**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-Q**

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

**Forthe quarterly period ended December 31, 2006**

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

**Forthe transition period from                             to**

**Commissionfile number 1-8533**

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**DRS Technologies, Inc.**

**(Exact name of registrant asspecified in its charter)**

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

 

| **5 Sylvan Way, Parsippany, New Jersey 07054**             |
|------------------------------------------------------------|
| (Address of  principal executive offices)                  |
| **(973) 898-1500**                                    |
| (Registrant’s  telephone number, including area code) |

 

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

Indicate by check mark whether the Registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act. (Check one):

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

 

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

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date.

| **Class**                       |   | **Outstanding  at February 5, 2007** |
|---------------------------------|--------|-------------------------------------------|
| Common Stock -  $0.01 par value |   | 40,524,491                                |

 

 

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**DRS TECHNOLOGIES,INC. AND SUBSIDIARIES**

**Indexto Quarterly Report on Form 10-QFor the Quarter Ended December 31, 2006**

|            | ** ** | ** **                                                                                            | ** ** | Page   | ** ** |   |
|------------|------------|-------------------------------------------------------------------------------------------------------|------------|--------|------------|--------|
|       | ** ** | **PART I—FINANCIAL  INFORMATION**                                                           |       |   |       |   |   |
| Item  1.   |       | Financial  Statements (unaudited)                                                                     |       |   |       |   |   |
|       |       | Consolidated  Balance Sheets—December 31, 2006 and March 31, 2006                      |       |   | 1          |   |   |
|       |       | Consolidated Statements of Earnings—Three and Nine  Months Ended December 31, 2006 and 2005 |       |   | 2          |   |   |
|       |       | Consolidated Statements of Cash Flows—Nine Months  Ended December 31, 2006 and 2005         |       |   | 3          |   |   |
|       |       | Notes  to the Consolidated Financial Statements                                                       |       |   | 4          |   |   |
| Item 2.    |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations           |       |   | 35         |   |   |
| Item 3.    |       | Quantitative and Qualitative Disclosure about Market  Risk                                            |       |   | 49         |   |   |
| Item  4.   |       | Controls  and Procedures                                                                              |       |   | 49         |   |   |
|       | ** ** | **PART II—OTHER  INFORMATION**                                                              |       |   |       |   |   |
| Item 1.    |       | Legal Proceedings                                                                                     |       |   | 49         |   |   |
| Item 1A.   |       | Risk  Factors                                                                                         |       |   | 52         |   |   |
| Item 6.    |       | Exhibits                                                                                              |       |   | 52         |   |   |
| Signatures |       |                                                                                                  | 53         |   |       |
|            |            |                                                                                                       |            |        |            |        |  |  |  |

 

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**PART I- FINANCIAL INFORMATION**

**Item1. Financial Statements**

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

**(Unaudited)**

| ** **                                                                                                                                                                       | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|--------------------|------------|
| ** **                                                                                                                                                                       | ** ** | **2006**              | ** ** | **2006**           | ** ** |
| **Assets**                                                                                                                                                                       | ** ** |
| Current assets                                                                                                                                                                   | ** ** |                  | ** ** | ** **         |       |   |   |
| Cash and cash equivalents                                                                                                                                                        |       |                  | $          | 49,551             | ** ** |   | $ | 1,293 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $1,780                                                                                                           |       |                  |       | ** **         |       |   |   |
| and $1,668 as of December 31, 2006 and  March 31, 2006, respectively                                                                                                   |       |                  | 503,097    | ** **         |       | 432,678 |   |
| Inventories, net                                                                                                                                                                 |       |                  | 363,980    | ** **         |       | 331,206 |   |
| Prepaid expenses, deferred income taxes and other  current assets                                                                                                                |       |                  | 126,615    | ** **         |       | 135,613 |   |
| Total current assets                                                                                                                                                             |       |                  | 1,043,243  | ** **         |       | 900,790 |   |
| Property, plant  and equipment, less accumulated depreciation of $170,377 and $138,324 at  December 31, 2006 and March 31, 2006, respectively                          |       |                  | 225,091    | ** **         |       | 220,506 |   |
| Acquired  intangible assets, net                                                                                                                                                 |       |                  | 205,099    | ** **         |       | 231,139 |   |
| Goodwill                                                                                                                                                                         |       |                  | 2,633,965  | ** **         |       | 2,608,068 |   |
| Deferred income  taxes and other noncurrent assets                                                                                                                               |       |                  | 57,243     | ** **         |       | 58,616 |   |
| **Total assets**                                                                                                                                                                 |       |                  | $          | 4,164,641          | ** ** |   | $ | 4,019,119 |   |
| **Liabilities and Stockholders’ Equity**                                                                                                                                    |       |
| Current liabilities                                                                                                                                                              | ** ** |                  | ** ** | ** **         |       |   |   |
| Current installments of long-term debt                                                                                                                                           |       |                  | $          | 5,150              | ** ** |   | $ | 4,622 |   |
| Accounts payable                                                                                                                                                                 |       |                  | 230,315    | ** **         |       | 224,673 |   |
| Accrued expenses and other current liabilities                                                                                                                                   |       |                  | 478,978    | ** **         |       | 471,068 |   |
| Total current liabilities                                                                                                                                                        |       |                  | 714,443    | ** **         |       | 700,363 |   |
| Long-term debt, excluding current installments                                                                                                                                   |       |                  | 1,854,509  | ** **         |       | 1,828,771 |   |
| Other liabilities                                                                                                                                                                |       |                  | 144,704    | ** **         |       | 138,405 |   |
| **Total liabilities**                                                                                                                                                            |       |                  | 2,713,656  | ** **         |       | 2,667,539 |   |
| Commitments and contingencies                                                                                                                                                    |       |                  |       | ** **         |       |   |   |
| Stockholders’ equity                                                                                                                                                        |       |                  |       | ** **         |       |   |   |
| Preferred stock, $10 par value per share. Authorized  2,000,000 shares; none issued at December 31, 2006 and March 31,  2006                                           |       |                  | —     | ** **         |       | — |   |
| Common Stock, $.01 par value per share. Authorized  100,000,000 shares; issued 40,471,698 and 39,912,541 shares at  December 31, 2006 and March 31, 2006, respectively |       |                  | 405        | ** **         |       | 399 |   |
| Additional paid-in capital                                                                                                                                                       |       |                  | 1,090,420  | ** **         |       | 1,076,786 |   |
| Retained earnings                                                                                                                                                                |       |                  | 355,669    | ** **         |       | 277,706 |   |
| Accumulated other comprehensive earnings                                                                                                                                         |       |                  | 4,491      | ** **         |       | 3,885 |   |
| Unamortized stock compensation                                                                                                                                                   |       |                  | —     | ** **         |       | (7,196 | ) |
| **Total stockholders’ equity**                                                                                                                                              |       |                  | 1,450,985  | ** **         |       | 1,351,580 |   |
| **Total  liabilities and stockholders’ equity**                                                                                                                             |       |                  | $          | 4,164,641          | ** ** |   | $ | 4,019,119 |   |

 

See Accompanying Notes to Consolidated Financial Statements.

1

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**DRSTECHNOLOGIES, INC. AND SUBSIDIARIES Consolidated Statements of Earnings(in thousands, except per-share data)**

**(Unaudited)**

| ** **                                                  | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                  | ** ** | **December 31,**            | ** ** | **December 31,**           | ** ** |
| ** **                                                  | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenue:                                                    |       |                             |       |                            |       |   |   |   |   |
| Products sales                                              |       | $                                | 511,692    |                            | $          | 361,213 |   | $ | 1,500,180 |   | $ | 998,036 |   |
| Services                                                    |       | 168,669                          |       | 28,277                          |       | 521,984 |   | 91,843 |   |
| Total revenues                                              |       | 680,361                          |       | 389,490                         |       | 2,022,164 |   | 1,089,879 |   |
| Costs and  expenses                                         |       | 603,734                          |       | 344,663                         |       | 1,808,664 |   | 971,417 |   |
| Operating income                                            |       | 76,627                           |       | 44,827                          |       | 213,500 |   | 118,462 |   |
| Interest income                                             |       | 370                              |       | 2,283                           |       | 868 |   | 6,228 |   |
| Interest and  related expenses                              |       | 30,268                           |       | 12,458                          |       | 90,789 |   | 36,959 |   |
| Other (income)  expense, net                                |       | (71                              | )          | 134                             |       | 1 |   | 446 |   |
| Earnings before non-controlling interests and income  taxes |       | 46,800                           |       | 34,518                          |       | 123,578 |   | 87,285 |   |
| Non-controlling  interests                                  |       | 131                              |       | 477                             |       | 1,089 |   | 1,559 |   |
| Earnings before income taxes                                |       | 46,669                           |       | 34,041                          |       | 122,489 |   | 85,726 |   |
| Income taxes                                                |       | 11,575                           |       | 14,297                          |       | 40,906 |   | 33,010 |   |
| Net earnings                                                |       | $                                | 35,094     |                            | $          | 19,744 |   | $ | 81,583 |   | $ | 52,716 |   |
| **Net  earnings per share of common stock:**                |       |                             |       |                            |       |   |   |   |   |
| Basic earnings per share:                                   |       | $                                | 0.88       |                            | $          | 0.71 |   | $ | 2.05 |   | $ | 1.91 |   |
| Diluted earnings per share:                                 |       | $                                | 0.86       |                            | $          | 0.69 |   | $ | 2.01 |   | $ | 1.84 |   |
| **Dividends  per common share**                             |       | $                                | 0.03       |                            | $          | 0.03 |   | $ | 0.09 |   | $ | 0.09 |   |

 

See Accompanying Notes to Consolidated Financial Statements.

2

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**DRSTECHNOLOGIES, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows(in thousands)**

**(Unaudited)**

| ** **                                                                      | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                      | ** ** | **December 31,**           | ** ** |
| ** **                                                                      | ** ** | **2006**                        | ** ** | **2005** | ** ** |
| **Cash Flows from Operating  Activities**                                       | ** ** | ** **                      |       |   |   |
| Net Earnings                                                                    |       | $                               | 81,583     |   | $ | 52,716 |   |
| Adjustments to reconcile  net earnings to cash flows from operating activities: |       |                            |       |   |   |
| Depreciation and amortization                                                   |       | 57,122                          |       | 31,719 |   |
| Share-based compensation                                                        |       | 8,224                           |       | 1,895 |   |
| Deferred income taxes                                                           |       | 2,959                           |       | (500 | ) |
| Inventory reserve and provision for doubtful accounts                           |       | 963                             |       | 766 |   |
| Amortization and write-off of deferred financing fees                           |       | 4,419                           |       | 2,846 |   |
| Other, net                                                                      |       | (150                            | )          | (439 | ) |
| Changes in assets  and liabilities, net of effects from business combinations:  |       |                            |       |   |   |
| (Increase) decrease in accounts receivable                                      |       | (69,498                         | )          | 22,844 |   |
| Increase in inventories                                                         |       | (44,252                         | )          | (37,053 | ) |
| Decrease (increase) in prepaid expenses and other  current assets               |       | 13,863                          |       | (3,453 | ) |
| Increase in accounts payable                                                    |       | 3,254                           |       | 27,365 |   |
| Decrease in accrued expenses and other current  liabilities                     |       | (6,806                          | )          | (30,876 | ) |
| Increase (decrease) in customer advances                                        |       | 7,619                           |       | (7,981 | ) |
| Decrease in pension and postretirement benefit  liabilities                     |       | 973                             |       | 347 |   |
| Other, net                                                                      |       | 1,381                           |       | (742 | ) |
| **Net cash provided by operating activities**                                   |       | 61,654                          |       | 59,454 |   |
| **Cash  Flows from Investing Activities**                                       |       |                            |       |   |   |
| Capital expenditures                                                            |       | (38,113                         | )          | (26,311 | ) |
| Payments pursuant to business combinations, net of  cash acquired               |       | (9,761                          | )          | (54,489 | ) |
| Dispositions of property, plant and equipment                                   |       | 348                             |       | 946 |   |
| Other, net                                                                      |       | 60                              |       | 22 |   |
| **Net cash used in investing activities**                                       |       | (47,466                         | )          | (79,832 | ) |
| **Cash  Flows from Financing Activities**                                       |       |                            |       |   |   |
| Return of advanced interest on senior subordinated  notes                       |       | —                          |       | (1,986 | ) |
| Debt issuance costs                                                             |       | —                          |       | (681 | ) |
| Borrowings of long-term debt                                                    |       | 30,459                          |       | — |   |
| Repayment of long-term debt                                                     |       | (3,423                          | )          | (32,037 | ) |
| Excess tax benefit realized from share-based payment  arrangements              |       | 2,258                           |       | — |   |
| Proceeds from stock option exercises                                            |       | 8,517                           |       | 9,750 |   |
| Dividends paid                                                                  |       | (3,619                          | )          | (2,508 | ) |
| Other                                                                           |       | 245                             |       | — |   |
| **Net cash provided by (used in) financing  activities**                        |       | 34,437                          |       | (27,462 | ) |
| **Effect  of exchange rates on cash and cash equivalents**                      |       | (367                            | )          | 654 |   |
| **Net  increase (decrease) in cash and cash equivalents**                       |       | 48,258                          |       | (47,186 | ) |
| **Cash and  cash equivalents, beginning of period**                             |       | 1,293                           |       | 306,852 |   |
| **Cash and  cash equivalents, end of period**                                   |       | $                               | 49,551     |   | $ | 259,666 |   |

 

See Accompanying Notes to the Consolidated Financial Statements.

3

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

**1.**   Descriptionof Business

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

On October 2, 2006,the Company implemented a new organizational operating structure that realignedits three operating groups the Command, Control, Communications, Computer andIntelligence Group, the Surveillance & Recconnaisance (SR) Group andthe Sustainment Systems & Services (S3) Group, into four operatingsegments. The four operating segments are the Command, Control, Communications,Computers and Intelligence (C4I) Segment, the Reconnaissance, Surveillance andTarget Acquisition (RSTA) Segment, the Sustainment Systems (SS) Segment and theTechnical Services (TS) Segment. All other operations, primarily our CorporateHeadquarters, are grouped in Other. See Note 12 for a description of eachsegment. All prior-year amounts presented by segment have been reclassified toreflect the new operating segment structure.

**2.**   Basisof Presentation

The accompanying unaudited consolidated financialstatements include all wholly-owned and majority-owned subsidiaries and acontrolling interests of DRS. The financial statements 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, 2006, theresults of its operations for the three- and nine-month periods ended December 31,2006 and 2005, and its cash flows for the nine-month periods ended December 31,2006 and 2005. The results of operations and cash flows for the interim periodsended December 31, 2006 are not necessarily indicative of the results tobe expected for the full year. Certain fiscal 2006 amounts have beenreclassified to conform to the fiscal 2007 presentation. These interimConsolidated Financial Statements should be read in conjunction with theConsolidated Financial Statements of the Company for the fiscal year ended March 31,2006, included in the Company’s filing on Form 10-K for the yearended March 31, 2006.

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

4

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

**3.**   ESSIAcquisition

On January 31, 2006, DRS completed itsacquisition of Engineered Support Systems, Inc. (ESSI) for $1.93 billionin cash and DRS common stock. ESSI, formerly headquartered in St. Louis,Missouri, is a supplier of integrated military electronics, support equipmentand technical services focused on advanced sustainment and logistics supportsolutions for all branches of the U.S. armed services, major prime defensecontractors, certain international militaries, homeland security forces and selectedgovernment and intelligence agencies. ESSI also produces specialized equipmentand systems for commercial and industrial applications. The results of ESSIhave been included in our financial statements since the date of acquisition.

Inaccordance with EITF 95-3, “Recognition of Liabilities in Connection witha Purchase Business Combination”, the Company recorded a $5.7 million liabilityin the preliminary purchase price allocation in connection with a plan toinvoluntarily terminate approximately 190 employees of ESSI, as well as exitcertain leased facilities. The Company expects payments to be substantiallycomplete by the fourth quarter of fiscal 2007.

| ** **                                   | ** ** | **Balance at  March 31,** | ** ** | **Nine Months Ended  December 31, 2006** | ** ** | **Balance at  December 31,** | ** ** |
|----------------------------------------------|------------|-------------------------------------|------------|--------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                   | ** ** | **2006**                            | ** ** | **Additions**                                                | ** ** | **Payments**                           | ** ** | **2006** | ** ** |
| ** **                                   | ** ** | ** **                          | ** ** | **(in thousands)**                                      | ** ** | ** **                             | ** ** |
| Employee  severance and termination benefits |       |                                | $          | 5,129                                                        |       |                                   |       | $ | — |   |   |   | $ | (4,363 | ) |   |   | $ | 766 |   |   |
| Facility and  other exit costs               |       |                                | —     |                                                         |       |                                   | 554        |   |   |   | (521 | ) |   |   | 33 |   |   |
| Total                                        |       |                                | $          | 5,129                                                        |       |                                   |       | $ | 554 |   |   |   | $ | (4,884 | ) |   |   | $ | 799 |   |   |

 

The Company finalized itsvaluation of certain tangible and acquired intangible assets and is in theprocess of finalizing certain other discrete purchase price allocation matters;thus the the preliminary allocation of purchase price will change, however,such change will not be material to the consolidated balance sheet. Ourpreliminary purchase price allocation as of December 31, 2006 has notchanged materially from the allocation included in Note 2 to the Company’sconsolidated financial statements for the fiscal year ended March 31, 2006(see Note 6). The Company will complete the purchase price allocation in conjunctionwith its January 2007 accounting close.

**4.**   Share-BasedCompensation

**Adoptionof SFAS 123R**   InDecember 2004, the Financial Accounting Standards Board (FASB) issued SFASNo. 123 (revised 2004), “Share-Based Payment” (SFAS 123R). SFAS 123Rreplaces SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS No. 123),and supercedes Accounting Principles Board Opinion No. 25, “Accounting forStock Issued to Employees” (APB No. 25). SFAS 123R addresses theaccounting for transactions in which an enterprise receives employee servicesin exchange for (a) equity instruments of the enterprise or (b) liabilitiesthat are based on the fair value of the enterprise’s 

equity instruments or thatmay be settled by the issuance of such equity instruments. SFAS 123R requirescompanies to recognize compensation cost in an amount equal to the fair valueof share-based awards expected to vest.

On April 1, 2006, DRS adopted SFAS 123R, asinterpreted by SEC Staff Accounting Bulletin No. 107, using the modifiedprospective method. Under this method, the Company is required to record 

5

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

compensation cost for theunvested portion of previously granted awards that were outstanding as of April 1,2006. Results for prior periods have not been restated. The Company previouslyaccounted for share-based compensation under the recognition and measurementprinciple of APB No. 25 and related interpretations. Prior to adoptingSFAS 123R, no share-based compensation cost was reflected in net income forstock options, as stock options granted had an exercise price equal to themarket value of the underlying common stock on the date of the grant. Also,prior to the SFAS 123R adoption, compensation cost for restricted stock andrestricted stock units (collectively “non-vested stock”) was recorded based onthe closing market value on the last trading day prior to the date of grant andforfeitures were accounted for as they occurred. Compensation cost fornon-vested stock was charged to unamortized stock compensation in Stockholders’equity and amortized to expense over the requisite vesting periods. With theadoption of SFAS 123R on April 1, 2006, unamortized stock compensationrelating to previous grants of non-vested stock of $7.2 million was nettedagainst additional paid-in capital and forfeitures of non-vested stock areestimated at the date of grant and adjusted as circumstances warrant.Additionally, prior to the adoption of SFAS 123R, the Company presented all taxbenefits of deductions resulting from the exercise of stock options asoperating cash flows in the Consolidated Statement of Cash Flows. SFAS 123Rrequires excess tax benefits (i.e., the tax benefit recognized upon exercise ofstock options in excess of the benefit recognized as compensation cost forthose options) to be classified as financing cash flows in the ConsolidatedStatement of Cash Flows. Pursuant to SFAS 123R, tax benefits resulting from theexercise of stock options, which have been presented as operating cash flowsprior to the adoption of SFAS 123R are not reclassified to financingactivities, but rather continue to be presented as operating cash flows.

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

In thethree- and nine-month periods ended December 31, 2006, we recorded totalshare-based costs related to stock options and non-vested stock of $2.8 millionand $8.9 million, respectively. Such amounts were recognized in theconsolidated financial statements as follows:

| ** **                                                                        | ** ** | **Three Months Ended  December 31,** | ** ** | **Nine Months Ended  December 31,**       | ** ** |
|-----------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                        | ** ** | **    2006 **              | ** ** | **    2005    ** | ** ** | **   2006   ** | ** ** | **   2005   ** | ** ** |
| ** **                                                                        | ** ** | **(in thousands)**                             | ** ** |
| Total cost of  share-based payment plans                                          |       | $                                                   | 2,833      |                                                     |       | $ | 791 |   |   |   | $ | 8,883 |   |   |   | $ | 1,895 |   |   |
| Amounts  capitalized in inventory                                                 |       | $                                                   | 1,619      |                                                     |       | $ | 791 |   |   |   | $ | 3,891 |   |   |   | $1,895 |   |   |
| Amounts charged  against earnings for amounts previously capitalized in inventory |       | $                                                   | 1,442      |                                                     |       | $ | 859 |   |   |   | $ | 3,232 |   |   |   | $ | 1,269 |   |   |
| Amounts charged against earnings  before income tax benefit                       |       | $                                                   | 2,656      |                                                     |       | $ | 859 |   |   |   | $ | 8,224 |   |   |   | $ | 1,269 |   |   |

 

As a result of applying SFAS 123R to the Company’sstock options, DRS’s earnings before income taxes and net earnings for thethree months ended December 31, 2006 were $1.2 million and$0.7 million lower, respectively, and for the nine months ended December 31,2006 were $5.0 million and $3.0 million lower, respectively, than ifthe Company had continued to account for share-based compensation under APB No. 25.Basic and diluted earnings per share for the three months ended December 31,2006 would 

6

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

have been $0.90 per shareand $0.88 per share, respectively, and for the nine months ended December 31,2006 would have been $2.13 per share and $2.08 per share, respectively, if theCompany had not adopted SFAS 123R. Reported amounts for the three months ended December 31,2006 were $0.88 per basic share and $0.86 per diluted share, and for the ninemonths ended December 31, 2006 were $2.05 per basic share and $2.01 perdiluted share.

**PriorPeriod Pro Forma Information**   Prior to April 1, 2006, the Company applied theintrinsic-value-based method of accounting prescribed by APB 25, and itsrelated interpretations. Compensation expense for stock options granted to anemployee or director was recognized in earnings based on the excess, if any, ofthe quoted market price of DRS common stock at the date of grant, or othermeasurement date, over the amount an employee or director must pay to acquire thecommon stock. When the exercise price of the option granted to an employee ordirector equaled or exceeded the quoted market price of DRS common stock at thedate of grant, the Company did not recognize compensation expense. Compensationcost for nonvested stock was recorded based on the market value of DRS commonstock on the date of grant.

The table below comparesthe “as reported” net earnings and earnings per share to the “pro forma” netearnings and earnings per share for the three- and nine-month periods ended December 31,2005, that the Company would have reported if it had elected to recognizecompensation expense in accordance with the fair-value-based method ofaccounting of SFAS No. 123. For purposes of determining the pro formaeffects of SFAS No. 123, the estimated fair value of options granted wascalculated using the Black-Scholes option pricing valuation model. Forfeitureswere accounted for as they occurred and no amount of stock option expense wascapitalized into inventory or other assets, but instead were considered periodexpenses.

| ** **                                                                                                           | ** ** | **Three Months  Ended  December 31,**           | ** ** | **Nine Months  Ended  December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                                                           | ** ** | **2005**                                                  | ** ** | **2005**                                       | ** ** |
| ** **                                                                                                           | ** ** | **(in thousands,  except per-share data)** | ** ** |
| Net earnings, as  reported                                                                                           |       |                                                      | $          | 19,744                                         |       |   |   | $ | 52,716 |   |   |
| Add: Stock-based  compensation expense included in reported net earnings, net of taxes                               |       |                                                      | 478        |                                           |       |   | 1,145 |   |   |
| Less: Total  stock-based compensation expense determined under  fair-value-based method for all awards, net of taxes |       |                                                      | (2,601     | )                                              |       |   | (6,860 | ) |   |
| Pro forma net  earnings                                                                                              |       |                                                      | $          | 17,621                                         |       |   |   | $ | 47,001 |   |   |
| Earnings per share:                                                                                                  |       |                                                      |       |                                           |       |   |   |   |   |
| Basic - as reported                                                                                                  |       |                                                      | $          | 0.71                                           |       |   |   | $ | 1.91 |   |   |
| Basic - pro forma                                                                                                    |       |                                                      | $          | 0.63                                           |       |   |   | $ | 1.70 |   |   |
| Diluted - as reported                                                                                                |       |                                                      | $          | 0.69                                           |       |   |   | $ | 1.84 |   |   |
| Diluted - pro  forma                                                                                                 |       |                                                      | $          | 0.61                                           |       |   |   | $ | 1.65 |   |   |

 

**Share-basedCompensation Plans**   OnAugust 7, 1996, the stockholders approved the 1996 Omnibus Plan (1996Plan). Under the terms of the Omnibus Plan, which expired on June 16,2006, options could be granted to key employees, directors and consultants ofthe Company. The 1996 Plan initially was limited to 500,000 shares of DRScommon stock and was ultimately increased, with stockholder approval, to 

7

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

5,875,000 shares of DRScommon stock. Awards under the 1996 Plan were at the discretion of theExecutive Compensation Committee and could be made in the form of incentivestock options, non-qualified stock options, stock appreciation rights,restricted stock and restricted stock units, phantom stock, stock bonuses andother awards. The Company has historically utilized newly issued shares of DRS commonstock to satisfy its equity-based compensation awards.

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

***Stock Options***   Unlessthe Executive Compensation Committee expressly provides otherwise, optionsgranted under the Omnibus Plan have a contractual term of ten years andgenerally are not exercisable prior to one year after the date of grant, with25% of the options granted exercisable on each of the first four anniversariesof the date of grant. On July 6, 2005, the Company granted 209,500 stockoptions that 

fully vested on March 31,2006. In accordance with the July 6, 2005 stock option grant, recipientsare required to hold any shares acquired upon exercise of the options prior to March 31,2008 (net of any shares sold or withheld to pay the exercise price and anyapplicable statutory minimum federal, state and local tax requirements) for aperiod of one year following the date of exercise. The Company’s decision tomodify its traditional vesting terms for the July 6, 2005 stock optiongrant was made pursuant to management’s evaluation of the Company’s overallincentive compensation strategy. As a part of the evaluation, managementconsidered the amount of compensation expense that would otherwise have beenrecognized in the Company’s results of operations in future periods under SFAS123R. The July 6, 2005 stock option grant had a $4.8 million impact on theCompany’s fiscal 2006 pro forma pre-tax compensation expense.

During fiscal 1999, the Compensation Committee of theBoard of Directors issued options to purchase 250,000 shares of DRS commonstock with vesting terms similar to awards issued under the 1996 Plan at exerciseprices in excess of the market price on the date of grant. During the quarter endedDecember 31, 2006, 70,000 of these options were exercised, the remaining optionsexpire in fiscal 2009.

The stock options exercised during fiscal 2000included 50,000 shares, which are being held by the Company in “book entry”form. Book entry shares are not considered issued or outstanding and areexcluded from the tables below. However, these shares are included in theCompany’s diluted earnings per share calculations for the three- and nine-monthperiods ended December 31, 2006 and 2005.

8

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

Thefollowing table summarizes information regarding the Company’s stock optionactivity and amounts as of and for the nine-month period endedDecember 31, 2006.

| ** **                                                | ** ** | **Number of  Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term (years)** | ** ** | **Aggregate  Intrinsic  Value  (in thousands)** | ** ** |
|-----------------------------------------------------------|------------|-----------------------------|------------|----------------------------------------|------------|------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| Outstanding at  March 31, 2006                       |       | 2,913,358                   |       |                                   | $          | 29.08                                                            |       |                                                 |       |   |   |   |   |   |   |   |
| Granted                                                   |       | 232,412                     |       |                                   | $          | 49.49                                                            |       |                                                 |       |   |   |   |   |   |   |   |
| Exercised                                                 |       | (370,274                    | )          |                                   | $          | 23.11                                                            |       |                                                 |       |   |   |   |   |   |   |   |
| Forfeited/cancelled                                       |       | (148,090                    | )          |                                   | $          | 36.80                                                            |       |                                                 |       |   |   |   |   |   |   |   |
| Outstanding at  December 31, 2006                    |       | 2,627,406                   |       |                                   | $          | 31.31                                                            |       |                                                 |       |    6.2    |   |   |   | $ | 56,159 |   |   |
| Vested and expected to vest at December 31,  2006(1) |       | 2,604,346                   |       |                                   | $          | 31.25                                                            |       |                                                 |       |    6.2    |   |   |   | $ | 55,823 |   |   |
| Exercisable at  December 31, 2006                    |       | 1,921,949                   |       |                                   | $          | 28.96                                                            |       |                                                 |       |    5.5    |   |   |   | $ | 45,615 |   |   |

----

(1)Representsoutstanding options reduced by expected forfeitures.

The aggregate intrinsic values, disclosed in the tableabove, represent the difference between DRS’s closing stock price on the lasttrading day of the third quarter (December 29, 2006) and the exerciseprice, multiplied by the number of in-the-money stock options for each category.

The total intrinsic values of stock options exercised,based on the difference between DRS’s stock price at the time of exercise andthe related exercise price, during the nine months ended December 31, 2006and 2005, was $9.5 million and $12.7 million, respectively. Totalcompensation expense related to stock options was $1.2 million and $5.0million, for the three- and nine-month periods ended December 31, 2006,respectively. At December 31, 2006, unrecognized compensation costsrelated to stock options was $9.5 million ($5.7 million after income taxes),which is expected to be recognized over a weighted average remaining period of 2.3years.

The estimated weighted average grant date fair valueof each stock option awarded was $16.41 and $21.44 for the three-and nine-monthperiods ended December 31, 2006, respectively, and $23.51 and $22.22 forthe three-and nine-month periods ended December 31, 2005, respectively.

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

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

9

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

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

·       *Expected Dividend Yield  *Expecteddividend yield is based on DRS’s expected payments relative to the currentmarket price of DRS common stock.

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

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

Changes in assumptions canmaterially impact the estimated fair value of stock options. The weightedaverage assumptions used in the valuation model are presented in the tablebelow.

| ** **                                      | ** ** | **Nine Months  Ended  December 31,** | ** ** |
|-------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                      | ** ** | **2006**                                       | ** ** |
| Expected holding  period (in years)             |       |                                           | 5.6        |   |   |
| Expected  volatility                            |       |                                           | 38.91      | % |   |
| Expected dividend  yield                        |       |                                           | 0.24       | % |   |
| Risk-free  interest rate                        |       |                                           | 4.94       | % |   |
| Weighted-average fair  value of options granted |       |                                           | $          | 21.44 |   |   |
|                                                 |            |                                                |            |  |  |  |

 

**RestrictedStock and Restricted Stock Units**   Restricted stock awards aregranted to certain employees, as permitted under the 2006 Plan in the name ofthe employee, who has all the rights of a stockholder, subject to certainrestrictions. The restricted stock cliff vests three years from the date ofgrant. Restricted stock units are granted in the name of the employee; however,the participant has no rights as a stockholder. These restricted stock unitsare redeemed for DRS common stock once a three year cliff vesting period hasbeen satisfied. The cost of the grants, as determined by the market prices ofthe common stock at the grant dates, net of expected forfeitures, is recognizedover the vesting periods.

Compensation cost for non-vested stock for the threemonths ended December 31, 2006 and 2005 was $1.6 million and$0.8 million, respectively, and $3.9 million and $1.9 million for thenine months ended December 31, 2006 and 2005, respectively. As of December 31,2006, total unrecognized compensation costs related to non-vested stock awardswas $13.4 million and that amount is expected to be recognized over a weightedaverage remaining period of 2.2 years.

10

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

The following tabledetails the activity in non-vested stock awards for the nine months ended December 31,2006.

| ** **                                     | ** ** | **Nine Months Ended  December 31, 2006** | ** ** |
|------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                     | ** ** | **Number of  Shares**                                   | ** ** | **Weighted  Average Grant  Date Fair Value  per Share** | ** ** |
| Nonvested -  Balance at March 31, 2006    |       |                                                         | 281,590    |   |   |   | $ | 40.81 |   |   |
| Granted                                        |       |                                                         | 247,208    |   |   |   | $ | 49.86 |   |   |
| Vested                                         |       |                                                         | (39,760    | ) |   |   | $ | 25.45 |   |   |
| Forfeited / cancelled                          |       |                                                         | (57,610    | ) |   |   | $ | 47.75 |   |   |
| Nonvested - Balance at  December 31, 2006 |       |                                                         | 431,428    |   |   |   | $ | 46.81 |   |   |

 

**5.**   Inventories

Inventoriesare summarized as follows:

| ** **                                             | ** ** | **December 31,**   | ** ** | **March 31,** | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|--------------------|------------|
| ** **                                             | ** ** | **2006**                | ** ** | **2006**           | ** ** |
| ** **                                             | ** ** | **(in thousands)** | ** ** |
| Work-in-process                                        |       |                    | $          | 442,384            |       |   | $ | 368,991 |   |
| General and  administrative costs                      |       |                    | 66,290     |               |       | 63,836 |   |
| Raw material and  finished goods                       |       |                    | 51,089     |               |       | 66,706 |   |
|                                                   |       |                    | 559,763    |               |       | 499,533 |   |
| Less: Progress  payments and certain customer advances |       |                    | 186,100    |               |       | 158,967 |   |
|   Inventory  reserve                              |       |                    | 9,683      |               |       | 9,360 |   |
| Total                                                  |       |                    | $          | 363,980            |       |   | $ | 331,206 |   |

 

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

11

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

The table below presents asummary of G&A, IRAD and B&P costs included in inventoried contractcosts and changes to them, including amounts used in the determination of costsand expenses. The cost data in the table below does not include the G&A,IRAD and B&P costs for the Company’s lines of businesses that are notprimarily contracted with the U.S. government, such costs are expensed asincurred.

| ** **                                   | ** ** | **Three Months Ended  December 31,** | ** ** | **Nine Months Ended  December 31,** | ** ** |
|----------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                   | ** ** | **2006**                                            | ** ** | **2005**                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                   | ** ** | **(in thousands)**                             | ** ** |
| Balance in  inventory at beginning of period |       | $                                                   | 65,223     |                                               | $          | 50,813 |   | $ | 63,836 |   | $ | 47,365 |   |
| Add: Incurred costs                          |       | 91,877                                              |       | 57,697                                             |       | 266,938 |   | 162,970 |   |
| Less: Amounts included in costs and expenses |       | (90,810                                             | )          | (58,236                                            | )          | (264,484 | ) | (160,061 | ) |
| Balance in inventory at  end of period       |       | $                                                   | 66,290     |                                               | $          | 50,274 |   | $ | 66,290 |   | $ | 50,274 |   |

 

Total expenditures forIRAD amounted to approximately $12.6 million and $12.1 million for thethree-month periods ended December 31, 2006 and 2005, respectively, and$37.9 million and $33.5 million, respectively, for the nine-month periods thenended.

**6.**   Goodwilland Intangible Assets

Thefollowing disclosure presents certain information regarding the Company’sacquired intangible assets as of December 31, 2006 and March 31,2006. 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, 2006**          | ** ** |       | ** ** | ** **                                  |       |                            | ** ** | ** **                    |       |                 | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Technology-based intangibles              |       |       | 18  years  | ** **                                  |       |                            | $          | 47,861                        |       |                 |       | $ | (16,243 | ) |   |   | $ | 31,618 | ** ** |   |
| Customer and contract-related intangibles |       |       | 11  years  | ** **                                  |       |                            | 214,428    |                          |       |                 | (40,947    | ) |   |   | 173,481 | ** ** |   |
| Total                                     |       |       |       | ** **                                  |       |                            | $          | 262,289                       |       |                 |       | $ | (57,190 | ) |   |   | $ | 205,099 | ** ** |   |
| **As of  March 31, 2006**            | ** ** |       | ** ** | ** **                                  |       |                            | ** ** | ** **                    |       |                 | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Technology-based intangibles              |       |       | 18  years  | ** **                                  |       |                            | $          | 47,861                        |       |                 |       | $ | (14,100 | ) |   |   | $ | 33,761 | ** ** |   |
| Customer and contract-related intangibles |       |       | 11  years  | ** **                                  |       |                            | 217,190    |                          |       |                 | (19,812    | ) |   |   | 197,378 | ** ** |   |
| Total                                     |       |       |       | ** **                                  |       |                            | $          | 265,051                       |       |                 |       | $ | (33,912 | ) |   |   | $ | 231,139 | ** ** |   |

 

The aggregate acquired intangible asset amortizationexpense for the three-month periods ended December 31, 2006 and 2005 was$7.9 million and $2.2 million, respectively, and for the nine-month periodsended December 31, 2006 and 2005 was $23.3 million and $6.3 million,respectively. The acquired intangible amortization expense, based on grosscarrying amounts at December 31, 2006, is estimated to be $31.4 millionfor fiscal 2007, $29.2 million per year for fiscal 2008, $29.2 million forfiscal 2009, $28.3 million for fiscal 2010 and $27.5 million forfiscal 2011.

12

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

As discussed in Note 1, the Company realigned itsoperating segments in the third quarter of fiscal 2007. The table belowreconciles the change in the carrying amount of goodwill by operating segmentfor the period from March 31, 2006 to December 31, 2006.

| ** **                              | ** ** | **C4I  Segment**        | ** ** | **RSTA  Segment** | ** ** | **SS  Segment** | ** ** | **TS  Segment** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|-------------------------|------------|-------------------|------------|-----------------|------------|-----------------|------------|-----------|------------|
| ** **                              | ** ** | **(in thousands)** | ** ** |
| Balance as of  March 31, 2006      |       | $                       | 658,453    |              | $          | 168,586         |       | $               | 1,045,502  |      | $          | 735,527 |   | $ | 2,608,068 |   |
| ESSI acquisition                        |       | —                  |       | —            |       | 6,758           |       | 12,034          |       | 18,792    |       |
| Codem acquisition earn-out              |       | 838                     |       | —            |       | —          |       | —          |       | 838       |       |
| WalkAbout acquisition earn-out          |       | 253                     |       | —            |       | —          |       | —          |       | 253       |       |
| Night Vision Equipment earn-out         |       | —                  |       | 6,627             |       | —          |       | —          |       | 6,627     |       |
| Transfer of operating unit (A)          |       | (4,929                  | )          | —            |       | —          |       | 4,929           |       | —    |       |
| Other adjustments                       |       | (1,895                  | )          | —            |       | —          |       | —          |       | (1,895    | )          |
| Foreign currency translation adjustment |       | 1,108                   |       | —            |       | 174             |       | —          |       | 1,282     |       |
| Balance as of  December 31, 2006   |       | $                       | 653,828    |              | $          | 175,213         |       | $               | 1,052,434  |      | $          | 752,490 |   | $ | 2,633,965 |   |

----

(A)       On April 1, 2006, DRSTechnical Services, Inc. (TSI), an operating unit of the C4I Segment, wasconsolidated into an operating unit of the TS Segment to achieve certainoperating synergies. For the three- and nine-month periods ended December 31,2005, the TSI operating unit recorded $3.7 million and $14.0 million inrevenues, respectively, and $0.3 million and $0.7 million of operating income,respectively, and had $9.3 million of assets at December 31, 2005,which was considered immaterial for purposes of restating prior year goodwillbalances and segment information for both the C4I Segment and the TS Segment.

In connection with the neworganizational operating structure implemented October 2, 2006 the Companytested its goodwill for impairment. The change in operating structuresignificantly changed the composition of certain reporting units, which under SFASNo. 142, “Goodwill and Other Intangible Assets,” requires the Company totest for impairment. The Company completed its impairment test with noadjustment to the carrying value of its goodwill for the three- and nine-monthperiods ended December 31, 2006.

13

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

**7. ProductWarranties**

Productwarranty costs generally are accrued when the covered products are delivered tothe customer. 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, 2006 and 2005, which are included in accrued expensesand other current liabilities.

| ** **                                                | ** ** | **Nine Months Ended  December 31,** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                | ** ** | **2006**                                           | ** ** | **2005** | ** ** |
| ** **                                                | ** ** | **(in thousands)**                            | ** ** |
| Balance at beginning  of period                           |       | $ 29,829                                      |       | $ 21,839 |   |
| Acquisitions during the period                            |       | (1,070                                             | )          | 360 |   |
| Accruals for product warranties issued during the  period |       | 17,035                                             |       | 6,853 |   |
| Settlements made during the period                        |       | (14,501                                            | )          | (9,388 | ) |
| Other                                                     |       | 68                                                 |       | 31 |   |
| Balance at end of  the period                             |       | $ 31,361                                      |       | $ 19,695 |   |

 

 

**8.**   Debt

| ** **                                     | ** ** | **December 31,  2006** | ** **                      | **March 31,  2006** | ** ** |
|------------------------------------------------|------------|-----------------------------|---------------------------------|--------------------------|------------|
| ** **                                     | ** ** | **(in thousands)**     | ** **                      |
| Credit Facility:                               |       |                        |                            |                     |       |   |   |
| Revolving line of credit                       |       |                        | $    70,000 |                     |       | $    40,000 |   |
| Term Loan                                      |       |                        | 272,938                         |                     |       | 275,000 |   |
| Canadian Term  Loan                            |       |                        | 8,881                           |                     |       | 9,853 |   |
| 65¤8%  Senior Notes due 2016              |       |                        | 350,000                         |                     |       | 350,000 |   |
| 2.00% Convertible  Senior Notes due 2026       |       |                        | 345,000                         |                     |       | 345,000 |   |
| 75¤8%  Senior Subordinated Notes due 2018 |       |                        | 250,000                         |                     |       | 250,000 |   |
| 67¤8%  Senior Subordinated Notes due 2013 |       |                        | 550,000                         |                     |       | 550,000 |   |
| Unamortized bond premium  on 6 7/8% Senior     |       |                        |                            |                     |       |   |   |
| Subordinated Notes                             |       |                        | 7,736                           |                     |       | 8,585 |   |
| Other obligations                              |       |                        | 5,104                           |                     |       | 4,955 |   |
|                                           |       |                        | 1,859,659                       |                     |       | 1,833,393 |   |
| Less:                                          |       |                        |                            |                     |       |   |   |
| Current  installments of long-term debt        |       |                        | 5,150                           |                     |       | 4,622 |   |
| Total long-term  debt                          |       |                        | $ 1,854,509                |                     |       | $ 1,828,771 |   |

 

The weighted average interest rate on the Company’sterm loan borrowings under its Credit Facility was 6.9% as of December 31,2006 (6.3% as of March 31, 2006). The weighted average interest rate underthe revolving line of credit borrowings was 6.8% at December 31, 2006(6.2% as of March 31, 2006).

14

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

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, 2006,$45.2 million was contingently payable under letters of credit and bankguarantees. Of this amount, approximately $0.9 million and $0.4 million inletters of credit and bank guarantees, respectively, as of December 31,2006, were issued under a previous credit agreement and by a bank agreement forthe Company’s U.K. subsidiary, respectively, and are not considered whendetermining the availability under the Company’s revolving line of credit. At December 31,2006, the Company had $286.1 million of availability under its revolving lineof credit.

On March 29, 2006, DRS Technologies CanadaCompany (DRS Canada) established a five-year senior secured term loan forapproximately $9.9 million (C$11.5 million), maturing on April 1, 2011.The weighted average interest rate on the term loan was 6.0% as of December 31,2006 (5.5% as of March 31, 2006).

Accrued interest expense at December 31, 2006 andMarch 31, 2006 was $28.9 million and $27.3 million, respectively.

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

**9.**   Earningsper Share

Basic earnings per share(EPS) is computed by dividing net earnings by the weighted average number ofshares of common stock outstanding during each period. The computation ofdiluted earnings per share includes the effect of shares from the assumedexercise of dilutive stock options, restricted stock and restricted stockunits. The following table presents the components of basic and dilutedearnings per share:

| ** **                                 | ** ** | **Three Months Ended  December 31,**           | ** ** | **Nine Months Ended  December 31,** | ** ** |
|--------------------------------------------|------------|---------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                 | ** ** | **2006**                                                      | ** ** | **2005**                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                 | ** ** | **(in thousands, except per-share data)** | ** ** |
| **Basic EPS computation**                  | ** ** | ** **                                                    | ** ** | ** **                                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net earnings                               |       | $ 35,094                                                 |       | $ 19,744                                      |       | $ 81,583 |   | $ 52,716 |   |
| Weighted average common shares outstanding |       | 39,879                                                        |       | 27,778                                             |       | 39,742 |   | 27,645 |   |
| Basic earnings per share                   |       | $   0.88                                       |       | $   0.71                            |       | $   2.05 |   | $   1.91 |   |
| **Diluted EPS computation**                | ** ** | ** **                                                    | ** ** | ** **                                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net earnings                               |       | $ 35,094                                                 |       | $ 19,744                                      |       | $ 81,583 |   | $ 52,716 |   |
| Diluted common  shares outstanding         |       |                                                          |       |                                               |       |   |   |   |   |
| Weighted average common shares outstanding |       | 39,879                                                        |       | 27,778                                             |       | 39,742 |   | 27,645 |   |
| Stock options and restricted stock         |       | 861                                                           |       | 942                                                |       | 932 |   | 951 |   |
| Diluted common  shares outstanding         |       | 40,740                                                        |       | 28,720                                             |       | 40,674 |   | 28,596 |   |
| Diluted earnings per  share                |       | $   0.86                                       |       | $   0.69                            |       | $   2.01 |   | $   1.84 |   |

 

At December 31, 2006and 2005, there were 401,716 options and 22,500 options outstanding, respectively,that were excluded from the diluted EPS calculation because their inclusionwould have had an antidilutive effect on EPS. For the three- and nine-monthperiods ended December 31, 2006, DRS’s 2% 

15

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

ConvertibleSenior Notes had no impact on EPS because the average stock price during theperiods was below $59.70 per share, and the convertible notes, if converted,would have required only cash at settlement.

**10.   ComprehensiveEarnings**

The components ofcomprehensive earnings for the three- and nine-month periods ended December 31,2006 and 2005 consisted of the following:

| ** **                                                                                     | ** ** | **Three Months Ended  December 31,** | ** ** | **Nine Months Ended  December 31,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                     | ** ** | **2006**                                            | ** ** | **2005**                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                                     | ** ** | **(in thousands)**                             | ** ** |
| Net earnings                                                                                   |       | $ 35,094                                       |       | $ 19,744                                      |       | $ 81,583 |   | $ 52,716 |   |
| Other comprehensive earnings:                                                                  |       |                                                |       |                                               |       |   |   |   |   |
| Foreign currency  translation adjustments                                                      |       | (1,047                                              | )          | (562                                               | )          | 1,534 |   | 283 |   |
| Minimum pension  liability, net of income taxes                                                |       | (251                                                | )          | —                                             |       | (908 | ) | — |   |
| Unrealized net gains on  hedging instruments arising during the period, net of income tax |       | —                                              |       | —                                             |       | (20 | ) | — |   |
| Amortization of  unrealized gain on terminated instruments, net of income taxes           |       | —                                              |       | (49                                                | )          | — |   | (141 | ) |
| Comprehensive earnings                                                                         |       | $ 33,796                                       |       | $ 19,133                                      |       | $ 82,189 |   | $ 52,858 |   |

 

**11.**   Pensionsand Other Employee Benefits

The following tablesummarizes the components of net periodic benefit cost for the Company’spension and postretirement benefit plans for the three- and nine-month periodsended December 31, 2006 and 2005. These plans are more fully described inNote 12 to the Company’s Consolidated Financial Statements for the year ended March 31,2006.

| ** **                                        | ** ** | **Funded  Pension Plans**                          | ** ** | **Postretirement  Benefit Plans** | ** ** | **Unfunded  Supplemental  Retirement  Plans** | ** ** |
|---------------------------------------------------|------------|---------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                        | ** ** | **Three Months Ended December 31,** | ** ** |
| ** **                                        | ** ** | **(in thousands)**                                 | ** ** |
| ** **                                        | ** ** | **2006**                                                | ** ** | **2005**                               | ** ** | **2006**                                      | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Service cost                                      |       | $ 1,834                                            |       | $    988           |       | $ 146                                    |       | $ 150 |   | $ 143 |   | $ 136 |   |
| Interest cost                                     |       | 3,243                                                   |       | 1,511                                  |       | 320                                           |       | 241 |   | 318 |   | 279 |   |
| Expected return on plan  assets                   |       | (3,490                                                  | )          | (1,769                                 | )          | (56                                           | )          | (42 | ) | — |   | — |   |
| Amortization of  unrecognized loss (gain)         |       | 117                                                     |       | 43                                     |       | (8                                            | )          | (2 | ) | 47 |   | 42 |   |
| Amortization of  transition obligation            |       | —                                                  |       | —                                 |       | 28                                            |       | 27 |   | — |   | — |   |
| Amortization of  unrecognized  prior-service cost |       | 39                                                      |       | 1                                      |       | (6                                            | )          | — |   | 194 |   | 194 |   |
| Net periodic benefit  cost                        |       | $ 1,743                                            |       | $    774           |       | $ 424                                    |       | $ 374 |   | $ 702 |   | $ 651 |   |

 

 

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

 

| ** **                                       | ** ** | **Funded  Pension Plans**                         | ** ** | **Postretirement   Benefit Plans** | ** ** | **Unfunded  Supplemental  Retirement  Plans** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------------|------------|----------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                       | ** ** | **Nine Months Ended December 31,** | ** ** |
| ** **                                       | ** ** | **2006**                                               | ** ** | **2005**                                     | ** ** | **2006**                                      | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                       | ** ** | **(in thousands)**                                | ** ** |
| Service cost                                     |       | $   5,503                               |       | $ 2,964                                 |       | $  437                              |       | $  450 |   | $  429 |   | $  408 |   |
| Interest cost                                    |       | 9,728                                                  |       | 4,533                                        |       | 959                                           |       | 723 |   | 955 |   | 837 |   |
| Expected return  on plan assets                  |       | (10,470                                                | )          | (5,307                                       | )          | (169                                          | )          | (126 | ) | — |   | — |   |
| Amortization of  unrecognized loss (gain)        |       | 350                                                    |       | 129                                          |       | (25                                           | )          | (6 | ) | 141 |   | 126 |   |
| Amortization of  transition obligation           |       | —                                                 |       | —                                       |       | 84                                            |       | 81 |   | — |   | — |   |
| Amortization of  unrecognized prior-service cost |       | 117                                                    |       | 3                                            |       | (18                                           | )          | — |   | 583 |   | 582 |   |
| Net periodic benefit  cost                       |       | $   5,228                               |       | $ 2,322                                 |       | $ 1,268                                  |       | $ 1,122 |   | $ 2,108 |   | $ 1,953 |   |

 

The Company expects to contribute $7.9 million and $2.3million to its pension and postretirement plans, respectively, during thefiscal year ended March 31, 2007, of which $6.4 million and $1.2 million,were contributed during the nine-month period ended December 31, 2006.

**12.**   OperatingSegments

As discussed in Note 1, on October 2, 2006, theCompany implemented a new organizational operating structure which realignedits three operating groups into four operating segments. The four operatingsegments are the Command, Control, Communications, Computers and Intelligence(C4I) Segment, the Reconnaissance, Surveillance and Target Acquisition (RSTA)Segment, the Sustainment Systems (SS) Segment and the Technical Services (TS)Segment. All other operations, primarily our Corporate Headquarters, aregrouped in Other. Prior-year balances and results of operations for the C4IGroup, SR Group and S3 Group have been reclassified to reflect this managementreporting change.

In connection with the realignment the Companyrecorded net severance-related charges of $3.7 million during the secondquarter of fiscal 2007.  During the thirdquarter of fiscal 2007 approximately $2.2 million of the reserve was utilized,net of additions of $0.2 million.  TheCompany expects the payments to be substantially complete by the end of thefourth quarter of fiscal 2007.

The Command, Control, Communications and Intelligence(C4I) Segment is comprised of the following business areas: Command, Controland Communications (C3), which includes naval display systems, shipcommunications systems, radar systems, technical support, electronicmanufacturing and system integration services, secure voice and datacommunications, air combat training, electronic warfare and network systems, andhigh-speed digital data and imaging systems; Power Systems, which includesnaval and industrial power generation, conversion, propulsion, distribution andcontrol systems; Intelligence Technologies, which includes signalsintelligence, communications intelligence, data collection, processing anddissemination equipment, and unmanned vehicles and mission and flightrecorders; and Tactical Systems, which includes battle management tacticalcomputer systems, peripherals, electronic test, and diagnostics and vehicleelectronics.

The Reconnaissance, Surveillance & TargetAcquisition (RSTA) Segment develops and produces electro-optical sighting,targeting and weapon sensor systems, aircraft weapons alignment systems and 

17

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

image intensification (I2 ) night vision, combat identification andlaser aimers/illuminator products, and provides electronic manufacturingservices.

The Sustainment Systems (SS) Segment designs,engineers and manufactures integrated military electronics, equipmenttransporters, environmental control systems, fuel and water distributionsystems, power generators and power supplies primarily for the U.S. Departmentof Defense and allied military forces.

The Technical Services (TS) Segment providesengineering services, logistics and training services, advanced technologyservices, asset protection systems and services, telecommunication systemsintegration and information technology services, and vehicle armor kits formilitary, humanitarian, disaster recovery and emergency responder applications.

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

Transactions between segments generally are negotiatedand accounted for under terms and conditions that are similar to othergovernment and commercial contracts; however, these intercompany transactionsare eliminated in consolidation. The Company evaluates segment-levelperformance based on revenues and operating income, as presented in theConsolidated Statements of Earnings. Operating income, as shown, includesamounts allocated from DRS Corporate operations using an allocation methodologyprescribed by U.S. government regulations for government contractors.

18

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

|  

** **                             | ** ** | ** **              | ** **                                             | **RSTA**    | ** ** | **SS**                               | ** ** | **TS**                                                                                      | ** ** | ** **                                                                | ** ** | ** **                           | ** ** |
|------------------------------------------------|------------|-------------------------|--------------------------------------------------------|-------------|------------|--------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                     | ** ** | **C4I Segment**    | ** **                                             | **Segment** | ** ** | **Segment**                          | ** ** | **Segment**                                                                                 | ** ** | **Other**                                                                 | ** ** | **Total**                            | ** ** |
| ** **                                     | ** ** | **(in thousands)** | ** **                                             |
| **Three Months Ended  December 31, 2006** |       |                    |                                                   |        |       |                                 |       |                                                                                        |       |                                                                      |       |                                 |       |   |   |
| Total revenues                                 |       |                    | $                                                      | 268,816     |       |                                 | $          | 167,910                                                                                     |       | $                                                                         | 104,004    |                                 | $          | 152,409 |   | $ | — |   | $ | 693,139 |   |
| Intersegment revenues                          |       |                    | (763                                                   | )           |       | (1,124                               | )          | (8,010                                                                                      | )          | (2,881                                                                    | )          | —                               |       | (12,778 | ) |
| External revenues                              |       |                    | $                                                      | 268,053     |       |                                 | $          | 166,786                                                                                     |       | $                                                                         | 95,994     |                                 | $          | 149,528 |   | $ | — |   | $ | 680,361 |   |
| Operating income                               |       |                    | $                                                      | 27,669      |       |                                 | $          | 20,588                                                                                      |       | $                                                                         | 17,039     |                                 | $          | 11,390 |   | $ | (59 | ) | $ | 76,627 |   |
| Total assets                                   |       |                    | 1,245,035                                              |        |       | 464,241                              |       | 1,300,872                                                                                   |       | 988,539                                                                   |       | 165,954                              |       | 4,164,641 |   |
| Depreciation and amortization                  |       |                    |          6,015 |        |       |       3,379 |       |          4,840                                      |       |       3,311                                      |       |       1,214 |       |       18,759 |   |
| Capital expenditures                           |       |                    |          4,750 |        |       |       2,179 |       |          1,629                                      |       |          642                      |       |       1,695 |       |       10,895 |   |
| **Three Months Ended December 31, 2005**  |       |                    |                                                   |        |       |                                 |       |                                                                                        |       |                                                                      |       |                                 |       |   |   |
| Total revenues                                 |       |                    | $                                                      | 276,607     |       |                                 | $          | 114,240                                                                                     |       | $                                                                         | —     |                                 | $          | — |   | $ | — |   | $ | 390,847 |   |
| Intersegment revenues                          |       |                    | (747                                                   | )           |       | (610                                 | )          | —                                                                                      |       | —                                                                    |       | —                               |       | (1,357 | ) |
| External revenues                              |       |                    | $                                                      | 275,860     |       |                                 | $          | 113,630                                                                                     |       | $                                                                         | —     |                                 | $          | — |   | $ | — |   | $ | 389,490 |   |
| Operating income (loss)                        |       |                    | $                                                      | 31,101      |       |                                 | $          | 13,744                                                                                      |       | $                                                                         | —     |                                 | $          | — |   | $ | (18 | ) | $ | 44,827 |   |
| Total assets                                   |       |                    | 1,195,024                                              |        |       | 380,074                              |       |                — |       |             — |       | 316,775                              |       | 1,891,873 |   |
| Depreciation and amortization                  |       |                    |          6,260 |        |       |       3,446 |       |                — |       |             — |       |       1,072 |       |       10,778 |   |
| Capital expenditures                           |       |                    |          3,502 |        |       |       4,704 |       |                — |       |             — |       |       1,851 |       |       10,057 |   |
| **Nine Months Ended December 31, 2006**   |       |                    |                                                   |        |       |                                 |       |                                                                                        |       |                                                                      |       |                                 |       |   |   |
| Total revenues                                 |       |                    | $                                                      | 815,150     |       |                                 | $          | 433,975                                                                                     |       | $                                                                         | 319,436    |                                 | $          | 504,909 |   | $ | — |   | $ | 2,073,470 |   |
| Intersegment revenues                          |       |                    | (3,406                                                 | )           |       | (3,825                               | )          | (39,109                                                                                     | )          | (4,966                                                                    | )          | —                               |       | (51,306 | ) |
| External revenues                              |       |                    | $                                                      | 811,744     |       |                                 | $          | 430,150                                                                                     |       | $                                                                         | 280,327    |                                 | $          | 499,943 |   | $ | — |   | $ | 2,022,164 |   |
| Operating income                               |       |                    | $                                                      | 88,072      |       |                                 | $          | 46,412                                                                                      |       | $                                                                         | 41,654     |                                 | $          | 36,578 |   | $ | 784 |   | $ | 213,500 |   |
| Total assets                                   |       |                    | 1,245,035                                              |        |       | 464,241                              |       | 1,300,872                                                                                   |       | 988,539                                                                   |       | 165,954                              |       | 4,164,641 |   |
| Depreciation and amortization                  |       |                    |       18,790                  |        |       |    10,755                  |       |       13,424                                                       |       |    10,397                                                       |       |       3,756 |       |       57,122 |   |
| Capital expenditures                           |       |                    |       18,270                  |        |       |       8,368 |       |          4,262                                      |       |       2,895                                      |       |       4,318 |       |       38,113 |   |
| **Nine Months Ended December 31, 2005**   |       |                    |                                                   |        |       |                                 |       |                                                                                        |       |                                                                      |       |                                 |       |   |   |
| Total revenues                                 |       |                    | $                                                      | 797,285     |       |                                 | $          | 295,936                                                                                     |       | $                                                                         | —     |                                 | $          | — |   | $ | — |   | $ | 1,093,221 |   |
| Intersegment revenues                          |       |                    | (1,445                                                 | )           |       | (1,897                               | )          | —                                                                                      |       | —                                                                    |       | —                               |       | (3,342 | ) |
| External revenues                              |       |                    | $                                                      | 795,840     |       |                                 | $          | 294,039                                                                                     |       | $                                                                         | —     |                                 | $          | — |   | $ | — |   | $ | 1,089,879 |   |
| Operating income (loss)                        |       |                    | $                                                      | 84,372      |       |                                 | $          | 36,544                                                                                      |       | $                                                                         | —     |                                 | $          | — |   | $ | (2,454 | ) | $ | 118,462 |   |
| Total assets                                   |       |                    | 1,195,024                                              |        |       | 380,074                              |       |                — |       |             — |       | 316,775                              |       | 1,891,873 |   |
| Depreciation and amortization                  |       |                    |       18,587                  |        |       |    10,201                  |       |                — |       |             — |       |       2,931 |       |       31,719 |   |
| Capital  expenditures                          |       |                    |       11,181                  |        |       |    11,008                  |       |                — |       |             — |       |       4,122 |       |       26,311 |   |

 

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

**13.**   SupplementalCash Flow Information

| ** **                                                                           | ** ** | **Nine Months Ended  December 31,** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                           | ** ** | **2006**                                           | ** ** | **2005** | ** ** |
| ** **                                                                           | ** ** | **(in thousands)**                            | ** ** |
| Cash paid for:                                                                       |       |                                               |       |   |   |
| Income taxes                                                                         |       | $                                                  | 31,003     |   | $ | 35,624 |   |
| Interest                                                                             |       | $                                                  | 85,487     |   | $ | 43,038 | * |
| Supplemental disclosure  of significant non-cash investing and financing activities: |       |                                               |       |   |   |
| Acquisition costs for business combinations, net                                     |       | $                                                  | —     |   | $ | 11,848 |   |
| Acquisition earn-out - Night Vision  Systems, Inc.                              |       | $                                                  | 6,627      |   | $ | — |   |
| Acquisition earn-out - WalkAbout                                                     |       | $                                                  | 279        |   | $ | — |   |
| Contribution of  fixed assets to joint venture                                       |       | $                                                  | 1,000      |   | $ | — |   |

----

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

**14.**   CashDividends on DRS Common Stock

On November 2, 2006,the Board of Directors declared a $0.03 per common share cash dividend, payableon December 29, 2006 to stockholders of record as of December 15,2006. Cash dividends paid for the three- and nine-month periods ended December 31,2006 were  $1.2 million and $3.6 million,respectively. On February 8, 2007, the Board of Directors declared a $0.03 per common share cash dividend,payable on March 30, 2007 to stockholders of record as of March 15,2007.

**15.**   Contingenciesand Related Party Transactions

**Contingencies—****Various**legalactions, claims, assessments and other contingencies arising out of previousbusiness combinations and arising in the normal course of the Company’sbusiness, including certain matters described below, are pending against theCompany and certain of its subsidiaries. These matters are subject to manyuncertainties, and it is possible that some of these matters could beultimately decided, resolved or settled adversely. The Company has recordedaccruals totaling $4.4 million and $4.3 million at December 31, 2006and March 31, 2006, respectively, for losses related to those matters thatit considers to be probable and that can be reasonably estimated (certain legaland environmental matters are discussed in detail below). Based on the Company’songoing analysis of various factual, legal and equitable considerations it hasrecorded an accrual of $11.8 million against goodwill reflecting theprobable income tax impact of information uncovered in our ongoing internalinvestigation of historical ESSI stock option practices. Although the ultimateamount of liability at December 31, 2006 that may result from thosematters for which the Company has recorded accruals is not ascertainable, theCompany believes that any amounts exceeding the Company’s recorded accrualsshould not materially affect the Company’s financial condition or liquidity. Itis possible, however, that the ultimate resolution of those matters couldresult in a material adverse effect on the Company’s results of operationsand/or cash flows from operating activities for a particular reporting period.

Some environmental laws, such as the ComprehensiveEnvironmental Response, Compensation and Liability Act of 1980 (also known asCERCLA or the Superfund law) and similar state statutes, can impose 

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

liability for the entirecost of the clean up of contaminated sites upon any of the current or formersite owners or operators (or upon parties who send waste to these sites),regardless of the lawfulness of the original activities that led to thecontamination. In July 2000, prior to its acquisition by 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 rightswere transferred to a third party by a trustee in bankruptcy, and the Companybelieves that the mine was operated by such third party until approximately1969. The Company understands that there are other companies in the chain of titleto the mining rights subsequent to Tech-Sym’s alleged predecessor, and,accordingly, that there are other potentially responsible parties (PRPs) forthe environmental conditions at the site, including the U.S. government asowner, operator and arranger at the site. During its period of ownership, IDTretained a technical consultant in connection with this matter, who conducted alimited, preliminary review of site conditions and communicated with the NPSregarding actions that may be required at the site by all of the PRPs. On February 6,2005, the NPS sent the Company an Engineering Evaluation/Cost Analysis WorkPlan (the “NPS EE/CA”) under CERCLA (the ‘‘CERCLA Letter’’) with regards toOperable Unit 1 of the Orphan Mine site. In the Company’s view, the NPS EE/CAincluded additional clean up not covered by CERCLA. The CERCLA Letter alsorequested (a) payment of $0.5 million for costs incurred by the NPSrelated to the Orphan Mine, and (b) a ‘‘good faith offer’’ to conduct theresponse activity outlined by the NPS and to reimburse the NPS for futurecosts. The NPS advised that a similar letter has been sent to another PRP. TheCompany initiated discussions with the other PRP and with NPS, and engaged atechnical consultant to evaluate the existing documentation and the site indepth. As a result, on September 29, 2005, the technical consultantsubmitted to the NPS, on behalf of the Company and the other PRP, analternative Engineering Evaluation/Cost Analysis Work Plan (the “alternativeEE/CA”) with regards to Operating Units 1 and 2 of the Orphan Mine site.

In December 2005 and August 2006, the PRPsand NPS met to discuss the technical merits of the alternative EE/CA and waysto resolve certain differences between the alternative EE/CA and the NPS EE/CAprovided with the CERCLA Letter. Since late 2005, the parties have alsodiscussed certain legal issues relating to the process for implementing analternative EE/CA and entering into a settlement agreement that wouldmemorialize the parties’ intent. The potential liability associated withimplementation of an EE/CA can change substantially due to such factors asadditional information on the nature or extent of contamination, methods ofremediation that might be recommended or required, changes in the apportionmentof costs among the responsible parties and other actions by governmentalagencies or private parties.

In connection with the Company’s acquisition ofEngineered Support Systems, Inc. (“ESSI”) in January 2006, theCompany has been made aware of certain legal actions, claims, assessments andother contingencies, certain of which are described below.

In December 2004, ESSI was notified by theEnforcement Division of the SEC of the issuance of a formal order directing aprivate investigation captioned *In the Matter ofEngineered Support Systems, Inc.* and was notified that the SEChad issued subpoenas to various individuals associated with ESSI to produce 

21

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

certain documents. The SECstaff also requested that ESSI produce certain documents in connection with theinvestigation. The subpoenas related to trading in ESSI stock around ESSI’searnings releases in 2003 and to the adequacy of certain disclosures made byESSI regarding related-party transactions in 2002 and 2003 involving insurancepolicies placed by ESSI through an insurance brokerage firm in which an ESSIdirector was a principal at the time of the transactions.

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

In connection with the foregoing SEC investigation,ESSI and certain of its directors and officers have provided information and/ortestimony to the SEC. On November 14, 2005, ESSI was informed by theEnforcement Division of the SEC that one of ESSI’s former directors andofficers, and subsequently a consultant to ESSI, had been issued a so-calledWells notice informing him that the staff of the SEC was consideringrecommending that the SEC bring a civil injunctive action against him in connectionwith the SEC’s investigation into trading in 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 notreceived a Wells notice and continues to cooperate with the investigation.

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

In May 2006, the Company was advised that theEnforcement Division of the SEC and the U.S. Attorney’s office had eachexpanded its investigation to include possible “backdating” of the timing ofoption grants at ESSI prior to the time ESSI was acquired by DRS. As a part ofits investigation, the SEC issued subpoenas to certain officers and employeesof ESSI to provide testimony and produce certain documents. InFebruary 2007, the SEC filed civil injunctive actions in the United StatesDistrict Court for the Eastern District of Missouri, Eastern Division allegingthat ESSI’s former Chief Financial Officer and former controller participatedin a backdating scheme.  The SEC reportedthat the former controller had settled this action by consenting todisgorgement, financial penalties, an officer and director bar and a permanentsuspension from practicing before the SEC as an accountant. Although ESSIcontinues to be a subject of the U.S. Attorney’s office’s investigation, theU.S. Attorney’s office has advised the Company that ESSI is not a target.Because the events being investigated occurred prior to the time of the Company’sacquisition of ESSI, the U.S. Attorney’s office has further advised the Companythat it considers DRS to be a witness, not a subject or target of itsinvestigation.

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

22

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

In September 2006, ESSI was advised that theInternal Revenue Service was commencing an audit of its Federal tax return forthe fiscal year ended October 31, 2004. In January 2007, ESSI was advisedthat the Internal Revenue Service had expanded its audit to include ESSI’sFederal tax returns for the tax periods ended October 31, 2005 andJanuary 31, 2006. In connection  with these audits, ESSI has received severalinformation document requests (“IDRs”) asking for specific information relatingto stock option deductions provided therein. The Company is cooperating withthis process.

**TheCompany has recorded an accrual against goodwill to reflect the likelydisallowance of certain compensation deductions taken on several of ESSI’sprevious State and Federal income tax returns. Principally, this adjustment wasmade to account for Internal Revenue Code Section 162(m) and its limitations onthe deductibility of certain non-performance based compensation.**

**In July2006, DRS and one of the Company’s subsidiaries, DRS Training and ControlSystems, Inc. (“TCS”) were each issued a subpoena by the United States DistrictCourt for the Northern District of Florida (“Florida District Court”). Thesubpoenas were issued in connection with an inquiry being conducted by the AntitrustDivision of the U.S. Department of Justice (“DOJ”) and require TCS to producecertain documents related to an investigation the Company believes involvesallegations of anticompetitive activity in certain international markets. Inaddition, certain employees and officers of TCS were served with subpoenas totestify before the grand jury of the Florida District Court with regard to thismatter. The DOJ is continuing its investigation, but we have no information asto when the DOJ will conclude this process. The Company has cooperated with theDOJ in producing documents in response to the subpoenas. The Company hascommenced an internal investigation regarding this matter, which the Companyexpects to continue through the conclusion of the DOJ’s investigatory process.**

**Related Party Transactions****  **The Company currently leases abuilding in Oakland, New Jersey, owned by LDR Realty Co., a partnership thatwas wholly owned in equal amounts by David E. Gross, DRS’s cofounder and theformer President and Chief Technical Officer, and the late Leonard Newman, DRS’scofounder, the former Chairman of the Board, Chief Executive Officer, andSecretary and the father of Mark S. Newman, the Company’s current Chairman ofthe Board, President and Chief Executive Officer. The lease agreement with amonthly rental of $21,200 expires on April 30, 2007. Following LeonardNewman’s death in November 1998, Mrs. Ruth Newman, the wife ofLeonard Newman and the mother of Mark S. Newman, succeeded to Leonard Newman’sinterest in LDR Realty Co.

Skadden,Arps, Slate, Meagher & Flom LLP, a law firm to which a member of ourBoard is of counsel, provided legal services to the Company during the ninemonths ended December 31, 2006 and 2005. Fees paid to Skadden, Arps,Slate, Meagher & Flom LLP for the nine months ended December 31,2006 and 2005 were $3.0 million and $2.2 million, respectively.

Kronish Lieb Weiner & Hellman LLP, a law firmof which Alison Newman, sister of Mark S. Newman, is a partner, provided legalservices to the Company during the nine months ended December 31, 2005.The Company paid fees to Kronish Lieb Weiner & Hellman LLP of $0.2million for the nine months ended December 31, 2005.

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

Aspresented in Note 8, “Debt”, the Company has $350.0 million 65¤8% Senior Notes, $550.0million 67¤8% Senior SubordinatedNotes, $250.0 million 75¤8% Senior Subordinated Notesand $345.0 million 2% Convertible Senior Notes outstanding (collectively, theNotes). The Notes are fully and unconditionally 

23

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

guaranteed, jointly and severally, by the Company’swholly-owned domestic subsidiaries (the Guarantor Subsidiaries). The foreignsubsidiaries and certain domestic subsidiaries of DRS (the Non-GuarantorSubsidiaries) do not guarantee the Notes.

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

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

b)               the GuarantorSubsidiaries,

c)                the Non-GuarantorSubsidiaries, and

d)               DRSTechnologies, Inc. on a consolidated basis

Theinformation includes elimination entries necessary to consolidate the Parentwith the Guarantor and Non-Guarantor Subsidiaries.

TheGuarantor and Non-Guarantor subsidiaries are presented on a combined basis. Theprincipal elimination entries eliminate investments in subsidiaries andintercompany balances and transactions. Separate financial information for eachof the Guarantor and Non-Guarantor Subsidiaries are not presented becausemanagement believes such financial statements would not be meaningful toinvestors.

24

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

**CondensedConsolidating Balance SheetAs of December 31, 2006(in thousands)**

| ** **                                           | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                           |       |                |       |                        |       |                              |       |             |       |             |       |   |   |   |   |
| **Current assets**                                   |       |                |       |                        |       |                              |       |             |       |             |       |   |   |   |   |
| Cash and cash equivalents                            |       | $                   | 30,117     |                        | $          | (2,006                            | )          |             | $          | 21,440           |       |   | $ | — |   |   | $ | 49,551 |   |   |
| Accounts receivable, net                             |       | 4                   |       | 476,902                     |       |                              | 26,191     |             |       | —           |       |   | 503,097 |   |   |
| Inventories, net                                     |       | (5,709              | )          | 330,193                     |       |                              | 39,496     |             |       | —           |       |   | 363,980 |   |   |
| Prepaid expenses and other current assets            |       | 6,237               |       | 115,179                     |       |                              | 12,466     |             |       | (7,267           | )          |   | 126,615 |   |   |
| Intercompany receivables                             |       | 2,095,317           |       | —                      |       |                              | 24,115     |             |       | (2,119,432       | )          |   | — |   |   |
| **Total current assets**                             |       | 2,125,966           |       | 920,268                     |       |                              | 123,708    |             |       | (2,126,699       | )          |   | 1,043,243 |   |   |
| Property, plant and equipment, net                   |       | 14,612              |       | 201,285                     |       |                              | 9,194      |             |       | —           |       |   | 225,091 |   |   |
| Acquired  intangibles, net                           |       | —              |       | 204,546                     |       |                              | 553        |             |       | —           |       |   | 205,099 |   |   |
| Goodwill                                             |       | 24,115              |       | 2,570,195                   |       |                              | 39,655     |             |       | —           |       |   | 2,633,965 |   |   |
| Deferred income  taxes and other noncurrent assets   |       | 48,948              |       | 8,076                       |       |                              | 10,151     |             |       | (9,932           | )          |   | 57,243 |   |   |
| Investment in  subsidiaries                          |       | 1,147,206           |       | 46,643                      |       |                              | —     |             |       | (1,193,849       | )          |   | — |   |   |
| **Total assets**                                     |       | $                   | 3,360,847  |                        | $          | 3,951,013                         |       |             | $          | 183,261          |       |   | $ | (3,330,480 | ) |   | $ | 4,164,641 |   |   |
| **Liabilities  and Stockholders’ Equity**       |       |                |       |                        |       |                              |       |             |       |             |       |   |   |   |   |
| **Current liabilities**                              |       |                |       |                        |       |                              |       |             |       |             |       |   |   |   |   |
| Current installments of long-term debt               |       | $                   | 2,750      |                        | $          | 196                               |       |             | $          | 2,204            |       |   | $ | — |   |   | $ | 5,150 |   |   |
| Accounts payable                                     |       | 5,783               |       | 205,419                     |       |                              | 19,113     |             |       | —           |       |   | 230,315 |   |   |
| Accrued expenses and other current liabilities       |       | 54,175              |       | 401,765                     |       |                              | 30,256     |             |       | (7,218           | )          |   | 478,978 |   |   |
| Intercompany payables                                |       | —              |       | 888,972                     |       |                              | 23,828     |             |       | (912,800         | )          |   | — |   |   |
| Total current liabilities                            |       | 62,708              |       | 1,496,352                   |       |                              | 75,401     |             |       | (920,018         | )          |   | 714,443 |   |   |
| Long-term debt, excluding current installments       |       | 1,842,923           |       | 3,295                       |       |                              | 8,291      |             |       | —           |       |   | 1,854,509 |   |   |
| Other liabilities                                    |       | 4,230               |       | 126,995                     |       |                              | 23,410     |             |       | (9,931           | )          |   | 144,704 |   |   |
| **Total liabilities**                                |       | 1,909,861           |       | 1,626,642                   |       |                              | 107,102    |             |       | (929,949         | )          |   | 2,713,656 |   |   |
| **Total stockholders’ equity**                  |       | 1,450,986           |       | 2,324,371                   |       |                              | 76,159     |             |       | (2,400,531       | )          |   | 1,450,985 |   |   |
| **Total liabilities  and stockholders’ equity** |       | $                   | 3,360,847  |                        | $          | 3,951,013                         |       |             | $          | 183,261          |       |   | $ | (3,330,480 | ) |   | $ | 4,164,641 |   |   |

 

25

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

**Condensed Consolidating Balance SheetAs of March 31, 2006(in thousands)**

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

** **

26

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

**CondensedConsolidating Statements of Earnings Three Months Ended December 31, 2006(in thousands)**

| ** **                                                 | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Revenues**                                               |       |                | $          | —                      |       |                              |       | $                | 624,840    |             |       |   | $ | 59,936 |   |   |   | $ | (4,415 | ) |   |   | $ | 680,361 |   |   |
| Cost and expenses                                          |       |                | 18         |                        |       |                              | 551,798    |             |       |             | 56,335     |   |   |   | (4,417 | ) |   |   | 603,734 |   |   |
| Operating income                                           |       |                | (18        | )                           |       |                              | 73,042     |             |       |             | 3,601      |   |   |   | 2 |   |   |   | 76,627 |   |   |
| Interest income                                            |       |                | 300        |                        |       |                              | 21         |             |       |             | 49         |   |   |   | — |   |   |   | 370 |   |   |
| Interest and  related expense                              |       |                | 30,036     |                        |       |                              | 83         |             |       |             | 149        |   |   |   | — |   |   |   | 30,268 |   |   |
| Other income  (expense), net                               |       |                | (114       | )                           |       |                              | 87         |             |       |             | 98         |   |   |   | — |   |   |   | 71 |   |   |
| Management fees                                            |       |                | 701        |                        |       |                              | (661       | )                |       |             | (40        | ) |   |   | — |   |   |   | — |   |   |
| Royalties                                                  |       |                | 526        |                        |       |                              | —     |             |       |             | (526       | ) |   |   | — |   |   |   | — |   |   |
| Intercompany  interest                                     |       |                | 24,728     |                        |       |                              | (24,651    | )                |       |             | (77        | ) |   |   | — |   |   |   | — |   |   |
| Earnings before non-controlling interest and income  taxes |       |                | (3,913     | )                           |       |                              | 47,755     |             |       |             | 2,956      |   |   |   | 2 |   |   |   | 46,800 |   |   |
| Non-controlling  interest                                  |       |                | —     |                        |       |                              | —     |             |       |             | 131        |   |   |   | — |   |   |   | 131 |   |   |
| Earnings before income taxes                               |       |                | (3,913     | )                           |       |                              | 47,755     |             |       |             | 2,825      |   |   |   | 2 |   |   |   | 46,669 |   |   |
| Income taxes                                               |       |                | (974       | )                           |       |                              | 11,974     |             |       |             | 573        |   |   |   | 2 |   |   |   | 11,575 |   |   |
| Earnings from  subsidiary entities                         |       |                | 38,033     |                        |       |                              | —     |             |       |             | —     |   |   |   | (38,033 | ) |   |   | — |   |   |
| **Net  earnings**                                          |       |                | $          | 35,094                      |       |                              |       | $                | 35,781     |             |       |   | $ | 2,252 |   |   |   | $ | (38,033 | ) |   |   | $ | 35,094 |   |   |

 

27

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

**CondensedConsolidating Statements of EarningsThree 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 non-controlling interest and income  taxes |       |                | (3,516     | )                           |       |                              | 35,949     |             |       |             | 2,090      |   |   |   | (5 | ) |   |   | 34,518 |   |   |
| Non-controlling  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 from  subsidiary entities                         |       |                | 21,733     |                        |       |                              | —     |             |       |             | —     |   |   |   | (21,733 | ) |   |   | — |   |   |
| **Net  earnings**                                          |       |                | $          | 19,744                      |       |                              |       | $                | 20,870     |             |       |   | $ | 863 |   |   |   | $ | (21,733 | ) |   |   | $ | 19,744 |   |   |

 

28

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

**CondensedConsolidating Statements of EarningsNine Months Ended December 31, 2006(in thousands)**

| ** **                                                 | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Revenues**                                               |       | $                   | —     |                        | $          | 1,853,484                         |       |             | $          | 181,900          |       |   |   | $ | (13,220 | ) |   |   | $ | 2,022,164 |   |   |
| Cost and expenses                                          |       | (899                | )          | 1,654,184                   |       |                              | 168,611    |             |       |             | (13,232    | ) |   |   | 1,808,664 |   |   |
| Operating income                                           |       | 899                 |       | 199,300                     |       |                              | 13,289     |             |       |             | 12         |   |   |   | 213,500 |   |   |
| Interest income                                            |       | 691                 |       | 69                          |       |                              | 108        |             |       |             | —     |   |   |   | 868 |   |   |
| Interest and  related expense                              |       | 90,081              |       | 240                         |       |                              | 468        |             |       |             | —     |   |   |   | 90,789 |   |   |
| Other income  (expense), net                               |       | (53                 | )          | 125                         |       |                              | (73        | )                |       |             | —     |   |   |   | (1 | ) |   |
| Management fees                                            |       | 2,151               |       | (2,030                      | )          |                              | (121       | )                |       |             | —     |   |   |   | — |   |   |
| Royalties                                                  |       | 1,666               |       | —                      |       |                              | (1,666     | )                |       |             | —     |   |   |   | — |   |   |
| Intercompany  interest                                     |       | 74,608              |       | (74,341                     | )          |                              | (267       | )                |       |             | —     |   |   |   | — |   |   |
| Earnings before non-controlling interest and income  taxes |       | (10,119             | )          | 122,883                     |       |                              | 10,802     |             |       |             | 12         |   |   |   | 123,578 |   |   |
| Non-controlling  interest                                  |       | —              |       | —                      |       |                              | 1,089      |             |       |             | —     |   |   |   | 1,089 |   |   |
| Earnings before income taxes                               |       | (10,119             | )          | 122,883                     |       |                              | 9,713      |             |       |             | 12         |   |   |   | 122,489 |   |   |
| Income taxes                                               |       | (3,384              | )          | 41,038                      |       |                              | 3,240      |             |       |             | 12         |   |   |   | 40,906 |   |   |
| Earnings from  subsidiary entities                         |       | 88,318              |       | —                      |       |                              | —     |             |       |             | (88,318    | ) |   |   | — |   |   |
| **Net  earnings**                                          |       | $                   | 81,583     |                        | $          | 81,845                            |       |             | $          | 6,473            |       |   |   | $ | (88,318 | ) |   |   | $ | 81,583 |   |   |

 

29

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIES Notes to the 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 non-controlling interest and income  taxes |       | (11,159             | )          |                        | 89,701     |                              |       |             | 8,753      |             |       |   | (10 | ) |   |   | 87,285 |   |   |
| Non-controlling  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 from  subsidiary entities                         |       | 59,584              |       |                        | —     |                              |       |             | —     |             |       |   | (59,584 | ) |   |   | — |   |   |
| **Net  earnings**                                          |       | $                   | 52,716     |                        |       | $                                 | 55,160     |             |       |             | $          | 4,424 |   |   |   | $ | (59,584 | ) |   |   | $ | 52,716 |   |   |

p

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

**CondensedConsolidating Statements of Cash Flows**Nine Months EndedDecember 31, 2006(in thousands)

| ** **                                                         | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Net  cash provided by (used in) operating activities**           |       | $                   | 41,512     |                        |       | $                                 | (708       | )                |       |             | $          | 20,850 |   |   |   | $ | — |   |   |   | $ | 61,654 |   |   |
| **Cash  Flows from Investing Activities**                          |       |                |       |                        |       |                              |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Capital expenditures                                               |       | (4,423              | )          |                        | (30,675    | )                                 |       |             | (3,015     | )                |       |   | — |   |   |   | (38,113 | ) |   |
| Payments pursuant to business combinations, net of  cash acquired  |       | (8,608              | )          |                        | (1,153     | )                                 |       |             | —     |             |       |   | — |   |   |   | (9,761 | ) |   |
| Other, net                                                         |       | 85                  |       |                        | 323        |                              |       |             | —     |             |       |   | — |   |   |   | 408 |   |   |
| **Net cash used in investing activities**                          |       | (12,946             | )          |                        | (31,505    | )                                 |       |             | (3,015     | )                |       |   | — |   |   |   | (47,466 | ) |   |
| **Cash  Flows from Financing Activities**                          |       |                |       |                        |       |                              |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Borrowings of long-term debt                                       |       | 30,000              |       |                        | —     |                              |       |             | 459        |             |       |   | — |   |   |   | 30,459 |   |   |
| Repayments of long-term debt                                       |       | (2,063              | )          |                        | (177       | )                                 |       |             | (1,183     | )                |       |   | — |   |   |   | (3,423 | ) |   |
| Proceeds from exercise of stock options                            |       | 8,517               |       |                        | —     |                              |       |             | —     |             |       |   | — |   |   |   | 8,517 |   |   |
| Excess tax benefit realized from share-based payment  arrangements |       | 2,258               |       |                        | —     |                              |       |             | —     |             |       |   | — |   |   |   | 2,258 |   |   |
| Dividends paid                                                     |       | (3,619              | )          |                        | —     |                              |       |             | —     |             |       |   | — |   |   |   | (3,619 | ) |   |
| Other                                                              |       | —              |       |                        | 245        |                              |       |             | —     |             |       |   | — |   |   |   | 245 |   |   |
| Parent company                                                     |       | (49,447             | )          |                        | 49,659     |                              |       |             | (212       | )                |       |   | — |   |   |   | — |   |   |
| **Net cash (used in) provided by financing activities**            |       | (14,354             | )          |                        | 49,727     |                              |       |             | (936       | )                |       |   | — |   |   |   | 34,437 |   |   |
| **Effect of exchange rates on cash and cash equivalents**          |       | —              |       |                        | —     |                              |       |             | (367       | )                |       |   | — |   |   |   | (367 | ) |   |
| **Net  increase in cash and cash equivalents**                     |       | 14,212              |       |                        | 17,514     |                              |       |             | 16,532     |             |       |   | — |   |   |   | 48,258 |   |   |
| **Cash  and cash equivalents, beginning of period**                |       | 15,905              |       |                        | (19,520    | )                                 |       |             | 4,908      |             |       |   |   |   |   |   | 1,293 |   |   |
| **Cash and cash equivalents, end  of period**                      |       | $                   | 30,117     |                        |       | $                                 | (2,006     | )                |       |             | $          | 21,440 |   |   |   | $ | — |   |   |   | $ | 49,551 |   |   |

 

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

**CondensedConsolidating Statements of Cash FlowsNine 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                                                             |       | 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                           |       | 9,750               |       |                        | —     |                              |       |             | —     |             |       |   | — |   |   |   | 9,750 |   |   |
| Dividends paid                                                    |       | (2,508              | )          |                        | —     |                              |       |             | —     |             |       |   | — |   |   |   | (2,508 | ) |   |
| Parent company                                                    |       | 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 |   |   |

 

**17.**   RecentlyIssued Accounting Pronouncements

In February 2006, theFASB issued SFAS No. 155, “Accounting for Certain Hybrid FinancialInstruments—an amendment of FASB Statements No. 133 and 140” (SFAS No. 155).SFAS No. 155 permits a fair value remeasurement for any hybrid financialinstrument that contains an embedded derivative that would otherwise requirebifurcation. This accounting standard will be effective for the 

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

Company beginning April 1,2007. SFAS No. 155 is not expected to have an impact on the Company’sfinancial position, results of operations or cash flows.

In July of 2006, theFASB issued FASB Interpretation (FIN) No. 48, “Accounting for Uncertaintyin Income Taxes—an interpretation of FASB Statement No. 109.” FIN 48prescribes a comprehensive model for how a company should recognize, measure,present, and disclose in its financial statements uncertain tax positions thatthe company has taken or expects to take on a tax return. FIN 48 states that atax benefit from an uncertain position may be recognized only if it is “morelikely than not” that the position is sustainable, based on its technicalmerits. The tax benefit of a qualifying position is the largest amount of taxbenefit that is greater than 50 percent likely of being realized upon ultimatesettlement with a taxing authority having full knowledge of all relevantinformation. The Company currently recognizes a tax position if it is probableof being sustained. FIN 48 is effective beginning April 1, 2007 for DRS.The Company is currently evaluating the impact that adopting FIN 48 will haveon its operations and financial condition.

In September of 2006,the FASB issued SFAS No. 157, “Fair Value Measurement.”  SFAS No. 157 defines fair value,establishes a framework for measuring fair value in generally acceptedaccounting principles (GAAP), and expands disclosures about fair valuemeasurements. This Statement applies under other accounting pronouncements thatrequire or permit fair value measurements, the Board having previouslyconcluded in those accounting pronouncements that fair value is the relevantmeasurement attribute. Accordingly, this Statement does not require any newfair value measurements. However, for some entities, the application of thisStatement will change current practice. This statement is effective beginning April 1,2007 for DRS. The Company is currently evaluating the impact that adopting SFASNo. 157 will have on its results of operations and financial condition.

In September of 2006,the FASB issued SFAS No. 158, “Employers Accounting for Defined BenefitPension and Other Postretirement Plans.” SFAS No. 158 requires recognition of the over or underfunded statusof postretirement plans, measured as the difference between the fair value ofthe plan assets and the benefit obligation. For pension plans, the benefitobligation is the projected benefit obligation and, for other postretirementplans, the benefit obligation is the accumulated postretirement obligation.Upon adoption, SFAS No. 158 requires the recognition of previouslyunrecognized actuarial gains and losses and prior service costs withinaccumulated other comprehensive income, net of tax (a component of stockholders’equity). The requirement to recognize the funded status of a benefit plan andthe disclosure requirements are effective for the Company’s fiscal year ending March 31,2007. The requirement to measure plan assets and benefit obligations as of theemployer’s fiscal year-end is effective for DRS’s fiscal year ending March 31,2009. Based on the Company’s unfunded obligations as of March 31, 2006,had the adoption of SFAS 158 been effective on that date, the result would havebeen to increase the Company’s total liabilities by approximately$36.9 million, increase deferred tax assets by approximately$14.5 million and to reduce total stockholders’ equity by approximately$22.4 million. The adoption of SFAS No. 158 is not expected to have animpact on the Company’s debt covenants.

In September 2006,the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108,“Considering the Effects of Prior Year Misstatements when QuantifyingMisstatements in Current Year Financial Statements” (“SAB 108”). SAB 108clarifies the staff’s views regarding the process of quantifying financialstatement misstatements. The SEC staff believes registrants must quantifyerrors using both a balance sheet and income statement approach and evaluatewhether either approach results 

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

in quantifying a misstatement that, when all relevantquantitative and qualitative factors are considered, is material. Uponadoption, SAB 108 permits registrants to adjust prior year financial statementerrors as of the beginning of this fiscal year that were immaterial under acompany’s previous method of evaluating errors but material under the methodprescribed by SAB 108, with an offsetting adjustment to the opening balance ofretained earnings. After adoption, if a misstatement is material to the currentyear financial statements, the prior year financial statements should also becorrected, even though such revision was, and continues to be, immaterial tothe prior year financial statements. Correcting prior year financial statementsfor immaterial errors would not require previously filed reports to be amended.Such correction would be made in the current period filings. The Company willapply the provision of SAB 108 in the fourth quarter of its fiscal yearending March 31, 2007 retroactively to the beginning of the fiscal year.The Company is currently evaluating the impact of such adoption.

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

We begin the Management’sDiscussion and Analysis of Financial Condition and Results of Operations(MD&A) of DRS Technologies, Inc., and its wholly-owned subsidiariesand controlling interests (hereinafter, we, us, our, the Company or DRS) with adiscussion of acquisition activity and a company overview, followed bysummaries of defense industry considerations and other business considerationsto provide context for understanding our business. This is followed by adiscussion of the critical accounting estimates that we believe are importantto understanding the assumptions and judgments incorporated in our reportedfinancial results, which we discuss under “Results of Operations.” We thenprovide an analysis of cash flows and discuss our financial commitments under “Liquidityand Capital Resources” and “Contractual Obligations,” respectively. ThisMD&A should be read in conjunction with the consolidated financialstatements and related notes contained herein and in our March 31, 2006Annual Report on Form 10-K.

**Forward-LookingStatements**

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

**BusinessCombinations**

On January 31, 2006 we completed our acquisitionof Engineered Support Systems, Inc. (ESSI) for $1.93 billion in cash andDRS common stock. In the transaction, a wholly-owned subsidiary of DRS wasmerged with ESSI, forming our Sustainment Systems (SS) and Technical Services(TS) operating segments. ESSI, formerly headquartered in St. Louis, Missouri,is a supplier of integrated military electronics, support equipment andtechnical services focused on advanced sustainment and logistics supportsolutions for all branches of the U.S. armed services, major prime defensecontractors, certain international militaries, homeland security forces andselected government and intelligence agencies. ESSI also produces specializedequipment and systems for commercial and industrial applications. The additionof ESSI has contributed a significant base of systems, products and servicesfocused on military force sustainment, technical and logistics support,integrated military electronics and field support equipment.

On June 27, 2005, we acquired WalkAbout ComputerSystems, Inc. (WalkAbout) in a stock purchase transaction forapproximately $13.8 million in cash, with additional consideration payable ofup to $5.0 million upon achievement of certain revenue targets for aperiod of two and a half years. WalkAbout, 

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formerly located in WestPalm Beach, Florida, is a manufacturer of several lines of rugged, mobiletablet PCs, serving industrial, municipal, military and government markets. Webelieve that the acquisition of WalkAbout has enhanced our position in thetactical computer systems business by broadening our product offerings.WalkAbout is being managed as part of our Command, Control, Communications,Computers and Intelligence (C4I) Segment.

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

**Company Overview**

DRS is a supplier of defense electronic products,systems and military support services. We provide high technology products,services and support to all branches of the U.S. military, major aerospace anddefense prime contractors, government intelligence agencies, internationalmilitary forces and industrial markets.

On October 2, 2006, we implemented a neworganizational operating structure that realigned our three operating groups:the Command, Control, Communications, Computer and Intelligence Group, theSurveillance & Recconnaisance Group and the Sustainment Systems &Services Group, into four operating segments. The four operating segments arethe Command, Control, Communications, Computers and Intelligence (C4I) Segment,the Reconnaissance, Surveillance and Target Acquisition (RSTA) Segment, theSustainment Systems (SS) Segment and the Technical Services (TS) Segment. Allother operations, primarily our Corporate Headquarters, are grouped in Other. Allprior-year amounts presented by segment have been reclassified to reflect thenew operating segment structure.

The C4I Segment 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, secure voice and datacommunications, air combat training, electronic warfare and network systems,and high-speed digital data and imaging systems; Power Systems, which includesnaval and industrial power generation, conversion, propulsion, distribution andcontrol systems; Intelligence Technologies, which includes signalsintelligence, communications intelligence, data collection, processing anddissemination equipment, and unmanned vehicles and mission and flightrecorders; and Tactical Systems, which includes battle management tacticalcomputer systems, peripherals, electronic test, and diagnostics and vehicleelectronics.

The RSTA Segment develops and produces electro-opticalsighting, targeting and weapon sensor systems, aircraft weapons alignmentsystems and image intensification (I2 )night vision, combat identification and laser aimers/illuminator products, andprovides electronic manufacturing services.

The SS Segment designs, engineers and manufacturesintegrated military electronics equipment transporters, environmental controlsystems, fuel and water distribution systems, power generators and powersupplies primarily for the U.S. Department of Defense and allied militaryforces.

The TS Segment provides engineering services,logistics and training services, advanced technology services, asset protectionsystems and services, telecommunication systems integration and informationtechnology services, and vehicle armor kits for military, humanitarian,disaster recovery and emergency responder applications.

On April 1, 2006, DRSTechnical Services, Inc. (TSI), an operating unit of the C4I Segment, wasconsolidated into an operating unit of the TS Segment to achieve certainoperating synergies. For the 

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three-and nine-month periods ended December 31, 2005 the operating unit recorded$3.7 million and $14.0 million in revenues, respectively, and $0.3 million and$0.7 million in operating income, respectively, and had $9.3 million ofassets at December 31, 2005, which was considered immaterial for purposesof restating prior year goodwill balances and segment information for the C4ISegment and the TS Segment.

**Defense IndustryConsiderations and Business Strategy**

The substantial majority of our revenue is generatedpursuant to written contractual arrangements to design, develop, manufactureand/or modify complex products and to provide related engineering, technicaland other services according to the specifications of the buyers (customers).Our primary “end-use” customer is the DoD. Our other customers include certain U.S.government intelligence agencies, foreign governments, commercial customers andother U.S. federal, state and local government agencies.

We believe markets for defense and related advancedtechnology systems and services for fiscal 2007 and beyond will continue to beaffected by the global war on terrorism, through the continued need formilitary missions and efforts in Iraq and Afghanistan. The war on terrorism hasfocused greater attention on homeland security and better communication andinterplay among local, state and federal government agencies and U.S. militaryservices. We believe the United States’ overall defense posture continues tomove toward a more joint-capabilities-based structure, which creates theability for a more flexible response with greater force mobility, strongerspace capabilities, enhanced missile defense, and improved information systemscapability and security.

We believe DoD budgets continue to experienceincreased focus on command, control, communications, computers, intelligence,surveillance and reconnaissance (C4ISR), precision guided weapons, unmannedaerial vehicles (UAVs), network-centric communications, Special OperationsForces (SOF) and missile defense. In addition, we believe the DoD philosophyhas focused on a transformation strategy that balances modernization andrecapitalization (or upgrading existing platforms), while enhancing readinessand joint operations. As a result, we believe defense budget programallocations continue to favor advanced information technologies related tocommand, control, communications, and computers (C4), and Intelligence,Surveillance and Reconnaissance (ISR). Furthermore, the DoD’s emphasis onsystem interoperability, force multipliers and providing battlefield commanderswith real-time data is increasing the electronic content of nearly all majormilitary 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 plan to continue to align our researchand development, manufacturing and new business efforts to complement ourcustomers’ requirements and to provide state-of-the-art products and services.We plan to maintain a diversified and broad business mix with limited relianceon any single program. We also intend to expand our technical services andsupport offerings to the DoD, thus diversifying our business beyond thehistorical investment accounts and into Operations and Maintenance fundedactivities.

A significant component ofour strategy has been to enhance our existing product base through selectiveacquisitions that add new products and technologies in areas that complementour present business base. We intend to continue acquiring select publicly and privatelyheld companies, as well as defense businesses of larger companies that (i) exhibitsignificant market position(s) in their business areas, (ii) offerproducts that complement and/or expand our product offerings, and (iii) displaygrowing revenues and positive operating income and cash flow prospects.

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**Other BusinessConsiderations**

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. We believe we have adequatelegal defenses for each of the actions and claims, and we believe that theirultimate disposition will not have a material adverse effect on ourconsolidated financial position, results of operations or liquidity. It ispossible, however, that the ultimate resolution of those matters could resultin a material adverse effect on our results of operations and/or cash flows fromoperating activities for a particular reporting period. (see Part II.Other Information, Item 1. Legal Proceedings).

Our sales to international customers involveadditional risks, such as exposure to currency fluctuations and changes inforeign economic and political environments. International transactionsfrequently involve increased financial and legal risks arising from stringentcontractual terms and conditions, and widely differing legal systems, customsand practices in foreign countries. We expect that international sales, as apercentage of our overall sales, may increase in future years as a result of,among other factors, our growth strategy and continuing changes in the defenseindustry.

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

**Critical AccountingPolicies**

Our consolidated financial statements and accompanyingnotes are prepared in accordance with accounting principles generally acceptedin the United States of America. Preparing consolidated financial statementsrequires us to make estimates and assumptions that affect the reported amountsof assets, liabilities, revenues and expenses, and disclosures of contingentassets and liabilities. These estimates and assumptions are affected by theapplication of our accounting policies. Our significant accounting policies aredescribed in Note 1 to the Consolidated Financial Statements included in our March 31,2006 Annual Report on Form 10-K. Except for the change in ouraccounting for share-based payments described below, there were no significantchanges in the Company’s critical accounting policies during the nine monthsended December 31, 2006. Critical accounting policies are those thatrequire application of management’s most difficult, subjective or complexjudgments, often as a result of the need to make estimates about the effects ofmatters that are inherently uncertain and may change in subsequent periods.Critical accounting policies for us include revenue recognition on contractsand contract estimates, valuation of goodwill and acquired intangible assets,pension plan and postretirement benefit plan obligations, accounting for incometaxes, share-based payments and other management estimates.

*Share-Based Compensation—**As*of April 1,2006 we adopted the provisions of Statement of Financial Accounting Standards No. 123(revised 2004), “Share-Based Payment” (SFAS 123R), as interpreted by SEC StaffAccounting Bulletin No. 107, which requires that the cost resulting fromall share-based 

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paymenttransactions be recognized in the financial statements at their fair values. Weadopted SFAS 123R using the modified prospective application method under whichthe provisions of SFAS 123R apply to new awards and to awards modified,repurchased, or cancelled after the adoption date. Under the fair valuerecognition provisions of this statement, share-based compensation cost ismeasured at the grant date based on the value of the award and is recognized asexpense over the vesting period. Determining the fair value of share-basedawards at the grant date requires judgment, including estimating our stockprice volatility and employee stock option exercise behaviors. Our expectedvolatility is based upon the historical volatility of our stock. The expectedlife of share-based awards is based on observed historical exercise patternsfor different groups of employees and directors. As share-based compensationexpense recognized in the consolidated statement of earnings is based on awardsultimately expected to vest, the amount of expense has been reduced forestimated forfeitures. SFAS 123R requires forfeitures to be estimated at thetime of grant and revised, if necessary, in subsequent periods if actualforfeitures differ from those estimates. Forfeitures are estimated based onhistorical experience.

**Results ofOperations**

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

| ** **                               | ** ** | **Three Months Ended  December 31,**   | ** ** | ** ** | ** ** | **Nine Months Ended  December 31,** | ** ** | ** ** | ** ** |
|------------------------------------------|------------|-------------------------------------------------------|------------|------------|------------|----------------------------------------------------|------------|------------|------------|
| ** **                               | ** ** | ** **                                            | ** ** | ** ** | ** ** | **Percent**                                        | ** ** | ** ** | ** ** | ** ** | ** ** | **Percent** | ** ** |
| ** **                               | ** ** | **2006**                                              | ** ** | **2005**   | ** ** | **Change**                                         | ** ** | **2006**   | ** ** | **2005** | ** ** | **Change** | ** ** |
| ** **                               | ** ** | **(in thousands, except percentages)** | ** ** |
| **Key performance metrics**              | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** **                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                                 |       | $                                                     | 680,361    |       | $          | 389,490                                            |       | 74.7%      |       | $ | 2,022,164 |   | $ | 1,089,879 |   | 85.5% |   |
| Operating income                         |       | $                                                     | 76,627     |       | $          | 44,827                                             |       | 70.9%      |       | $ | 213,500 |   | $ | 118,462 |   | 80.2% |   |
| Bookings                                 |       | $                                                     | 1,102,874  |       | $          | 304,151                                            |       | 262.6%     |       | $ | 2,800,243 |   | $ | 1,422,620 |   | 96.8% |   |
| **Other  significant financial metrics** | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** **                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest and  related expenses           |       | $                                                     | 30,268     |       | $          | 12,458                                             |       | 143.0%     |       | $ | 90,789 |   | $ | 36,959 |   | 145.6% |   |
| Income taxes                             |       | $                                                     | 11,575     |       | $          | 14,297                                             |       | (19.0%     | )          | $ | 40,906 |   | $ | 33,010 |   | 23.9% |   |
| **Significant  liquidity metrics (A)**   | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** **                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Free cash flow                           |       | $                                                     | 18,430     |       | $          | 14,408                                             |       | 27.9%      |       | $ | 23,541 |   | $ | 33,143 |   | (29.0% | ) |
| EBITDA                                   |       | $                                                     | 95,326     |       | $          | 54,994                                             |       | 73.3%      |       | $ | 269,532 |   | $ | 148,176 |   | 81.9% |   |

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

*Three- and Nine-Month Periods Ended December 31,2006, Compared with the Three- and Nine-Month Periods Ended December 31,2005*

**Revenuesand operating income****  **Consolidatedrevenues and operating income for the three-month period ended December 31,2006 increased $290.9 million and $31.8 million, respectively, to $680.4million 

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and $76.6 million,respectively, as compared with the corresponding period in the prior year. Theprimary driver of increased revenues was our acquisition of ESSI whichcontributed incremental (current quarter over corresponding prior year quarter)revenues of $241.9 million. Also contributing to the increase in revenuesin comparison to the same period in the prior year were increased shipments ofuncooled thermal weapons sights, ground-based target acquisition and missile control subsystems, visionenhancement equipment for ground-based vehicles, thermal imaging systems andchassis modernization kits. Partially offsetting the overall increase inrevenues were lower volume from airborne electro-optical sighting systemsproducts and services, and decreased shipments of airborne training pods,combat display workstations, formation flying avionics and lower revenues fromcommercial nuclear control cabinets.

The growth in operating income in the third quarter offiscal 2006, as compared with the corresponding prior year period, was dueprimarily to our acquisition of ESSI which contributed incremental operatingincome of $28.3 million, the overall increase in revenues, and strong marginsfrom our power systems business. Partially offsetting the overall increase inoperating income for the three months ended December 31, 2006, were overalllower margins from our intelligence business and lower margins on certainrugged computer systems. See Operating Segments discussion below for additionalinformation.

Consolidated revenues and operating income for thenine-month period ended December 31, 2006 increased $932.3 million and$95.0 million, respectively, to $2.0 billion and $213.5 million, respectively,as compared with the corresponding period in the prior year. The primary driverof the overall increase in revenues, as compared to the same period in theprior year was our acquisition of ESSI and our June 27, 2005 acquisitionof WalkAbout, which together contributed incremental (current year to date overcorresponding prior year to date) revenues of $772.8 million.  Also contributing to the increase in revenueswere increased shipments of target acquisition and missile control subsystems,uncooled thermal weapons sights, chassis modernization kits, higher engineeringand development revenue from a naval infrared search and track program andgreater shipments of thermal imaging systems. Partially offsetting the overallincrease in revenues were lower volume from airborne electro-optical sightingsystems products and services, decreased shipments of combat displayworkstations and the cancellation of a test range support program. Also we haddecreased shipments of secure voice systems and mission recorders.

The growth in operating income for the nine monthsended December 31, 2006, as compared with the corresponding prior yearperiod, was due primarily to the overall increase in revenues from ouracquisition of ESSI which contributed incremental operating income of $77.5million, higher revenues in our RSTA Segment and strong margins from our powersystems business. Partially offsetting the overall increase in operating incomefor the nine months ended December 31, 2006 were overall net lower marginsfrom our intelligence business and certain rugged computer systems. During the fiscal2007 period we also recorded $3.7 million of severance-related costs related tothe new organizational operating structure announced October 2, 2006. SeeOperating Segments discussion below for additional information.

As described in Note 4 to our unaudited ConsolidatedFinancial Statements, we adopted SFAS 123R effective April 1, 2006 usingthe modified prospective method. In the three- and nine-month periods endedDecember 31, 2006, we recorded total share-based costs related to stockoptions and nonvested stock of $2.8 million and $8.9 million, respectively, $2.7 millionand $8.2 million, respectively, which was charged to operating income.At  December 31, 2006, there was$9.5 million of unrecognized compensation costs related to stock options, whichis expected to be recognized over a weighted average remaining period of 2.3years. As of December 31, 2006, total unrecognized compensation costsrelated to non-vested stock awards was $13.4 million which is expected to berecognized over a weighted average remaining period of 2.2 years.

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As a result of applying SFAS 123R, our earnings beforeincome taxes for the three-and-nine month periods ended December 31, 2006were $1.2 million and $5.0 million lower, respectively, and net earnings duringthe same periods were $0.7 million lower and $3.0 million lower, respectively,than if we had continued to account for share-based compensation underAccounting Principles Bulletin (APB) No. 25.

Basic earnings per share for the three- and nine-monthperiods ended December 31, 2006 would have been $0.90 per share and $2.13per share, respectively, and diluted earnings per share would have been $0.88and $2.08, respectively, if we had not adopted SFAS 123R. For the three-andnine-month periods ended December 31, 2006 we reported basic earnings pershare of $0.88 and $2.05, respectively, and diluted earnings per share of $0.86and $2.01, respectively.

**Bookings****  **We define bookings as the value ofcontract awards received from the U.S. government, for which the U.S.government has appropriated funds, plus the value of contract awards and ordersreceived from customers other than the U.S. government. Bookings for thethree-month period ended December 31, 2006 increased $798.7 million,versus the same period in the prior year, to $1.1 billion. The primary driverof the increase was our acquisition of ESSI which contributed incrementalbookings of $302.6 million, as well as strong bookings for ground-basedtarget acquisition and missile control subsystems and thermal imaging systemsin our RSTA Segment.

Bookings for the nine-month period ended December 31,2006 increased $1.38 billion, versus the same period in the prior year, to $2.8billion. The primary drivers of the increase was our ESSI acquisition whichcontributed incremental bookings of $969.7 million, and to strong bookingsfor ground-based target acquisition and missile control subsystems and thermalimaging systems in our RSTA Segment.

**Interestand related expenses****  **Interestand related expenses increased $17.8 million and $53.8 million for the three-and nine-month periods ended December 31, 2006, respectively, as comparedwith the same period in the prior year, to $30.3 million and $90.8 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, 2006, as compared with thecorresponding period in the prior year. In connection with our acquisition ofESSI our average borrowings increased due to our January 31, 2006 issuanceof $350 million of 65¤8%senior notes, $250 million issuance of 75¤8% seniorsubordinated notes, $300 million 2% senior convertible notes and the February 8,2006 exercise of an over-allotment option for an additional $45 million 2%senior convertible notes. In addition there was $70.0 million outstandingagainst our revolving line of credit at December 31, 2006 (see Liquidityand Capital Resources below). We had no borrowings outstanding under ourrevolving credit facility at December 31, 2005.

**Income taxes****  **The provision for income taxes forthe three- and nine-month periods ended December 31, 2006, reflected aneffective income tax rate of approximately 24.8% and 33.4%, respectively, ascompared with 42.0% and 38.5%, respectively, in the same periods last year. Oureffective tax rate was lower this period primarily due to recording a discretecumulative benefit for certain export sales that were identified as qualifyingtransactions pursuant to the Extraterritorial Income Exclusion, the reinstatementof the Research & Development Credit and the reduction in state taxexpense resulting from internal integration and operational realignment, aswell as other items of individual insignificance. Excluding any discrete itemsthat may be recognized in the fourth quarter, we anticipate that our effectiveincome tax rate for the year ending March 31, 2007, will approximate 35%,inclusive of discrete items incurred through December 31, 2006 and willapproximate 38.8% without taking into account discrete items.

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**Operating Segments**

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

| ** **       | ** ** | **Three Months Ended  December 31,**            | ** ** | **Three Months  Ended Percent  Changes** | ** ** | **Nine Months Ended  December 31,** | ** ** | **Nine Months  Ended Percent  Changes** | ** ** |
|------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **       | ** ** | **2006**                                                       | ** ** | **2005**                                           | ** ** | **2006 vs. 2005**                        | ** ** | **2006**                                          | ** ** | **2005** | ** ** | **2006 vs. 2005** | ** ** |
| ** **       | ** ** | **(in thousands, except for percentages)** | ** ** |
| **C4I**          | ** ** | ** **                                                     | ** ** | ** **                                         | ** ** |                                               | ** ** | ** **                                        |       | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |
| Revenues         |       | $                                                              | 268,053    |                                               | $          | 275,860                                            |       |                                              | (2.8       | )% |   | $ | 811,744 |   | $ | 795,840 |   |   | 2.0 | % |   |
| Operating income |       | $                                                              | 27,669     |                                               | $          | 31,101                                             |       |                                              | (11.0      | )% |   | $ | 88,072 |   | $ | 84,372 |   |   | 4.4 | % |   |
| Operating margin |       | 10.3                                                           | %          | 11.3                                               | %          |                                               | (8.4       | )%                                                |       | 10.8 | % | 10.6 | % |   | 2.3 | % |   |
| **RSTA**         | ** ** | ** **                                                     | ** ** | ** **                                         | ** ** |                                               | ** ** | ** **                                        |       | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |
| Revenues         |       | $                                                              | 166,786    |                                               | $          | 113,630                                            |       |                                              | 46.8       | % |   | $ | 430,150 |   | $ | 294,039 |   |   | 46.3 | % |   |
| Operating income |       | $                                                              | 20,588     |                                               | $          | 13,744                                             |       |                                              | 49.8       | % |   | $ | 46,412 |   | $ | 36,544 |   |   | 27.0 | % |   |
| Operating margin |       | 12.3                                                           | %          | 12.1                                               | %          |                                               | 1.7        | %                                                 |       | 10.8 | % | 12.4 | % |   | (12.9 | )% |   |
| **SS**           | ** ** | ** **                                                     | ** ** | ** **                                         | ** ** |                                               | ** ** | ** **                                        |       | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |
| Revenues         |       | $                                                              | 95,994     |                                               | N/A        |                                               |       | N/A                                               |       |   | $ | 280,327 |   | N/A |   |   | N/A |   |   |
| Operating income |       | $                                                              | 17,039     |                                               | N/A        |                                               |       | N/A                                               |       |   | $ | 41,654 |   | N/A |   |   | N/A |   |   |
| Operating margin |       | 17.8                                                           | %          | N/A                                                |       |                                               | N/A        |                                              |       | 14.9 | % | N/A |   |   | N/A |   |   |
| **TS**           | ** ** | ** **                                                     | ** ** | ** **                                         | ** ** |                                               | ** ** | ** **                                        |       | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |
| Revenues         |       | $                                                              | 149,528    |                                               | N/A        |                                               |       | N/A                                               |       |   | $ | 499,943 |   | N/A |   |   | N/A |   |   |
| Operating income |       | $                                                              | 11,390     |                                               | N/A        |                                               |       | N/A                                               |       |   | $ | 36,578 |   | N/A |   |   | N/A |   |   |
| Operating margin |       | 7.6                                                            | %          | N/A                                                |       |                                               | N/A        |                                              |       | 7.3 | % | N/A |   |   | N/A |   |   |
| **Other**        | ** ** | ** **                                                     | ** ** | ** **                                         | ** ** |                                               | ** ** | ** **                                        |       | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |
| Operating loss   |       | $                                                              | (59        | )                                                  | $          | (18                                                | )          |                                              | (227.8     | )% |   | $ | 784 |   | $ | (2,454 | ) |   | 131.9 | % |   |

 

***Three-Month PeriodEnded December 31, 2006, Compared with the Three-Month Period Ended December 31,2005***

**C4ISegment**   Revenues decreased $7.8 million, or2.8%, to $268.1 million for the three-month period ended December 31,2006, as compared with the corresponding prior-year period. Operating incomedecreased $3.4 million, or 11.0%, to $27.7 million. The decrease in revenue wasprincipally attributable to decreased shipments of airborne training pods,combat display workstations, formation flying avionics and lower revenues fromcommercial nuclear control cabinets, the cancellation of a test range supportprogram and the April 1, 2006, transfer of the TSI operating unit to theTS Segment as described in Note 6 to our unaudited consolidated financialstatements included herein. Partially offsetting the lower revenue wereincreased shipments of chassis modernization kits, surface search radars,reactor monitoring equipment and power conversion equipment and higherengineering and development revenue from a naval infrared search and trackprogram.

The decrease in operating income for the three-monthsended December 31, 2006, as compared to the corresponding period in theprior year, were due to lower margins at certain of our intelligence businessesand certain rugged computer systems shipped under a new contract with unitprices lower than the previous contract. Partially offsetting our overall loweroperating income was improved margins from our power systems business.

**RSTASegment****  **Revenuesincreased $53.2 million, or 46.8%, to $166.8 million for the three-month periodended December 31, 2006, as compared with the corresponding prior-yearperiod. Operating 

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income increased $6.8million, or 49.8%, to $20.6 million. The increase in revenues was primarilyattributable to increased shipments of uncooled thermal weapons sights,ground-based target acquisition and missile control subsystems, visionenhancement equipment for ground-based vehicles, and thermal imaging systems. Partiallyoffsetting the overall increase in revenues were lower volume from airborneelectro-optical sighting systems products and services and laser aimers andilluminator products.

The increase in operating income for the three-monthperiod ended December 31, 2006, as compared with the corresponding periodin the prior year was largely due to higher overall revenues.

**SSSegment****  **TheSS Segment, which consists of operating units acquired from our acquisition ofESSI on January 31, 2006, recorded revenues of $96.0 million and operatingincome of $17.0 million. The primary revenue and operating income driversduring the period were demand for a heavy equipment transport refurbishmentprogram for the U.S. Army, and increased shipments of tactical quiet generatorsets and battlefield digital command, control and communication systems.

**TSSegment****  **TheTS Segment, which consists substantially of operating units acquired from ouracquisition of ESSI on January 31, 2006, recorded revenues of $149.5million and operating income of $11.4 million. The primary revenue andoperating income drivers in the segment were demand for equipment and servicesprovided under the Rapid Response (R2) program, defense satellite transmissionservices, mobile power generation and distribution equipment for the U.S. AirForce and tactical force and equipment security systems for the U.S. Army.Typical margins on contracts within this segment are from 5% to 8%.

**Other****  **The operating loss in Other consists of certainnon-allocable general and administrative expenses at DRS corporate.

***Nine-Month PeriodEnded December 31, 2006, Compared with the Nine-Month Period Ended December 31,2005***

**C4ISegment****  **Revenuesincreased $15.9 million, or 2.0%, to $811.7 million for the nine-month periodended December 31, 2006, as compared with the corresponding prior-yearperiod. Operating income increased $3.7 million, or 4.4%, to $88.1 million. Theincrease in revenue was largely attributable to increased shipments of chassismodernization kits, higher engineering and development revenue from a navalinfrared search and track program, increased shipments of reactor monitoringequipment and power conversion equipment, as well as higher revenues fromunmanned aerial vehicles, a cable assembly, cleaning and refurbishment programsand the April 1, 2006, transfer of the TSI operating unit to the TSSegment as described in Note 6 to our unaudited consolidated financialstatements included herein. Our June 27, 2005 acquisition of WalkAboutcontributed incremental revenues of $5.3 million to the nine-month period endedDecember 31, 2006. Partially offsetting the overall increase in revenueswere decreased shipments of combat display workstations, the cancellation of atest range support program, lower volume from secure voice systems, missionrecorders and rugged computer systems.

The increase in operating income for the nine-monthperiod ended December 31, 2006, as compared to the corresponding period inthe prior year, was driven primarily by improved margins in our Power Systemsbusiness, offset, in part, by lower margins from C4I’s intelligence businessand on certain rugged computer systems under a new contract.

**RSTASegment****  **Revenuesincreased $136.1 million, or 46.3%, to $430.2 million for the nine-month periodended December 31, 2006, as compared with the corresponding prior-yearperiod. Operating income increased $9.9 million, or 27.0%, to $46.4 million. Theincrease in revenues was primarily attributable to increased shipments ofground-based target acquisition and missile control subsystems, uncooledthermal weapons sights, thermal imaging systems, vision enhancement equipmentfor ground-based vehicles, and subsystems for a long-range surveillance system.Partially offsetting the overall increase 

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in revenues were lowervolume from airborne electro-optical sighting systems products and services,and laser aimers and illuminators.

The increase in operating income for the nine-monthperiod ended December 31, 2006, as compared with the corresponding periodin the prior year was largely due to higher overall revenues, offset in part bylow margins on a thermal weapon site program that is in the beginning of itsproduct life cycle and $2.0 million in severance-related costs related to thenew organizational operating structure announced October 2, 2006.

**SSSegment****  **TheSS Segment, recorded revenues of $280.3 million and operating income of$41.7 million. The primary revenue and operating income drivers were demandfor a heavy equipment transport refurbishment program for the U.S. Army, and anincrease in shipments of tactical quiet generator sets and battlefield digitalcommand control and communication systems. Operating income for the nine monthsended December 31, 2006, was unfavorably impacted by $1.2 million inseverance-related costs related to the new organizational operating structureannounced October 2, 2006.

**TSSegment****  **TheTS Segment, recorded revenues of $499.9 million and operating income of $36.6 million.The primary revenue and operating income drivers in the segment were demand forequipment and services provided under the Rapid Response (R2) program, defensesatellite transmission services, add-on commercial vehicle armor kits andmobile power generation and distribution equipment for the U.S. Air Force. Operatingincome for the nine months ended December 31, 2006, was unfavorablyimpacted by $0.5 million in severance-related costs related to the neworganizational operating structure announced October 2, 2006. Typicalmargins on contracts within this segment are from 5% to 8%.

**Other****  **During the nine months ended December 31,2006, we realized a $1.3 million gain on the collection of a note receivablethat had previously been partially reserved, partially offset by certain non-allocable general andadministrative expenses at DRS corporate. The $2.5 millionoperating loss in Other in the nine-month period ended December 31, 2005was driven primarily by a $2.0 million accrual recorded in the period inconnection with a litigation reserve.

**Liquidity and Capital Resources**

| ** **                                           | ** ** | **Nine Months Ended December 31,**                                                                           | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **          2006          ** | ** ** | **          2005          ** | ** ** |
| ** **                                           | ** ** | **(in thousands)**                                                                                                          | ** ** |
| Net cash provided  by operating activities           |       |                                                                                                                             | $          | 61,654 |   |   |   | $ | 59,454 |   |   |
| Net cash used in  investing activities               |       |                                                                                                                             | $          | (47,466 | ) |   |   | $ | (79,832 | ) |   |
| Net cash provided by  (used in) financing activities |       |                                                                                                                             | $          | 34,437 |   |   |   | $ | (27,462 | ) |   |

 

**Operatingactivities****  **Duringthe nine months ended December 31, 2006, we generated $61.7 million ofoperating cash flow, $2.2 million more than the $59.5 million of operating cashflow generated in the same period in the prior year. Net earnings increased$28.9 million to $81.6 million. Non-cash adjustments to reconcile net earningsto cash flows from operating activities increased $37.3 million over thecorresponding prior fiscal period, driven primarily by increased depreciationof fixed assets and amortization of intangible assets related to ouracquisition of ESSI, increased share-based compensation due to the applicationof SFAS 123R and a decrease in net deferred tax assets.

Changesin assets and liabilities, net of effects from business combinations, used $93.5 millionin cash for the nine months ended December 31, 2006. Accounts payableprovided $3.3 million of cash during the period. Accounts receivable used$69.5 million of cash as net billings exceeded collections. Inventoriesused $44.3 million of cash as inventories increased in certain of ourelectro-optical infrared sighting and targeting businesses, offset, in part, bydecreased inventories within certain tactical computing businesses. Accruedexpenses and other current liabilities used $6.8 million of cash. A netreduction in certain contract 

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related reserves were offset by increases in incometaxes payable, as income tax expense exceeded related payments, and in certaincompensation and warranty related accruals. Customer advances increased and netprepaid expenses and other current assets decreased generating$7.6 million and $13.9 million in cash, respectively. The $13.9 millionin cash generated by the decrease in net prepaid expenses and other currentassets resulted primarily from the collection of $30.6 million in ESSI incometax refunds, partially offset by $13.7 million of vendor advances.

**Investing activities****  **We paid $38.1 million for capitalimprovements during the nine months ended December 31, 2006, as comparedwith $26.3 million in the corresponding prior-year period. We expect ourcapital expenditures to be in the range of $50.0 million to $60.0 million infiscal 2007, as we continue to upgrade our facilities and integrate recentacquisitions into our existing businesses. Payments pursuant to businesscombinations totaled $9.8 million driven by $7.1 million and $1.2 million ofadditional consideration paid to satisfy earn-out obligations related to ouracquisitions of DKD, Inc. (now operating as a component of DRS Sensors &Targeting Systems, Inc.) and Codem System, Inc. (now operating as DRSCodem Systems, Inc.), respectively, and $1.5 million in ESSI acquisition-relatedpayments*.*

**Financing activities****  **For the nine months ended December 31,2006, financing activities generated $34.4 million in cash. We alsoreceived $10.8 million from the exercise of stock options and relatedexcess tax benefits and paid $3.6 million in cash dividends. We also madescheduled repayments under various long-term debt arrangements of$3.4 million during the first nine months of fiscal 2007. 

Simultaneously with the closing of our acquisition ofESSI, on January 31, 2006 we entered into an amended and restated creditfacility for up to an aggregate amount of $675.0 million with a syndicate oflenders (the Credit Facility), replacing our previously existing creditfacility. The Credit Facility consists of a $400.0 million senior securedrevolving line of credit and a $275.0 million senior secured term loan. Netborrowings on our revolving line of credit under our credit facility during thenine months ended December 31, 2006, were $30.0 million. We are permitted,on no more than two occasions, to increase the aggregate amount of the CreditFacility by up to $250.0 million, subject to certain restrictions. Any increasein the aggregate amount of the Credit Facility may be borrowed in the form ofeither additional term loans or available amounts under the revolving line ofcredit. The Credit Facility is guaranteed by substantially all of DRS’sdomestic subsidiaries. In addition, it is collateralized by liens onsubstantially all of the assets of our subsidiary guarantors’ and certain ofDRS’s other subsidiaries’ assets and by a pledge of a portion of certain of ournon-guarantor subsidiaries’ capital stock.

Fromtime to time, we enter into standby letters-of-credit and bank guaranteeagreements with financial institutions and customers, primarily relating to theguarantee of our future performance on certain contracts to provide productsand services and to secure advance payments we have received from ourcustomers. As of December 31, 2006, $45.2 million was contingently payableunder letters of credit and bank guarantees. Of this amount, approximately $0.9million and $0.4 million in letters of credit and bank guarantees,respectively, as of December 31, 2006, were issued under a previous creditagreement and by a bank agreement for our U.K. subsidiary, respectively, andare not considered when determining the availability under our revolving lineof credit. At December 31, 2006 approximately $43.0 million and $0.4million in letters of credit and bank guarantees, respectively, are due withinone year. At December 31, 2006, we had $286.1 million of availabilityunder our revolving line of credit.

On March 29,2006, DRS Technologies Canada Company (DRS Canada) established a five-yearsenior secured term loan for approximately $9.9 million (C$11.5 million),maturing on April 1, 2011. The proceeds of the loan were utilized topermit repatriation of certain amounts from Canada to the U.S. which weresubject to more favorable tax treatment under the Jobs Act. The debt iscollateralized by the assets of DRS Canada and guaranteed by DRS Technologies, Inc.We are subject to the same financial covenants under the DRS Canada loan, as weare under the Credit Facility, and DRS Canada is subject to other non-financialcovenants that are similar to those described for the Credit Facility.

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

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

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

The January 2006 Notes are unsecured. The 75¤8%senior subordinated notes rank behind the Credit Facility, the 65¤8% seniornotes, the Convertible Notes and trade payables and is pari passu with the 67¤8%senior subordinated notes. The January 2006 Notes were issued underindentures with The Bank of New York. Subject to a number of exceptions, theindentures restrict our ability and the ability of our subsidiaries to incurmore debt, pay dividends and make distributions, make certain investments,repurchase stock, create liens, enter into transactions with affiliates, enterinto sale lease-back transactions, merge or consolidate, and transfer or sellassets. The January 2006 Notes are unconditionally guaranteed, jointly andseverally, by certain of our existing and future domestic subsidiaries.

Accrued interest expense at December 31, 2006 andMarch 31, 2006 was approximately $28.9 million and$27.3 million, respectively.

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

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our control. There can beno assurance that sufficient funds will be available to enable us to serviceour indebtedness, make necessary capital expenditures or to make discretionaryinvestments.

**Equity****  **On November 2, 2006, the Boardof Directors declared a $0.03 per common share cash dividend, payable on December 29,2006 to stockholders of record as of December 15, 2006. On February 8,2007,  the Board of Directors declared a$0.03 per common share cash dividend, payable on March 30, 2007 tostockholders of record as of March 15, 2007.

**FreeCash Flow****  **Freecash flow represents net cash provided by operating activities less capitalexpenditures. Free cash flow for the three-month period ended December 31,2006 was $18.4 million or $4.0 million more than $14.4 million in thecorresponding period in the prior year. Free cash flow for the nine-monthperiod ended December 31, 2006 was $23.5 million or $9.6 million less than$33.1 million in the corresponding period in the prior year. See ‘‘Use ofNon-GAAP Financial Measures’’ below for additional discussion and information.

**EBITDA****  **Net earnings before net interest andrelated expenses (primarily the amortization and write-off of debt premium and issuancecosts), income taxes, depreciation and amortization (EBITDA) for thethree-month period ended December 31, 2006 was $95.3 million, or $40.3million greater than the $55.0 million in the corresponding period in the prioryear. EBITDA for the nine-month period ended December 31, 2006 was $269.5million, or $121.3 million greater than the $148.2 million in the correspondingperiod in the prior year. See ‘‘Use of Non-GAAP Financial Measures’’ below foradditional discussion and information.

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

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

**Backlog****  **Funded backlog represents productsor services that our customers have committed by contract to purchase from us.Due to the general nature of defense procurement and contracting, the operatingcycle for our military business typically has been long term. Military backlogcurrently consists of various production and engineering development contractswith varying delivery schedules and project timetables. Our backlog alsoincludes a significant amount of commercial off-the-shelf (COTS)-based systemsfor the military, which have shorter delivery times. Accordingly, revenues fora particular period, or year-to-year comparisons of reported revenues andrelated backlog positions may not be indicative of future results. Backlog at December 31,2006 was $3.14 billion, as compared with $2.40 billion at March 31, 2006.We booked $1.1 billion and $2.8 billion in new orders for the three- andnine-month periods ended December 31, 2006.

**InternalResearch and Development****  **In addition to customer-sponsored research anddevelopment, we also engage in internal research and development. Theseexpenditures reflect our continued investment in new technology anddiversification of our products. Expenditures for internal research anddevelopment for the three-month periods ended December 31, 2006 and 2005were $12.6 million and $12.1 million, respectively, and $37.9 million and $33.5million for the nine-month periods ended December 31, 2006 and 2005,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 

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GAAP in the Consolidated Balance Sheets, Statements ofEarnings, or Statements of Cash Flows of the Company. The components of EBITDAand a reconciliation of EBITDA and “free cash flow” with the most directlycomparable GAAP measure follows:

| ** **                                                                                     | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                                     | ** ** | **December 31,**            | ** ** | **December 31,**           | ** ** |
| ** **                                                                                     | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                                     | ** ** | **(in thousands)**          | ** ** |
| Net Earnings                                                                                   |       | $                                | 35,094     |                            | $          | 19,744 |   | $ | 81,583 |   | $ | 52,716 |   |
| Income taxes                                                                                   |       | 11,575                           |       | 14,297                          |       | 40,906 |   | 33,010 |   |
| Interest income                                                                                |       | (370                             | )          | (2,283                          | )          | (868 | ) | (6,228 | ) |
| Interest and  related expenses                                                                 |       | 30,268                           |       | 12,458                          |       | 90,789 |   | 36,959 |   |
| Depreciation and  amortization                                                                 |       | 18,759                           |       | 10,778                          |       | 57,122 |   | 31,719 |   |
| EBITDA (A)                                                                                     |       | 95,326                           |       | 54,994                          |       | 269,532 |   | 148,176 |   |
| Income taxes                                                                                   |       | (11,575                          | )          | (14,297                         | )          | (40,906 | ) | (33,010 | ) |
| Interest income                                                                                |       | 370                              |       | 2,283                           |       | 868 |   | 6,228 |   |
| Interest and  related expenses                                                                 |       | (30,268                          | )          | (12,458                         | )          | (90,789 | ) | (36,959 | ) |
| Deferred income  taxes                                                                         |       | (1,124                           | )          | (2                              | )          | 2,959 |   | (500 | ) |
| Changes in assets  and liabilities, net of effects from business combinations and divestitures |       | (27,549                          | )          | (7,409                          | )          | (93,466 | ) | (29,549 | ) |
| Other, net                                                                                     |       | 4,145                            |       | 1,354                           |       | 13,456 |   | 5,068 |   |
| Net cash provided by operating activities                                                      |       | 29,325                           |       | 24,465                          |       | 61,654 |   | 59,454 |   |
| Capital  expenditures                                                                          |       | (10,895                          | )          | (10,057                         | )          | (38,113 | ) | (26,311 | ) |
| Free cash flow  (B)                                                                            |       | $                                | 18,430     |                            | $          | 14,408 |   | $ | 23,541 |   | $ | 33,143 |   |

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(A)       We define EBITDA as netearnings before net interest and related expenses (principally amortization andwrite-off of debt premium and issuance costs), income taxes, depreciation andamortization. The table above presents the components of EBITDA and areconciliation of EBITDA to net cash provided by operating activities. EBITDAis presented as additional information because we believe it to be a usefulindicator of our debt capacity and our ability to service our debt. EBITDA isnot a substitute for operating income, net earnings or net cash flows fromoperating activities, as determined in accordance with GAAP. EBITDA is not acomplete net cash flow measure because EBITDA is a measure of liquidity thatdoes not include reductions for cash payments for an entity’s obligation toservice its debt, fund its working capital, business acquisitions, and capitalexpenditures and pay its income taxes. Rather, EBITDA is one potentialindicator of an entity’s ability to fund these cash requirements. EBITDA alsois not a complete measure of an entity’s profitability because it does notinclude costs and expenses for depreciation and amortization, interest andrelated expenses and income taxes. EBITDA, as we define it, may differ fromsimilarly named measures used by other entities and, consequently, could bemisleading unless all entities calculate and define EBITDA in the same manner.

(B)        Freecash flow is defined as net cash provided by operating activities less capitalexpenditures. We disclose free cash flow because we believe that it is usefulin evaluating our financial performance and measuring cash flows generated thatare available for investing and financing activities. We believe that the mostdirectly comparable GAAP financial measure to free cash flow is net cashprovided by operating activities. Free cash flow represents cash generatedafter paying for interest on borrowings, income taxes, capital expenditures andchanges in working capital, but before repaying outstanding debt and investingcash to acquire businesses and making other strategic investments. Thus, keyassumptions underlying free cash flow are that we will be able to refinance ourexisting debt when it matures with new debt and that we will be able to financeany new acquisitions we make by raising new debt or equity capital. We also usefree cash flow as a performance measure as a component of 

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our managementincentive compensation program. Free cash flow, as we define it, may differfrom similarly named measures used by other entities and, consequently, couldbe misleading unless all entities calculate and define free cash flow in thesame manner.

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

**Market Risk**

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

**Item 4.**                        Controlsand Procedures

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

**(b) Internal ControlOver Financial Reporting.****  **The addition of the business units added through the acquisitionof ESSI on January 31, 2006, resulted in a material change in internalcontrol over financial reporting. The acquired ESSI business units utilizeseparate information and accounting systems and processes. With the exceptionof the change in internal control over financial reporting as we integrate theacquired ESSI business units, there have not been any changes in the Company’sinternal control over financial reporting (as such term is defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act) during the three months ended December 31,2006 that have materially affected, or are reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

**PART II.   OTHERINFORMATION**

**Item 1.**                        LegalProceedings

Various legal actions, claims, assessments and othercontingencies arising out of previous business combinations and arising in thenormal course of our business, including certain matters described below, arepending against us and certain of our subsidiaries. These matters are subjectto many uncertainties, and it is possible that some of these matters could beultimately decided, resolved or settled adversely. We have recorded accrualstotaling $4.4 million and $4.3 million at December 31, 2006 and March 31,2006, respectively, for losses related to those matters that it considers to beprobable and that can be reasonably estimated (certain legal and environmentalmatters are discussed in detail below). Based our ongoing analysis of variousfactual, legal and equitable considerations we have recorded an accrual of$11.8 million against goodwill reflecting the probable income tax impactof information uncovered in our ongoing internal investigation of historicalESSI stock option practices. Although the ultimate amount of liability at December 31,2006 that may result from those matters for which we have recorded accruals isnot ascertainable, we believes that any amounts exceeding our recorded accrualsshould not materially affect our financial condition or liquidity. It ispossible, however, that the ultimate resolution of those matters could resultin a material adverse effect on our results of operations and/or cash flowsfrom operating activities for a particular reporting period.

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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 our acquisition of IDT, Tech-SymCorporation received a Section 104(e) Request for Information fromthe National Park Service (NPS), pursuant to CERCLA, regarding a site known asthe Orphan Mine site in the Grand Canyon National Park, Arizona, which is thesubject of an NPS investigation regarding the presence of residual radioactivematerials and contamination. A corporation of which Tech-Sym is an allegedsuccessor operated this uranium mine from 1956 to 1967. In 1962, the land wassold to the U.S. government and the alleged predecessor of Tech-Sym was given a25-year mining lease. In 1967, the mining rights were transferred to athird party by a trustee in bankruptcy, and we believe that the mine wasoperated by such third party until approximately 1969. We understand that thereare other companies in the chain of title to the mining rights subsequent toTech-Sym’s alleged predecessor, and, accordingly, that there are otherpotentially responsible parties (PRPs) for the environmental conditions at thesite, including the U.S. government as owner, operator and arranger at thesite. During its period of ownership, IDT retained a technical consultant inconnection with this matter, who conducted a limited, preliminary review ofsite conditions and communicated with the NPS regarding actions that may berequired at the site by all of the PRPs. On February 6, 2005, the NPS sentus an Engineering Evaluation/Cost Analysis Work Plan (the “NPS EE/CA”) underCERCLA (the ‘‘CERCLA Letter’’) with regards to Operable Unit 1 of the OrphanMine site. In our view, the NPS EE/CA included additional clean up not coveredby CERCLA. The CERCLA Letter also requested (a) payment of $0.5 millionfor costs 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, on September 29, 2005, the technicalconsultant submitted to the NPS, on behalf of us and the other PRP, analternative Engineering Evaluation/Cost Analysis Work Plan (the “alternativeEE/CA”) with regards to Operating Units 1 and 2 of the Orphan Mine site.

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

In connection with our acquisition of EngineeredSupport Systems, Inc. (“ESSI”) in January 2006, we have been madeaware of certain legal actions, claims, assessments and other contingencies,certain of which are described below.

In December 2004, ESSI was notified by theEnforcement Division of the SEC of the issuance of a formal order directing aprivate investigation captioned *In the Matter ofEngineered Support Systems, Inc.* and was notified that the SEChad issued subpoenas to various individuals associated with ESSI to producecertain documents. The SEC staff also requested that ESSI produce certain documentsin 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 

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2003 involving insurancepolicies placed by ESSI through an insurance brokerage firm in which an ESSIdirector was a principal at the time of the transactions.

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

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

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

In May 2006, we were advised that the EnforcementDivision of the SEC and the U.S. Attorney’s office had each expanded itsinvestigation to include possible “backdating” of the timing of option grantsat ESSI prior to the time ESSI was acquired by DRS. As a part of itsinvestigation, the SEC issued subpoenas to certain officers and employees ofESSI to provide testimony and produce certain documents. In February 2007,the SEC filed civil injunctive actions in the United States District Court forthe Eastern District of Missouri, Eastern Division alleging that ESSI’s formerChief Financial Officer and former controller participated in a backdatingscheme.  The SEC reported that the formercontroller had settled this action by consenting to disgorgement, financialpenalties, an officer and director bar and a permanent suspension frompracticing before the SEC as an accountant. Although ESSI continues to be asubject of the U.S. Attorney’s office’s investigation, the U.S. Attorney’soffice has advised us that ESSI is not a target. Because the events beinginvestigated occurred prior to the time of our acquisition of ESSI, the U.S.Attorney’s office has further advised us that it considers DRS to be a witness,not a subject or target of its investigation.

We are committed to full cooperation with regard to theforegoing investigations. We are unable to determine at this time either thetiming of the SEC or U.S. Attorney’s office investigations or the impact, ifany, the investigations could have on us.

In September 2006, ESSI was advised that theInternal Revenue Service was commencing an audit of its Federal tax return forthe fiscal year ended October 31, 2004. In January 2007, ESSI wasadvised that the Internal Revenue Service had expanded its audit to include ESSI’sFederal tax returns for the tax periods ended October 31, 2005 andJanuary 31, 2006. In connection with these audits, ESSI has receivedseveral information document requests (“IDRs”) asking for specific informationrelating to stock option deductions provided therein. We are cooperating withthis process.

We have recorded an accrual against goodwill toreflect the likely disallowance of certain compensation deductions taken onseveral of ESSI’s previous State and Federal income tax returns. 

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Principally, thisadjustment was made to account for Internal Revenue Code Section 162(m) and itslimitations on the deductibility of certain non-performance based compensation.

In July 2006, DRS and one of our subsidiaries, DRSTraining and Control Systems, Inc. (“TCS”) were each issued a subpoena by theUnited States District Court for the Northern District of Florida (“FloridaDistrict Court”). The subpoenas were issued in connection with an inquiry beingconducted by the Antitrust Division of the U.S. Department of Justice (“DOJ”)and require TCS to produce certain documents related to an investigation webelieve involves allegations of anticompetitive activity in certaininternational markets. In addition, certain employees and officers of TCS wereserved with subpoenas to testify before the grand jury of the Florida DistrictCourt with regard to this matter. The DOJ is continuing its investigation, butwe have no information as to when the DOJ will conclude this process. We havecooperated with the DOJ in producing documents in response to the subpoenas. Wehave commenced an internal investigation regarding this matter, which we expectto continue through the conclusion of the DOJ’s investigatory process.

**Item 1.A.**             RiskFactors

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

**Items 2, 3, 4 and 5are not applicable and have been omitted**

**Item 6.**                        Exhibits

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

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*                    Filed herewith

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|                              |     | DRS TECHNOLOGIES, INC.    |
|------------------------------|----------|---------------------------|
| Date: February 9,  2007 |     | /s/ RICHARD A. SCHNEIDER  |
|                         |     | Richard A. Schneider      |
| * *                     | * * | *Chief Financial Officer* |

 

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