff advised ESSI’s counsel that it had issued a subpoenadirected to ESSI and expanded its investigation to include ESSI’s disclosure ofa November 2004 stop-work order relating to ESSI’s Deployable Power Generationand Distribution Systems (“DPGDS”) program for the U.S. Air Force, and relatingto trading in ESSI stock by certain individuals associated with ESSI.

In connection with theforegoing SEC investigation, ESSI and certain of its directors and officershave provided information and/or testimony to the SEC.  On November 14, 2005, ESSI was informed by theEnforcement Division that one of ESSI’s former directors and officers, andsubsequently a consultant to ESSI, has been issued a so-called Wells noticeinforming him that the staff of the SEC was considering recommending that theSEC bring a civil injunctive action against him in connection with the SEC’sinvestigation into trading in ESSI common stock in 2003.  A Wells notice provides prospectivedefendants with an opportunity to respond to the SEC staff members before thestaff makes a formal recommendation on whether the SEC should pursuedisciplinary action against them.  ESSI,itself, has not received a Wells notice and continues to cooperate with theinvestigation.  

In January 2006, ESSI wasinformed that the U.S. Attorney (St. Louis, MO office) was initiating aninvestigation into ESSI’s disclosure of the DPGDS stop-work order and intotrading in ESSI stock by ESSI insiders which preceded such disclosure.  The U.S. Attorney has requested additionalinformation in connection with this investigation, which ESSI continues tofurnish.  We are unable to determine atthis time either the timing of the SEC or U.S. Attorney investigations or theimpact, if any, which the investigations could have on the Company.

***Amendment to Certificateof Incorporation***

On January 30,2006, a special meeting of the Company’s stockholders was held, at which theyapproved an amendment to the certificate of incorporation of DRS Technologies, Inc.to increase the number of authorized shares of DRS common stock from 50,000,000to 100,000,000 shares.

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**Item2.**   Management’s Discussion and Analysisof 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. This MD&Ashould be read in conjunction with the consolidated financial statements andrelated notes contained herein and in our March 31, 2005 Form 10-K.

**Forward-Looking Statements**

The following discussionand analysis contains forward-looking statements, within the meaning ofSection 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities Exchange Act of 1934, as amended, that arebased on management’s beliefs and assumptions, current expectations, estimatesand projections. Such statements, including statements relating to theCompany’s expectations for future financial performance, are not consideredhistorical facts and are considered forward-looking statements under thefederal securities laws. These statements may contain words such as “believes,”“anticipates,” “plans,” “expects,” “intends,” “estimates” or similarexpressions. These statements are not guarantees of our future performance andare subject to risks, uncertainties and other important factors that couldcause our actual performance or achievements to differ materially from thoseexpressed or implied by these forward-looking statements and include, withoutlimitation: the effect of our acquisition strategy on future operating results,including our ability to effectively integrate acquired companies into ourexisting operations; the uncertainty of acceptance of new products andsuccessful bidding for new contracts; the effect of technological changes orobsolescence relating to our products and services; and the effects ofgovernment regulation or shifts in government priorities (including changes inpriorities in response to the war on terrorism and to homeland security), asthey may relate to our products and services; and other risks or uncertaintiesdetailed in the Company’s Securities and Exchange Commission filings. Giventhese uncertainties, you should not rely on forward-looking statements. TheCompany undertakes no obligations to update any forward-looking statements,whether as a result of new information, future events or otherwise.

**BusinessCombinations and Disposals**

On January 31, 2006 we completed our acquisitionof Engineered Support Systems, Inc (ESSI). In the transaction, a wholly-ownedsubsidiary of DRS was merged with ESSI, forming DRS’s third operating segment—theSustainment Systems & Services Group.

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. The addition of ESSI isexpected to contribute a significant base of systems, products and servicesfocused on military force sustainment, technical and logistics support,integrated military electronics and field support equipment.

In the merger, each share of ESSI common stock wasconverted into the right to receive a combination of $30.10 in cash and 0.2628of a share of DRS common stock, valued at approximately $12.90, based on theaverage closing price of DRS’s common stock for the ten trading-day periodended 

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January 27, 2006. Thecash portion of the acquisition aggregated approximately $1.3 billion atclosing and we issued approximately 11.7 million shares of DRS commonstock. Total consideration for the acquisition was $1.9 billion, and the assumptionof $74.0 million of ESSI’s net debt at closing. In addition to the purchaseprice, the estimated costs related to the acquisition approximated $22.5million.

The Company financed the cash portion of theacquisition by utilizing existing excess cash on hand, revolving creditborrowings,  $275.0 million in term debtand $900 million of new debt securities, including $350 million aggregateprincipal amount of 65¤8%senior notes due 2016, $250 million aggregate principal amount of 75¤8%senior subordinated notes due 2018 and $300 million aggregate principal amountof 2.0% convertible senior notes due 2026 (with a 20% conversion premium).

On June 27, 2005, we acquired WalkAbout ComputerSystems Inc. (WalkAbout) in a stock purchase transaction for approximately$13.8 million in cash, with additional consideration payable of up to $5.0million upon achievement of certain revenue targets for a period of two and ahalf years. In addition to the purchase price, we recorded approximately $0.3million for acquisition-related costs. The results of WalkAbout have beenincluded in our financial statements 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. 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 April 15, 2005, we acquired CodemSystems, Inc. (Codem) in a stock purchase transaction for approximately$31.6 million in cash, with additional consideration payable of up to $5.0million upon achievement of certain annual bookings targets for a period ofthree years. In addition to the purchase price, we recorded approximately $0.4million for acquisition-related costs. The results of Codem’s operations havebeen included in our financial statements since the date of acquisition.

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 December 14, 2004, we acquired certain assetsand liabilities of Night Vision Equipment Co., Inc. and Excalibur ElectroOptics, Inc. (collectively referred to as NVEC hereinafter), aprivately-held business headquartered in Allentown, Pennsylvania. The purchaseprice was $47.2 million in cash, with additional consideration of up to amaximum of $37.5 million payable upon achieving certain annual revenue targetsfor a period of three years. Through December 31, 2005 additional considerationof $4.6 million  was payable to theformer owners of NVEC. 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.

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 Broadcast Technology.We have restated our financial statements, related financial statement data anddiscussions in 

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thisMD&A to present the operating results of these operating units asdiscontinued operations. Both companies operated as a part of our C4I Group.

**Company Overview**

DRS is a supplier of integrated defense electronicproducts, services and support. We provide high-technology products, servicesand support to all branches of the U.S. military, major aerospace and defenseprime contractors, government intelligence agencies, international militaryforces and industrial markets.

With the addition of ESSI, we have three principaloperating segments, on the basis of products and services offered: the Command,Control, Communications, Computers and Intelligence (C4I) Group, theSurveillance and Reconnaissance (SR) Group, and the SustainmentSystems & Services Group (S3). All other operations, including theactivities of our Corporate Headquarters and certain of our non-operatingsubsidiaries, are grouped in Other.

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, 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 and 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.

Our S3 Group (formerly ESSI) is comprised of thefollowing business areas: Sustainment Systems, which designs, engineers andmanufactures integrated military electronics and other military supportequipment, primarily for the DoD as well as related heat transfer and airhandling equipment for domestic commercial and industrial users and materialhandling equipment primarily for the U.S. Postal Service; Support Services,which provides engineering services, logistics and training services, advancedtechnology services, asset protection systems and services, telecommunicationsystems integration and information technology services, power generation anddistribution equipment and vehicle armor kits, primarily for the military.

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, related advanced technologysystems, and sustainment and support systems for the remainder of fiscal 2006and beyond will continue to be affected by the global war on terrorism, throughthe continued need for military missions and reconstruction efforts in Iraq andAfghanistan. The war on terrorism continues to focus greater attention onhomeland security and better communication and interplay between local, stateand federal government agencies and U.S. military services. Our nation’soverall defense posture continues to move toward a more capabilities-basedstructure, which creates the 

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ability for a moreflexible response with greater force mobility, stronger space capabilities, missiledefense, and improved information systems capability and security.

DoD budgets have experienced increased focus oncommand, control, communications, computers, intelligence, surveillance andreconnaissance (C4ISR), precision-guided weapons, unmanned aerial vehicles(UAVs), network-centric communications, Special Operations Forces (SOF) andmissile defense. In addition, the DoD philosophy has focused on atransformation strategy that balances modernization and recapitalization (orupgrading existing platforms), while enhancing readiness and joint operations.As a result, defense budget program allocations continue to favor advancedinformation technologies related to command, control, communications andcomputers (C4), and Intelligence, Surveillance and Reconnaissance (ISR).Furthermore, the DoD’s emphasis on system interoperability, force multipliersand providing battlefield commanders with real-time data is increasing theelectronic content of nearly all major military procurement and research programs.

Our strategy is designed to capitalize on the breadthof our technology and extensive expertise in order to meet the evolving needsof our customers. We intend to expand our share of existing programs andparticipate in new programs by leveraging the strong relationships that we havedeveloped with the DoD, several other U.S. government agencies and all of themajor U.S. defense prime contractors. We expect to continue to benefit from theoutsourcing of subsystems, components and products by prime contractors. Weplan to continue to align our research and development, manufacturing and newbusiness efforts to complement our customers’ requirements and to providestate-of-the-art products. We plan to maintain a diversified and broad businessmix with limited reliance on any single program, a significant follow-onbusiness and an attractive customer profile.

A significant component of our strategy has been toenhance our existing product base through selective acquisitions that add newproducts, technologies and services in areas that complement our presentbusiness base.

We believe that ouracquisition of ESSI provides several strategic benefits, including thefollowing:

·       Strengthenedalignment with future DoD requirements, which support the need for deployableand mobile forces, and capabilities to provide sustainment, reset,modernization and transformation services to our customers;

·       Opportunityto leverage ESSI’s well established services and support businesses to furtherexpand our customer base with new relationships, enhance our access toadditional program funding sources such as the DoD’s operations and maintenanceaccounts, and gain access to attractive and flexible contract vehicles;

·       Increasedscale which strengthens our ability to secure new contracts by increasingvisibility within the DoD and better serve existing customers with an expandedproduct base including products and services;

·       Increasedprogram and customer diversification, most notably with the U.S. Air Force, inlight of ESSI’s significant and complementary portfolio of contracts; and

·       Thefoundation to sell into the evolving homeland defense market by combiningESSI’s small scale systems integration capabilities with the combined company’sarray of products and subsystems.

We intend to continueacquiring select publicly and privately-held companies, as well as defensebusinesses of larger companies that (i) exhibit significant marketposition(s) in their business areas, (ii) offer products thatcomplement and/or expand our product offerings and (iii) display growingrevenues, positive operating income and cash flow prospects.

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**Other Business Considerations**

As a government contractor, we are subject to U.S.government oversight. The government may ask about and investigate our businesspractices and audit our compliance with applicable rules and regulations.Depending on the results of those audits and investigations, the governmentcould make claims against us. Under government procurement regulations andpractices, an indictment of a government contractor could result in thatcontractor being fined and/or suspended from being able to bid on, or beawarded, new government contracts for a period of time. A conviction couldresult in debarment for a specific period of time. Similar government oversightexists in most other countries where we conduct business.

We are party to various legal actions and claimsarising in the ordinary course of our business. In our opinion, we haveadequate legal defenses for each of the actions and claims, and we believe thattheir ultimate disposition will not have a material adverse effect on ourconsolidated financial position, results of operations or liquidity (seePart 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.

**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 nine months ended December 31, 2005. Critical accounting policiesare those that require application of management’s most difficult, subjectiveor complex judgments, often as a result of the need to make estimates about theeffects of matters that are inherently uncertain and may change in subsequentperiods. Critical accounting policies for us include revenue recognition oncontracts and contract estimates, valuation of goodwill and acquired intangibleassets, pension plan and postretirement benefit plan obligations, accountingfor income taxes and other management estimates.

**Results of Continuing Operations**

Our operating cycle islong-term and involves various types of production contracts and varyingproduction delivery schedules. Accordingly, operating results of a particularperiod, or year-to-year comparisons of recorded revenues and earnings, may notbe indicative of future operating results. Members of our senior managementteam regularly review key performance metrics and the status of operatinginitiatives within our business. These key performance indicators are primarilyrevenues, operating income and bookings. We review this information on amonthly basis through extensive operating segment reviews which include, amongother operating issues, detailed discussions related to significant programs,proposed investments in new business opportunities or property, plant, and 

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equipment and integration and cost reduction efforts.The following table presents a summary comparison of the key performancemetrics, other significant financial metrics and significant liquidity metricsmonitored by senior management of the Company.

| ** **                              | ** ** | **Three Months Ended  December 31,**   | ** ** | **Percent** | ** ** | **Nine Months Ended  December 31,** | ** ** | **Percent** | ** ** |
|-----------------------------------------|------------|-------------------------------------------------------|------------|-------------|------------|----------------------------------------------------|------------|-------------|------------|
| ** **                              | ** ** | **2005**                                              | ** ** | **2004**    | ** ** | **Change**                                         | ** ** | **2005**    | ** ** | **2004** | ** ** | **Change** | ** ** |
| ** **                              | ** ** | **(in thousands, except percentages)** | ** ** |
| **Key  performance metrics**            |       |                                                  |       |        |       |                                               |       |        |       |   |   |   |   |   |   |   |   |
| Revenues                                |       | $                                                     | 389,490    |        | $          | 338,232                                            |       |        | 15.2       | % |   | $ | 1,089,879 |   | $ | 947,436 |   |   | 15.0 | % |   |
| Operating income                        |       | $                                                     | 44,827     |        | $          | 39,249                                             |       |        | 14.2       | % |   | $ | 118,462 |   | $ | 101,555 |   |   | 16.6 | % |   |
| Bookings                                |       | $                                                     | 304,151    |        | $          | 359,840                                            |       |        | (15.5      | %) |   | $ | 1,422,620 |   | $ | 1,038,775 |   |   | 37.0 | % |   |
| **Other significant financial metrics** |       |                                                  |       |        |       |                                               |       |        |       |   |   |   |   |   |   |   |   |
| Interest and related expenses           |       | $                                                     | 12,458     |        | $          | 9,447                                              |       |        | 31.9       | % |   | $ | 36,959 |   | $ | 27,447 |   |   | 34.7 | % |   |
| Income taxes                            |       | $                                                     | 14,297     |        | $          | 12,500                                             |       |        | 14.4       | % |   | $ | 33,010 |   | $ | 31,053 |   |   | 6.3 | % |   |
| **Significant liquidity metrics  (A)**  |       |                                                  |       |        |       |                                               |       |        |       |   |   |   |   |   |   |   |   |
| Free cash flow                          |       | $                                                     | 14,408     |        | $          | 25,611                                             |       |        | (43.7      | %) |   | $ | 33,143 |   | $ | 60,606 |   |   | (45.3 | %) |   |
| EBITDA                                  |       | $                                                     | 54,994     |        | $          | 48,096                                             |       |        | 14.3       | % |   | $ | 148,176 |   | $ | 129,972 |   |   | 14.0 | % |   |

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(A)  See Liquidity and Capital Resources and Use of Non-GAAP FinancialMeasures for additional discussion and information.

***Three- and Nine-Month Periods Ended December 31,2005, Compared with the Three-and Nine-Month Periods Ended December 31,2004***

**Revenuesand operating income****  **Consolidatedrevenues and operating income for the three-month period endedDecember 31, 2005 increased $51.3 million and $5.6 million, respectively,to $389.5 million and $44.8 million, respectively, as compared with thecorresponding period in the prior year. The increase in revenues was largelydriven by our December 14, 2004 acquisition of NVEC and our April 15,2005 and June 27, 2005 acquisitions of Codem and WalkAbout, respectively,which contributed incremental (current quarter over corresponding prior-yearquarter) revenues of $31.1 million*.*Alsocontributing to the overall increase in revenues was increased shipments of certainrugged computer systems, thermal target acquisition and missile controlsubsystems and airborne training pods. Partially offsetting the overallincrease in revenues were decreased DD(X)-related ship propulsion engineeringservices and lower shipments of certain turbine generator sets.

The growth in operating income in the third quarter offiscal 2006, as compared with the corresponding prior year period, was dueprimarily to the overall increase in revenues and favorable margins from visionenhancement equipment for ground-based vehicles. Partially offsetting theoverall increase in operating income were losses from DD(X)-related shippropulsion engineering as a result of the continued development of thepermanent magnet motor technology, despite the U.S. Navy funding uncertainty.Fiscal 2006 third quarter operating income was also unfavorably impacted bycost growth on an electro-optical assembly program. The three recently acquiredoperating units, NVEC, Codem and WalkAbout, contributed $4.4 million ofincremental operating income for the three-month period ended December 31,2005. See Operating Segments discussion below for additional information.

Consolidated revenues and operating income for thenine-month period ended December 31, 2005 increased $142.4 million and$16.9 million, respectively, to $1.1 billion and $118.5 million, respectively,as compared with the corresponding period in the prior year. The increase inrevenues was largely driven by our acquisitions of NVEC, Codem and WalkAbout,which contributed incremental (current year-to-date over correspondingprior-year to date) revenues of $78.0 million. Also contributing to the overallincrease in revenues were increased shipments of certain rugged computersystems, certain airborne training pods, vision enhancement equipment forground-based vehicles, combat display workstations and flight range test andevaluation equipment. Partially offsetting the overall increase in revenueswere decreased DD(X)-

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related ship propulsionengineering services, lower shipments of certain turbine generator sets andlower volume from a light armored vehicle service life extension program whichwas substantially completed in fiscal 2005.

The growth in operating income for the nine monthsended December 31, 2005, as compared with the corresponding prior yearperiod, was due primarily to the overall increase in revenues and favorable marginson vision enhancement equipment for ground-based vehicles, the integratedsensor command system and flight control computer contract manufacturing. Partiallyoffseting the overall increase in operating income were losses fromDD(X)-related ship propulsion engineering. NVEC, Codem and WalkAboutcontributed $13.6 million to operating income for the nine-month period endedDecember 31, 2005. See Operating Segments discussion below for additionalinformation.

**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 December 31, 2005 decreased $55.7 million, versusthe same period in the prior year, to $304.2 million. The primary drivers ofthe decline were the timing of receipt of certain significant bookings ofground-based electro-optical sighting and targeting systems, certain ruggedcomputer systems, certain ground-based vehicle diagnostic systems and combatdisplay workstations which were received in the first half of fiscal 2006. OurNVEC, Codem and WalkAbout acquisitions contributed combined bookings of $15.9million.

Bookings for the nine-month period endedDecember 31, 2005 increased $383.8 million, versus the same period in theprior year, to $1.4 billion. The primary organic drivers of the increase arediscussed above. Our NVEC, Codem, and WalkAbout acquisitions contributedcombined incremental bookings of $78.4 million.

**Interestand related expenses****  **Interestand related expenses increased $3.0 million and $9.5 million for the three- andnine-month periods ended December 31, 2005, respectively, as compared withthe same period in the prior year, to $12.5 million and $37.0 million,respectively. The increase in interest and related expenses is primarily theresult of an increase in our average borrowings outstanding for the three- andnine-month periods ended December 31, 2005, as compared with thecorresponding period in the prior-year, due to our December 23, 2004,issuance of $200 million of 67¤8%senior subordinated notes (see Liquidity and Capital Resources below). We hadno borrowings outstanding under our revolving credit facility atDecember 31, 2005 and 2004.

**Incometaxes****  **Theprovision for income taxes for the three- and nine-month periods ended December 31,2005, reflected an effective income tax rate of approximately 42.0% and 38.5%,respectively, as compared with 42.6% 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 during the nine month period endedDecember 31, 2005. We anticipate our effective income tax rate for theyear ended March 31, 2006, will approximate 40%.

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**Operating Segments**

The following tablesets forth, by operating segment, revenues, operating income and operatingmargin for the three- and nine-month periods ended December 31, 2005 and2004, and the percentage increase or decrease of those current fiscal perioditems, as compared with the corresponding prior fiscal year period:

| ** **       | ** ** | **Three Months Ended  December 31,**            | ** ** | **Three Months**  Ended Percent  Changes | ** ** | **Nine Months Ended  December 31,** | ** ** | **Nine Months  Ended Percent  Changes** | ** ** |
|------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **       | ** ** | **2005**                                                       | ** ** | **2004**                                           | ** ** | **2005 vs. 2004**                        | ** ** | **2005**                                          | ** ** | **2004** | ** ** | **2005 vs. 2004** | ** ** |
| ** **       | ** ** | **(in thousands, except for percentages)** | ** ** |
| **C4I  Group**   |       |                                                           |       |                                               |       |                                               |       |                                              |       |   |   |   |   |   |   |   |   |
| Revenues         |       | $                                                              | 202,915    |                                               | $          | 189,033                                            |       |                                              | 7.3        | % |   | $ | 587,825 |   | $ | 515,741 |   |   | 14.0 | % |   |
| Operating income |       | $                                                              | 23,866     |                                               | $          | 23,095                                             |       |                                              | 3.3        | % |   | $ | 63,072 |   | $ | 55,772 |   |   | 13.1 | % |   |
| Operating margin |       | 11.8%                                                          |       | 12.2%                                              |       |                                               | (3.7       | %)                                                |       | 10.7% |   | 10.8% |   |   | (0.8 | %) |   |
| **SR Group**     | ** ** | ** **                                                     | ** ** | ** **                                         | ** ** |                                               |       |                                              | ** ** | ** ** | ** ** | ** ** | ** ** |   |   |   |   |
| Revenues         |       | $                                                              | 186,575    |                                               | $          | 149,199                                            |       |                                              | 25.1       | % |   | $ | 502,054 |   | $ | 431,695 |   |   | 16.3 | % |   |
| Operating income |       | $                                                              | 20,979     |                                               | $          | 16,173                                             |       |                                              | 29.7       | % |   | $ | 57,844 |   | $ | 45,888 |   |   | 26.1 | % |   |
| Operating margin |       | 11.2%                                                          |       | 10.8%                                              |       |                                               | 3.7        | %                                                 |       | 11.5% |   | 10.6% |   |   | 8.5 | % |   |
| **Other**        | ** ** | ** **                                                     | ** ** | ** **                                         | ** ** |                                               |       |                                              | ** ** | ** ** | ** ** | ** ** | ** ** |   |   |   |   |
| Operating loss   |       | $                                                              | (18        | )                                                  | $          | (19                                                | )          |                                              | 5.3        | % |   | $ | (2,454 | ) | $ | (105 | ) |   | (2237.1 | %) |   |

 

***Three-Month Period EndedDecember 31, 2005, Compared with the Three-Month Period Ended December 31, 2004***

**C4IGroup****  **Revenuesincreased $13.9 million, or 7.3%, to $202.9 million for the three-month periodended December 31, 2005, as compared with the corresponding prior-yearperiod. Operating income increased $0.8 million, or 3.3%, to $23.9 million. Theincrease in revenue was principally attributable to our acquisitions of Codemand WalkAbout, which contributed combined revenues of $14.3 million to thethree-month period ended December 31, 2005. Also contributing to theoverall increase in revenues were increased shipments of certain ruggedcomputer systems, and volume from nuclear control panel displays and propulsionplant controls and larger surveillance tuners integration programs. Partiallyoffsetting the overall increase in revenues were decreased DD(X)-related shippropulsion engineering services and decreased shipments of certain turbinegenerator sets.

The increase in operating income for the three-monthperiod ended December 31, 2005, as compared to the corresponding period inthe prior year, was driven primarily by the overall increase in revenues, aswell as the $2.4 million operating income contribution from our acquisitions ofCodem and WalkAbout, partially offset by DD(X)-related ship propulsion engineeringlosses, cost growth on certain turbine generator sets and severance-relatedcharges at our power systems strategic business unit.

**SRGroup****  **Revenuesincreased $37.4 million, or 25.1%, to $186.6 million for the three-month periodended December 31, 2005, as compared with the corresponding prior-yearperiod. Operating income increased $4.8 million, or 29.7%, to $21.0 million.The increase in revenues was primarily attributable to our December 14,2004 acquisition of NVEC which contributed incremental revenues of $16.7million. Revenues were also favorably impacted by increased shipments ofcertain thermal target acquisition and missile control subsystems and airborne trainingpods. Partially offsetting the overall increase in revenues were lower revenuesfrom a light armored vehicle service life extension program which wassubstantially completed in fiscal 2005, and lower shipments of certainelectro-optical sighting systems and unmanned aerial vehicles.

The increase in operating income for the three-monthperiod ended December 31, 2005, as compared with the corresponding periodin the prior year, was driven primarily by our acquisition of NVEC, whichcontributed $2.0 million to operating income, as well as favorable margins on drivervision enhancement equipment for ground-based vehicles and launch controlelectronics systems offset in part by cost growth 

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on an airborneelectro-optical assembly program. For the three months ended December 31,2004, operating income was unfavorably impacted by a $1.0 millionlitigation-related charge.

**Other****  **The operating loss in Other consistsof certain non-allocable general and administrative expenses at DRS corporate.

***Nine-Month Period EndedDecember 31, 2005, Compared with the Nine-Month Period EndedDecember 31, 2004***

**C4IGroup****  **Revenuesincreased $72.1 million, or 14.0%, to $587.8 million for the nine-month periodended December 31, 2005, as compared with the corresponding prior-yearperiod. Operating income increased $7.3 million, or 13.1%, to $63.1 million.

The increase in revenue was largely attributable toincreased shipments of certain rugged computer systems, combat displayworkstations, communications intelligence and signal intenlligence programs,and a cabling refurbishment program for the U.S. Army. Our acquisitions ofCodem and WalkAbout contributed incremental revenues of $30.5 million to thenine-month period ended December 31, 2005. Partially offsetting theoverall increase in revenues were decreased DD(X)-related ship propulsionengineering services and decreased shipments of certain turbine generator setsand satellite communication equipment.

The increase in operating income for the nine-monthperiod ended December 31, 2005, as compared to the corresponding period inthe prior year, was driven primarily by the overall increase in revenues, aswell as the $6.0 million of incremental operating income contribution from ouracquisitions of Codem and WalkAbout. Partially offsetting the overall increasein operating income were losses from DD(X)-related ship propulsion engineeringservices, cost growth on certain turbine generator sets and certain powerconversion, distribution and machinery control equipment and severance-relatedcharges at our power systems strategic business unit. Operating income for thenine months ended December 31, 2004 was unfavorably impacted by a $1.0million increase in the estimated liability associated with the Miltope litigation,$1.6 million in severance-related charges and $0.6 million in inventorywrite-offs on certain rugged computer systems.

**SRGroup****  **Revenuesincreased $70.4 million, or 16.3%, to $502.1 million for the nine-monthperiod ended December 31, 2005, as compared with the correspondingprior-year period. Operating income increased $12.0 million, or 26.1%, to $57.8million. The increase in revenues was primarily attributable to our acquisitionof NVEC, which contributed incremental revenues of $47.5 million. Revenues alsowere impacted favorably by increased shipments of airborne training pods, drivervision enhancement equipment for ground-based vehicles, flight range test andevaluation equipment, and electro-optical sensors and space electronics.Partially offsetting the overall increase in revenues were lower revenues from thelight armored vehicle service life extension program which was substantiallycompleted in fiscal 2005, and certain motor control products.

The increase in operating income for the nine-monthperiod ended December 31, 2005, as compared with the corresponding periodin the prior year, was driven by overall higher sales, our acquisition NVEC,which contributed $7.6 million to operating income,****and favorable margins on drivers vision enhancement equipmentand certain launch control electronics. The increase in operating income waspartially offset by decreased margins on a certain second generation thermalimaging system. For the nine months ended December 31, 2004, operatingincome was unfavorably impacted by a $1.0 million litigation-related charge.

**Other****  **The $2.5 million operating loss inOther in the nine-month period ended December 31, 2005 was drivenprimarily by a $2.0 million accrual recorded in the second quarter of fiscal2006, in connection with a litigation reserve. (See Part II, Item 1. LegalProceedings).

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**Results of Discontinued Operations**

Aconsolidated summary of the operating results of the discontinued operationsfor the three- and nine-month periods ended December 31, 2004 are asfollows:

| ** **                             | ** ** | **Three Months Ended  December 31, 2004** | ** ** | **Nine Months Ended  December 31, 2004** | ** ** |
|----------------------------------------|------------|---------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                             | ** ** | **(in thousands)**                                       | ** ** |
| Revenues                               |       |                                                          | $          | 8,212                                                        |       |   |   | $ | 27,759 |   |   |
| Earnings before  taxes                 |       |                                                          | $          | 1,030                                                        |       |   |   | $ | 3,020 |   |   |
| Income tax  expense                    |       |                                                          | 406        |                                                         |       |   | 1,198 |   |   |
| Earnings from  discontinued operations |       |                                                          | $          | 624                                                          |       |   |   | $ | 1,822 |   |   |

 

**Liquidityand Capital Resources**

| ** **                                                          | ** ** | **Nine MonthsEnded  December 31,** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                          | ** ** | **2005**                                     | ** ** | **2004** | ** ** |
| ** **                                                          | ** ** | **(in thousands)**                      | ** ** |
| Net cash provided  by operating activities of continuing operations |       | $                                            | 59,454     |   | $ | 81,348 |   |
| Net cash provided  by operating activities                          |       | $                                            | 59,454     |   | $ | 84,045 |   |
| Net cash used in  investing activities of continuing operations     |       | $                                            | (79,832    | ) | $ | (64,590 | ) |
| Net cash used in  investing activities                              |       | $                                            | (79,832    | ) | $ | (65,186 | ) |
| Net cash used in financing activities of continuing operations      |       | $                                            | (27,462    | ) | $ | 181,257 |   |
| Net cash used in  financing activities                              |       | $                                            | (27,462    | ) | $ | 181,234 |   |

 

**Operating activities****  **During the nine months endedDecember 31, 2005, we generated $59.5 million of operating cash flow fromcontinuing operations, $21.9 million less than the $81.3 million of operatingcash flow from continuing operations generated in the same period in the prioryear. Earnings from continuing operations increased $10.9 million to $52.7million. Non-cash adjustments to reconcile net earnings to cash flows fromoperating activities decreased $1.3 million over the corresponding prior fiscalperiod, driven primarily by a net reduction in inventory reserves and bondpremium amortization related to the $200.0 million senior subordinatednotes issued on December 23, 2004, offset, in part by increased depreciationof fixed assets related to increased capital investments in the current andprior periods, and increased stock-based compensation.

Changes in assets andliabilities, net of effects from business combinations, used $29.5 millionin cash for the nine months ended December 31, 2005. Inventories used $37.1million of cash for the nine-month period ended December 31, 2005.Increased inventories in certain of our electro-optical infrared sighting andtargeting businesses, and signals intelligence businesses were offset, in part,by decreased inventories within certain of our communications businesses. Weexpect to liquidate a significant amount of this inventory in the fourthquarter of fiscal 2006. Accrued expenses and other current liabilities used$30.9 million of cash during the period. The cash used by these accountsprimarily resulted from interest payments on the 67¤8% seniorsubordinated notes due 2013, the settlement of the Miltope litigation, incometax payments and the liquidation of certain contract-related reserves. Netliquidations in customer advances and net increases is prepaid expenses andother current assets used $8.0 million and $3.5 million in cash, respectively.Accounts payable increased $27.4 million as purchases required to buildinventories exceeded related payments. Accounts receivable contributed $22.8million to operating cash flow.

**Investing activities****  **We paid $26.3 million for capitalimprovements during the nine-month period ended December 31, 2005, ascompared with $20.7 million in the corresponding prior-year period. We expectour capital expenditures to range between $35.0 million to $45.0 million infiscal 2006, as we continue to upgrade our facilities and integrate recentacquisitions into our existing businesses. Payments 

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pursuant tobusiness combinations, net of cash acquired, totaled $54.5 million driven byour acquisitions of Codem and Walkabout, $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.), and $1.9 million in ESSI acquisition-related payments.

Our long-term growthstrategy includes a disciplined program of acquiring companies that are bothstrategic to our business and expected to be accretive to our earnings.Continuation of our acquisition program will depend, in part, on theavailability of financial resources at a cost of capital that is acceptable tous. We would expect to utilize cash generated by operations, as well as cashavailable under our amended and restated senior secured credit facility, whichalso may include the renegotiation of our credit limit to finance suchacquisitions. Other sources of capital could include proceeds from a sale ofour common stock and the placement of debt. We continually evaluate the capitalmarkets climate and may access such markets when the circumstances appearfavorable to us. We believe that sufficient capital resources will be availableto us from one or several of these sources to finance future acquisitions thatwe determine to be strategic and accretive to our net earnings. However, noassurances can be made that such financing will be available and at a cost thatis acceptable to us, that we will identify acceptable acquisition candidates,or that such acquisitions will be accretive to earnings.

**Financing Activities****  **For the nine-month period endedDecember 31, 2005, financing activities used $27.5 million in cash.Payments on long-term debt included $31.8 million of payments on our term loan,$30.0 million of which was paid at our discretion. Our discretionary term loanpayments caused us to record a $0.6 million charge to interest and relatedexpenses for the write-off of a portion of the related debt issuance costs. Werepaid $2.0 million in advanced interest that we received in connection withthe notes issued on December 23, 2004 (see below). For the nine monthsended December 31, 2005, we received $9.8 million from the exercise ofstock options and paid $2.5 million of cash dividends.

On October 30, 2003,we issued $350.0 million aggregate principal amount of 67¤8%Senior Subordinated Notes, due November 1, 2013 (the Notes). The Noteswere issued under an indenture with The Bank of New York (the Indenture).Subject to a number of exceptions, the Indenture restricts our ability and theability of our subsidiaries to incur more debt, make certain investments,repurchase stock, create liens, enter into transactions with affiliates, enterinto sale lease-back transactions, merge or consolidate, pay dividends, andtransfer or sell assets. The Notes are unconditionally guaranteed, jointly andseverally, by DRS’s current and future wholly-owned domesticsubsidiaries. The foreign subsidiaries and certain domestic subsidiaries of DRSdo not guarantee the Notes. See Note 15, “Guarantor and Non-guarantor FinancialStatements” for additional disclosures.

On December 23, 2004,we issued an additional $200.0 million aggregate principal amount of 67¤8%Senior Subordinated 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 fromNovember 1, 2004 to December 23, 2004), after deducting $3.7 millionin commissions and other costs related to the debt issuance. On May 1,2005, the advanced interest of $2.0 million was repaid in conjunction with thesemi-annual interest payments on the Notes.

The book value and fairvalue of the senior subordinated debt at December 31, 2005 wasapproximately $558.9 million and $522.5 million, respectively.

At December 31, 2005,we had a $411.0 million credit facility (the Credit Facility), consisting of a$175.0 million senior secured revolving line of credit and a $236.0 millionsenior secured term loan. As of December 31, 2005 and March 31, 2005,we had $135.7 million and $167.5 million, respectively, of term loansoutstanding against the Credit Facility. The Credit Facility was guaranteed bysubstantially all of DRS’s domestic subsidiaries. In addition, it wascollateralized by liens on substantially all of the assets of our subsidiaryguarantors and certain of DRS’s other subsidiaries’ assets and by a pledge ofcertain of our non-guarantor subsidiaries’ capital stock. The weighted averageinterest rate on our term loans was 5.9% 

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as ofDecember 31, 2005 (4.4% as of March 31, 2005), excluding the impactof the amortization of debt issuance costs. As of December 31, 2005, wehad $139.5 million available under our revolving line of credit. There were noborrowings under our revolving line of credit as of December 31, 2005 andMarch 31, 2005.

During the three monthsended December 31, 2005, the Company decided to prepay the remainingbalance of its term loan in the fourth quarter of fiscal 2006. The term loanwas repaid during the week of January 9, 2006, using available cash. As aresult, the term loan has been classified as a current liability on the December 31,2005 consolidated balance sheet.

Simultaneously with theclosing of our acquisition of ESSI, we entered into an amended and restated seniorsecured credit facility for up to an aggregate amount of $675.0 millionreplacing our Credit Facility. We also issued $350.0 million aggregateprincipal amount of 6 5/8%Senior Notes due 2016 and $250.0 million aggregate principal amount of 7 5/8%Senior Subordinated Notes due 2018 and $300.0 million aggregate principalamount of 2% Senior Convertible Notes due 2026 (with a 20% conversion premium).

Interest on the SeniorNotes and Senior Subordinated are paid semi-annually on February 1 and August 1with payments commencing August 1, 2006. Our obligations under the Notes will be fully and unconditionallyguaranteed, jointly and severally by certain of our existing and futuredomestic subsidiaries.

The Convertible Notes aresenior unsecured obligations and rank equally in right of payment with all ofour senior indebtedness.  We will paycontingent interest to the holders of the Convertible Notes during anysix-month period from February 1 to July 31, and from August 1 to January 31,commencing with the six-month period beginning on February 1, 2011, if thetrading price of a note for each of the five trading-day period ending on thethird trading day immediately preceding the first day of the relevant six-monthperiod equals 120% or more of the principal amount of the note. The amount ofcontingent interest payable per Convertible Note with respect to any six-monthperiod will equal 0.50% per annum of the average market price of such note forthe five trading day period referred to above. Our payment obligations under the Convertible Notes will be fully andunconditionally guaranteed, jointly and severally, on a senior unsecured basisby certain of our existing and future domestic subsidiaries.  The Convertible Notes will mature on February1, 2026, unless earlier converted, redeemed or repurchased.

TheConvertible Notes may be converted into cash and, if applicable, shares of ourcommon stock, based on a conversion rate of 16.7504 shares per $1,000 principalamount of Convertible Notes (representing a conversion price of approximately$59.70 per share of common stock), subject to adjustment only under thecircumstances described below. On or prior to February 1, 2010, the ConvertibleNotes may be converted by the holder only under the following circumstances:

·       duringthe five consecutive business-day period following any five consecutivetrading-day period in which the average trading price for the Convertible Noteswas less than 103% of the average of the closing sale price of our common stockduring such five trading-day period multiplied by the applicable conversionrate;

·       duringprescribed periods, upon the occurrence of specified corporate transactions orfundamental changes as described in the debt agreement.

·       ifwe have called the Convertible Notes for redemption, until the second businessday immediately preceding the redemption date.

AfterFebruary 1, 2010, the Convertible Notes may be converted by the holder intocash and shares, if any, of DRS’s common stock (as provided below) initially ata conversion rate of 16.7504 shares per $1,000 principal amount of ConvertibleNotes (equal to an initial conversion price of approximately $59.70 per shareof common stock), only under the following circumstances:

·       duringany calendar quarter (and only during such calendar quarter) commencing afterDecember 31, 2009, if the closing sale price of our common stock for at least20 trading days in the period of 30 

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consecutive tradingdays ending on the last trading day of the preceding calendar quarter, isgreater than or equal to 110% of the applicable conversion price;

·       onor after February 1, 2025;

·       duringthe five consecutive business-day period following any five consecutivetrading-day period in which the average trading price for the Convertible Noteswas less than 98% of the average of the closing sale price of our common stockduring such five trading-day period multiplied by the applicable currentconversion rate;

·       duringprescribed periods, upon the occurrence of specified corporate transactions orfundamental changes described in this offering memorandum; or

·       ifwe have called the Convertible Notes for redemption, until the second businessday immediately preceding the redemption date.

Upon anyconversion, we will deliver cash and shares of our common stock, if any, withan aggregate value (the ‘‘*conversion value*’’)equal to the applicable conversion rate multiplied by the average of theclosing sale prices of our common stock for each trading day in the 20consecutive trading day period commencing after (and including) the thirdtrading day following the date the Convertible Notes are tendered forconversion (the ‘‘applicable conversion period’’) as follows: 

·  an amount in cash equal to the lesser of (a)the principal amount of Convertible Notes surrendered for conversion and (b)the conversion value, and

·  if the conversion value is greater than theprincipal amount of the Convertible Notes, an amount of whole shares of ourcommon stock (the ‘‘*excess value*’’)equal to the sum of the daily share amounts for each trading day during theapplicable conversion period. We will pay the excess value in shares of ourcommon stock.

We may redeem the Convertible Notes in whole or inpart for cash, upon not less than 30 days’ nor more than 60 days’ notice beforethe redemption date, at any time on or after February 1, 2009 and prior toFebruary 4, 2011, if the sale price of our common stock has exceeded 130% ofthe conversion price for at least 20 trading days in any consecutive 30-daytrading period ending on the trading day prior to providing notice ofredemption, at a redemption price equal to 100% of the principal amount of theConvertible Notes to be redeemed plus any accrued and unpaid interest(including contingent interest and additional interest, if any) up to but notincluding the redemption date and a ‘‘make-whole’’ premium. We may, at any timeafter February 4, 2011, redeem the Convertible Notes in whole or in part forcash, upon not less than 30 days’ nor more than 60 days’ notice before theredemption date, at a redemption price equal to 100% of the principal amount ofthe Convertible Notes to be redeemed plus any accrued and unpaid interest(including contingent interest and additional interest, if any) up to but notincluding the redemption date.

Holders have the right to require us to purchase allor a portion of their Convertible Notes for cash on February 1, 2011, February1, 2016 and February 1, 2021, at a purchase price equal to 100% of theprincipal amount of the Convertible Notes plus accrued and unpaid interest(including additional interest, if any) to but not including the purchase date.

On February 8, 2006 we sold an additional $45.0 millionof Convertible Notes, pursuant to an over-allotment option exercised by theinitial purchasers of the Convertible Notes. We expect to use the net proceedsto repay indebtedness under our senior secured revolving line of credit.

From time to time, weenter into standby letters-of-credit and bank guarantee agreements withfinancial institutions and customers, primarily relating to the guarantee ofour future performance on certain contracts to provide products and servicesand to secure advance payments we have received from our customers. As ofDecember 31, 2005, an aggregate of $36.8 million was contingently payableunder 

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lettersof credit and bank guarantees. Approximately $0.9 million and $0.4 million inletters of credit and bank guarantees, respectively, as of December 31,2005 were issued outside of the Credit Facility and by a bank agreement for ourU.K. subsidiary, respectively, that are not considered when determining theavailability under our Credit Facility.

We have a mortgage notepayable that is secured by a lien on our 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 December 31, 2005 and March 31, 2005was $2.8 million and $3.0 million, respectively. Monthly payments of principaland interest totaling approximately $34 thousand will continue throughDecember 1, 2016.

Accrued interest expenseat December 31, 2005 and March 31, 2005 was approximately $7.1million and $16.5 million, respectively.

Based upon our anticipatedlevel of future operations, we believe that our existing cash and cashequivalents balances and our cash generated from operating activities, togetherwith available borrowings under our amended and restated senior secured creditfacility, will be adequate to meet our anticipated requirements for workingcapital, capital expenditures, commitments, research and developmentexpenditures, contingent purchase prices, program and other discretionaryinvestments, and interest and principal payments for the foreseeable future.There can be no assurance, however, that our business will continue to generatecash flow at current levels. If we are unable to generate sufficient cash flowfrom operations to service our debt, we may be required to sell assets, reduce capitalexpenditures, refinance all or a portion of our existing debt or obtainadditional financing. Our ability to make scheduled principal payments or topay interest on or to refinance our indebtedness depends on our futureperformance and financial results, which, to a certain extent, are subject togeneral conditions in or affecting the defense industry and to generaleconomic, political, financial, competitive, legislative and regulatory factorsbeyond our control. There can be no assurance that sufficient funds will beavailable to enable us to service our indebtedness, make necessary capitalexpenditures or to make discretionary investments.

**Free Cash Flow****  **Free cash flow represents net cashprovided by operating activities of continuing operations less capitalexpenditures. Free cash flow for the three-month period ended December 31,2005 was $14.4 million, or $11.2 million less than the $25.6 million of freecash flow in the corresponding period in the prior year. Free cash flow for thenine-month period ended December 31, 2005 was $33.1 million or $27.5million less than the $60.6 million of free cash flow in the correspondingperiod in the prior year. See “Use of Non-GAAP Financial Measures” below foradditional discussion and information.

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**EBITDA****  **Earnings from continuing operationsbefore net interest and related expenses (primarily the amortization andwrite-off of debt premium and issuance costs), income taxes, depreciation andamortization (EBITDA) for the three-month period ended December 31, 2005was $55.0 million, or $6.9 million greater than the $48.1 million of EBITDA inthe corresponding period in the prior year. EBITDA for the nine-month periodended December 31, 2005 was $148.2 million, or $18.2 million greater thanthe $130.0 million of EBITDA in the corresponding period in the prior year. See“Use of Non-GAAP Financial Measures” below for additional discussion andinformation.

**Contractual Obligations****  **Our contractual obligations andcommitments principally include obligations associated with our outstandingindebtedness, future minimum operating lease obligations, acquisition earn-outsand purchase obligations as set forth in the table below:

| ** **                     | ** ** | **As of December 31, 2005** | ** ** |
|--------------------------------|------------|-------------------------------------------------|------------|
| ** **                     | ** ** | **Payments Due by Period**       | ** ** |
| ** **                     | ** ** | **Total**                                       | ** ** | **Less than   year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More  than  5 years** | ** ** |
| ** **                     | ** ** | **(in thousands)**                         | ** ** |
| Long-term debt                 |       | $                                               | 688,543    |   | $ | 135,891 |   | $ | 423 |   | $ | 494 |   | $ | 551,735 |   |
| Operating lease  commitments   |       | 93,939                                          |       | 23,623 |   | 31,555 |   | 20,314 |   | 18,447 |   |
| Acquisition  earn-outs(A)      |       | 45,808                                          |       | 8,694 |   | 37,114 |   | — |   | — |   |
| Purchase  obligations(B)       |       | 51,358                                          |       | 39,677 |   | 11,681 |   | — |   | — |   |
| Total contractual  obligations |       | $                                               | 879,648    |   | $ | 207,885 |   | $ | 80,773 |   | $ | 20,808 |   | $ | 570,182 |   |

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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 onDecember 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.

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 December 31, 2005, we had contingent liabilities on outstanding lettersof 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 |       | $                                                         | 36,461     |   | $ | 33,421 |   |   | $ | 3,040 |   |   |   | $ | — |   |   |
| Bank guarantees            |       | $                                                         | 377        |   | $ | 335 |   |   | $ | 42 |   |   |   | $ | — |   |   |

 

**Backlog****  **Funded backlog represents productsor services that our customers have committed by contract to purchase from us.Due to the general nature of defense procurement and contracting, the operatingcycle for our military business typically has been long term. Military backlogcurrently consists of various production and engineering development contractswith varying delivery schedules and project timetables. Our backlog alsoincludes a significant amount of commercial off-the-shelf (COTS)-based systemsfor the military, which have shorter delivery times. Accordingly, revenues fora particular period, or year-to-year comparisons of reported revenues andrelated backlog positions may not be indicative of 

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future results. Backlog atDecember 31, 2005 was $1.6 billion, as compared with $1.3 billion atMarch 31, 2005. We booked $304.2 million and $1.4 billion in new ordersfor the three- and nine-month periods ended December 31, 2005.

**InternalResearch and Development****  **In addition to customer-sponsored research and development,we also engage in internal research and development. These expenditures reflectour continued investment in new technology and diversification of our products.Expenditures for internal research and development for the three-month periodsended December 31, 2005 and 2004 were $12.1 million and $9.2 million,respectively, and $33.5 million and $26.1 million for the nine-month periodsended December 31, 2005 and 2004, respectively.

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

| ** **                                                                                     | ** ** | **Three Months Ended  December 31,** | ** ** | **Nine Months Ended  December 31,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                     | ** ** | **2005**                                            | ** ** | **2004**                                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                     | ** ** | **(in thousands)**                             | ** ** |
| Earnings from  continuing operations                                                           |       | $                                                   | 19,744     |                                               | $          | 16,837 |   | $ | 52,716 |   | $ | 41,811 |   |
| Income taxes                                                                                   |       | 14,297                                              |       | 12,500                                             |       | 33,010 |   | 31,053 |   |
| Interest income                                                                                |       | (2,283                                              | )          | (389                                               | )          | (6,228 | ) | (687 | ) |
| Interest and  related expenses                                                                 |       | 12,458                                              |       | 9,447                                              |       | 36,959 |   | 27,447 |   |
| Depreciation and  amortization                                                                 |       | 10,778                                              |       | 9,701                                              |       | 31,719 |   | 30,348 |   |
| EBITDA(A)                                                                                      |       | 54,994                                              |       | 48,096                                             |       | 148,176 |   | 129,972 |   |
| Income taxes                                                                                   |       | (14,297                                             | )          | (12,500                                            | )          | (33,010 | ) | (31,053 | ) |
| Interest income                                                                                |       | 2,283                                               |       | 389                                                |       | 6,228 |   | 687 |   |
| Interest and  related expenses                                                                 |       | (12,458                                             | )          | (9,447                                             | )          | (36,959 | ) | (27,447 | ) |
| Deferred income  taxes                                                                         |       | (2                                                  | )          | 4                                                  |       | (500 | ) | (378 | ) |
| Changes in assets  and liabilities, net of effects from business combinations and divestitures |       | (7,409                                              | )          | 2,750                                              |       | (29,549 | ) | 1,980 |   |
| Other, net                                                                                     |       | 1,354                                               |       | 3,481                                              |       | 5,068 |   | 7,587 |   |
| Net cash provided by operating activities of  continuing operations                            |       | 24,465                                              |       | 32,773                                             |       | 59,454 |   | 81,348 |   |
| Capital  expenditures                                                                          |       | (10,057                                             | )          | (7,162                                             | )          | (26,311 | ) | (20,742 | ) |
| Free cash flow(B)                                                                              |       | $                                                   | 14,408     |                                               | $          | 25,611 |   | $ | 33,143 |   | $ | 60,606 |   |

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(A)       Wedefine EBITDA as net earnings from continuing operations before net interestand related expenses (principally amortization and write-off of debt premiumand issuance costs), income taxes, depreciation and amortization. The tableabove presents the components of EBITDA and a reconciliation of EBITDA to netcash provided by operating activities of continuing operations. EBITDA ispresented as additional information because we believe it to be a usefulindicator of our debt capacity and our ability to service our debt. EBITDA isnot a substitute for operating income, net earnings or cash flows fromoperating activities of continuing operations, as determined in accordance withGAAP. EBITDA is not a complete net cash flow measure because EBITDA is ameasure of liquidity that does not reflect cash flows from discontinuedoperations, and does not include reductions for cash payments for an entity’sobligation to service its debt, fund its working capital, businessacquisitions, and capital expenditures and pay its income taxes. Rather, EBITDAis one 

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potential indicatorof an entity’s ability to fund these cash requirements. EBITDA also is not acomplete measure of an entity’s profitability because it does not include costsand expenses for depreciation and amortization, interest and related expenses andincome taxes, and it also does not include the results of operations ofdiscontinued operations. EBITDA, as we define it, may differ from similarlynamed measures used by other entities and, consequently, could be misleadingunless all entities calculate and 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 continuing operations.Free cash flow represents cash generated after paying for interest onborrowings, income taxes, capital expenditures and changes in working capital,but before repaying outstanding debt, investing cash to acquire businesses andmaking other strategic investments, and it does not reflect cash flows ofdiscontinued operations. Thus, key assumptions underlying free cash flow arethat the Company will be able to refinance its existing debt when it matureswith new debt and that the Company will be able to finance any new acquisitionsit makes by raising new debt or equity capital. We also use free cash flow as aperformance measure as a component of our management incentive compensationprogram. Free cash flow, as we define it, may differ from similarly namedmeasures used by other entities and, consequently, could be misleading unlessall entities calculate and define free cash flow in the same manner.

**Item3.   Quantitative and 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. The significantchanges in those risks since the filing of the above referenced Annual Report aredescribed below.

**Interest Rate Risk**

Simultaneously with theclosing of our acquisition of ESSI on January 31, 2006, the Companyentered into an amended and restated senior secured credit facility for up toan aggregate amount of $675.0 million, replacing the Company’s then existing CreditFacility. The amended and restated senior secured credit facility consists of(i) a seven-year term loan facility in an aggregate principal amount equalto $275.0 million, with principal repayable in quarterly installments at a rateof 1.00% per year and the balance to be repaid in equal quarterly installmentsbeginning six years following the completion of the acquisition, and(ii) a six-year revolving credit facility in an aggregate principal amountof $400.0 million, to be repaid in full on the sixth anniversary of the closingdate of the facility. Borrowings under the amended and restated senior securedcredit facility will bear interest, at our option, at either the base rate (thehigher of the prime rate announced by the commercial bank to be selected by theadministrative agent to the facility or the federal funds effective rate plus0.50%), plus an applicable margin, or at the rate at which Eurodollar depositsfor one, two, three or six months are offered in the interbank Eurodollarmarket, which is referred to as the Eurodollar Rate, plus an applicable margin.

Simultaneously with the closing of our acquisition ofESSI, we also entered into $900 million of new debt securities, including $350million aggregate principal amount of 65¤8% senior notesdue 2016, $250 million aggregate principal amount of 75¤8% seniorsubordinated notes due 2018 and $300 million aggregate principal amount of 2.0%convertible senior notes due 2026. The interest rates on our senior notes andour senior subordinated notes are fixed.

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The Convertible Notes issued in connection with theacquisition of ESSI contain certain provisions that are considered embeddedderivatives, as defined by Financial Accounting Standards Board StatementNo. 133, ‘‘Accounting for Derivative Instruments and Hedging Activities,’’as amended. Such embedded derivatives may be required to be bifurcated from thehost instrument and recorded at fair value on the balance sheet with subsequentchanges in fair value recognized in our statement of operations. The values ofthe embedded derivatives are not expected to be material, based on the terms ofthe Convertible Notes.

**Foreign CurrencyExchange Risk**

We operate and conduct business in foreign countriesand, as a result, are exposed to movements in foreign currency exchange rates.More specifically, our net equity is impacted by the conversion of the netassets of foreign subsidiaries for which the functional currency is not theU.S. dollar for U.S. reporting purposes. Our exposure to foreign currencyexchange risk related to our foreign operations is not material to our resultsof operations, cash flows or financial position. Beginning inJanuary 2006, in order to mitigate the risk associated with certain ofthese contracts denominated in foreign currency we have entered into foreigncurrency forward contracts. We account for these contracts as cash flow hedges.

At December 31, 2005,the Company had no open derivative contracts to manage market, interest orforeign currency risks.

**Item 4. Controls and 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) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of theend of the period covered by this report. Based on such evaluation, theCompany’s Chief Executive Officer and Chief Financial Officer have concludedthat, as of the end of such period, the Company’s disclosure controls andprocedures are effective in recording, processing, summarizing and reporting,on a timely basis, information required to be disclosed by the Company in thereports that it files or submits under the Exchange Act.

(b)         InternalControl Over Financial Reporting. There have not been any changes in theCompany’s internal control over financial reporting (as such term is defined inRules 13a-15(f) and 15d-15(f) under the ExchangeAct) during the three months ended December 31, 2005 that have materiallyaffected, or are reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

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**PART II. OTHER INFORMATION**

**Item 1. Legal Proceedings**

We are party to various legal actions and claimsarising in the ordinary course of our 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 ispossible that some of these matters could be ultimately decided, resolved orsettled adversely. We have recorded accruals totaling $4.5 million and $10.2million at December 31, 2005 and March 31, 2005, respectively, forlosses related to those matters that we consider to be probable and that can bereasonably estimated (certain legal and environmental matters are discussed indetail below). Although the ultimate amount of liability at December 31,2005 that may result from those matters for which we have recorded accruals isnot ascertainable, we believe that any amounts exceeding our recorded accrualsshould not materially affect our financial condition or liquidity. It ispossible, however, that the ultimate resolution of those matters could resultin a material adverse effect on our results of operations for a particularreporting period.

On October 3, 2001, a lawsuit was filed byMiltope Corporation and IV Phoenix Group, Inc., against DRSTechnologies, Inc., DRS Electronic Systems, Inc. and a number ofindividual defendants, several of whom had been employed by DRS ElectronicSystems, Inc. The plaintiffs’ claims against DRS related generally to theactivities of certain former employees of IV Phoenix Group and the hiring ofsome of those employees by us. On May 4, 2005, DRS entered into asettlement agreement, pursuant to which we agreed to pay $7.5 million to theplaintiffs, and litigation involving the parties was resolved to theirsatisfaction, with the elimination of all outstanding claims. A charge of $6.5million was recorded in the fourth quarter of fiscal 2005 to increase ouraccrual for the matter to $7.5 million as of March 31, 2005. Thesettlement payment was made on May 5, 2005.

Some environmental laws, such as the ComprehensiveEnvironmental Response, Compensation and Liability Act of 1980 (also known asCERCLA or the Superfund law) and similar state statutes, can impose liabilityfor the entire cost of the clean up of contaminated sites upon any of thecurrent or former site owners or operators (or upon parties who send waste tothese sites), regardless of the lawfulness of the original activities that ledto the contamination. In July 2000, prior to its acquisition by IntegratedDefense Technologies, Inc. (IDT), and prior to DRS’s acquisition of IDT,Tech-Sym Corporation received a Section 104(e) Request forInformation from the National Park Service (NPS), pursuant to CERCLA, regardinga site known as the Orphan Mine site in the Grand Canyon National Park,Arizona, which is the subject of an NPS investigation regarding the presence ofresidual radioactive materials and contamination. A corporation of whichTech-Sym is an alleged successor operated this uranium mine from 1956 to 1967.In 1962, the land was sold to the U.S. government and the alleged predecessorof Tech-Sym was given a 25-year mining lease.  In 1967, the mining rights were transferredto a third 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 otherpotentially responsible parties (PRPs) for the environmental conditions at thesite, 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. The initial remediation estimate forthe CERCLA related cleanup of the Operable Unit 1 (the upper mine area) sitewas $0.8 million and a second, independent evaluation estimated remediationcosts at $1.0 million. On February 6, 2005, the NPS sent us an EngineeringEvaluation/Cost Analysis Work Plan under CERCLA (the ‘‘CERCLA Letter’’) withregards to Operable Unit 1 of the Orphan Mine site. In our view, this Work Planincluded additional 

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cleanup not covered byCERCLA. The CERCLA Letter also requested (a) payment of $0.5 million forcosts incurred by the NPS related to the Orphan Mine, and (b) a ‘‘goodfaith offer’’ to conduct the response activity outlined by the NPS and toreimburse the NPS for future costs. The NPS advised that a similar letter hasbeen sent to another PRP. We initiated discussions with the other PRP and withNPS, and engaged a technical consultant to evaluate the existing documentationand the site in depth.   As a result, onSeptember 29, 2005, the technical consultant submitted to the NPS, onbehalf of us and the other PRP, an alternative (the lower mine area) EngineeringEvaluation/Cost Analysis Work Plan (the “EE/CA”) with regards to OperatingUnits 1 and 2 of the Orphan Mine Site.

On December 6, 2005 the PRPs and NPS met todiscuss the alternative EE/CA. The meeting focused on the technical merits ofthe alternative EE/CA and certain differences between the alternative EE/CA andthe NPS EE/CA provided with the CERCLA Letter. The differences included analternative sampling technique and the inclusion of Operable Unit 2 in theEE/CA. In addition, certain legal issues relating to the process forimplementing an agreed upon EE/CA were discussed. It is anticipated that furthermeetings will be held between the PRPs and NPS early in 2006. The potentialliability can change substantially due to such factors as additionalinformation on the nature or extent of contamination, methods of remediationrequired, changes in the apportionment of costs among the responsible partiesand other actions by governmental agencies or private parties.

On November 24, 2004, a lawsuit was filed in theUnited States District Court for the District of Colorado by ITTIndustries, Inc., a corporation of the State of Indiana, against DRSTactical Systems, Inc. The plaintiff alleged DRS breached a subcontractbetween DRS and ITT and sought damages in excess of $5.0 million. The claimgenerally related to the performance by DRS and our predecessors, DRS TacticalSystems (West), Inc. and Catalina Research Inc., under a subcontract for acomponent being supplied to ITT under ITT’s prime contract with the U.S. Army.On February 14, 2005, DRS Tactical Systems, Inc. filed its answer,affirmative defenses and counterclaims. The counterclaims alleged breach ofcontract and breach of duties of good faith and fair dealing and sought damagesof no less than $1.8 million. We and ITT agreed to conduct nonbindingmediation, as a result of which the case was settled on August 31, 2005with the execution of mutual releases and no damages due to either party.

In connection with the January 31, 2006 acquisition ofEngineered Support Services, Inc. (“ESSI”), we were made aware of certain legalactions, claims, assessments and other contingencies, certain of which aredescribed below and could be deemed material.

In December 2004, ESSI was notified by the EnforcementDivision of the SEC of the issuance of a formal order directing a privateinvestigation captioned *In the Matter ofEngineered Support Systems, Inc.* and was notified that the SEC hadissued subpoenas to various individuals associated with ESSI to produce certaindocuments.  The SEC staff also requestedthat ESSI produce certain documents in connection with the investigation.  The subpoenas related to trading in ESSIstock around ESSI’s earnings releases in 2003 and to the adequacy of certaindisclosures made by ESSI regarding related-party transactions in 2002 and 2003involving insurance policies placed by ESSI through an insurance brokerage firmin which an ESSI director was a principal at the time of the transactions.

On or about September 23, 2005, the SEC staff advisedESSI’s counsel that it had issued a subpoena directed to ESSI and expanded itsinvestigation to include ESSI’s disclosure of a November 2004 stop-work orderrelating to ESSI’s Deployable Power Generation and Distribution Systems(“DPGDS”) program for the U.S. Air Force, and relating to trading in ESSI stockby certain individuals associated with ESSI.

In connection with the foregoing SEC investigation,ESSI and certain of its directors and officers have provided information and/ortestimony to the SEC.  On November 14,2005, ESSI was informed by the Enforcement Division that one of ESSI’s formerdirectors and officers, and subsequently a consultant to ESSI has been issued aso-called Wells notice informing him that the staff of the SEC was consideringrecommending that the SEC bring a civil injunctive action against him inconnection with the SEC’s 

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investigation into tradingin ESSI common stock in 2003.  A Wellsnotice provides prospective defendants with an opportunity to respond to theSEC staff members before the staff makes a formal recommendation on whether theSEC should pursue disciplinary action against them.  ESSI, itself, has not received a Wells noticeand continues to cooperate with the investigation.  

In January 2006, ESSI was informedthat the U.S. Attorney (St. Louis, MO office) was initiating an investigationinto ESSI’s disclosure of the DPGDS stop-work order and into trading in ESSIstock by ESSI insiders which preceded such disclosure.  The U.S. Attorney has requested additionalinformation in connection with this investigation, which ESSI continues tofurnish.  We are unable to determine atthis time either the timing of the SEC or U.S. Attorney investigations or theimpact, if any, which the investigations could have on the Company.

**Item 6. Exhibits**

(a)           Exhibits

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

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*                    Filed herewith

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

|                              | DRS TECHNOLOGIES, INC.    |
|------------------------------|---------------------------|
|                         | Registrant                |
| Date: February 9,  2006 | /s/ RICHARD A. SCHNEIDER  |
|                         | Richard A. Schneider      |
| * *                     | *Chief Financial Officer* |

 

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